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Law360 (August 19, 2020, 5:24 PM EDT) -- The United States Oil Fund, a popular exchange-traded fund that tracks oil prices, disclosed Wednesday that the U.S. Securities and Exchange Commission is considering an enforcement action related to huge losses the fund sustained when the price of oil plummeted in April.
In a regulatory filing, the oil-tied ETF said it had received a Wells notice from the SEC regarding USO's disclosures in late April and early May, after U.S. oil prices plunged into negative territory for the first time ever as the nation's oil storage capacity neared its limit due to a historic coronavirus-induced demand slump.
USO said only that the disclosures being investigated regarded "constraints imposed on USO's ability to invest in Oil Futures Contracts," and that the SEC's staff has recommended that the agency file an enforcement action against the fund, its sponsor and sponsor CEO John Love.
The fund noted that Wells notices are not formal charges of wrongdoing and that USO, its sponsor and Love "maintain that USO's disclosures and their actions were appropriate."
"They intend to vigorously contest the allegations made by the SEC staff in the Wells notice and expect to engage in a dialogue with the SEC staff regarding this matter," the filing said.
The SEC declined to comment Wednesday.
A Wells notice is a letter from SEC staff stating that the agency plans to seek authorization to bring a civil action over violations of securities laws. The process also offers the company a chance to explain why enforcement action should not be taken.
Founded in 2006 by sponsor United States Commodity Fund LLC, USO is an ETF that gives retail investors exposure to the oil market by using near-term futures contracts to track the price of West Texas Intermediate light sweet crude oil, which declined a record 306% on April 20 to –$36.98 per barrel.
Attributed to a worldwide collapse in oil demand due to the COVID-19 pandemic and a lack of storage for crude oil, the crash led to huge losses for USO, which used an investment strategy by which it automatically sells its front-month futures contracts and buys up the following month's if the latter has a higher contract price.
The strategy forced USO to replace its futures contracts with more expensive ones as oil prices crashed, leading the fund to state in late April that it may no longer be able to reflect the spot prices of oil and would reshuffle its funds to futures contracts with later expiration dates. On April 21, the fund said it had issued all of its remaining shares and announced a one-for-eight reverse stock split the following day.
The reverse split dramatically reduced USO's number of outstanding shares while increasing their price, which had fallen about 30% between April 20 and April 22.
Since June, USO investors have targeted the fund, its sponsor and Love with three securities fraud suits in New York federal court, alleging that they'd been misled about the risks USO and its investment strategy faced from "exceptional threats" like an oil price war between Russia and Saudi Arabia.
The plaintiff investors have alleged that USO belatedly disclosed those threats and their impacts in April and May, after the fund had already lost billions of dollars and was forced to transform its investment strategy.
Berger Montague PC and Faruqi & Faruqi LLP each filed motions this week to consolidate and lead those securities suits.
--Additional reporting by Tom Zanki. Editing by Alyssa Miller.
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