By Dean Seal

Law360 (August 21, 2020, 5:05 PM EDT) -- Days after disclosing that a U.S. Securities and Exchange Commission suit could be coming its way, the United States Oil Fund revealed Friday that the government's commodities regulator is also considering an enforcement action over the popular fund's disclosures surrounding April's oil price crash.

USO, a popular exchange-traded fund that tracks oil prices, said in a regulatory filing that it received a Wells notice from the U.S. Commodity Futures Trading Commission on Aug. 19 informing it that agency staff had recommended an action against the fund, its sponsor and sponsor CEO John Love.

The notice came two days after the SEC sent a similar Wells notice to USO regarding its 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.

Friday's filing doesn't go into detail on the contents of the CFTC's Wells notice but addresses it in a section that also details the putative securities class actions and derivative suit USO is facing over its actions surrounding the April price collapse that caused USO to suffer heavy losses.

The fund noted that Wells notices are not formal charges of wrongdoing and said, as it did in response to the SEC's Wells notice, 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 CFTC staff in the Wells notice and expect to engage in a dialogue with the CFTC staff regarding this matter," according to Friday's regulatory filing.

The CFTC declined to comment when reached Friday.

A Wells notice is a letter from a regulator's staff stating the agency has investigated a company and plans to seek authorization to bring a civil action over a possible violation of the law. In this case, the CFTC said it may allege violations of the Commodity Exchange Act and other regulations under its purview. 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 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.

On Aug. 10, another shareholder filed derivative claims against USO's top brass for allegedly failing to act in good faith in connection with a March stock offering and failing to acknowledge the consequences of extraordinary market conditions, like the Russia-Saudi Arabia oil price war and the COVID-19 pandemic, until after the April crash.

USO said in its regulatory filing on Friday that it and its co-defendants in the derivative case "intend to vigorously contest such claims and move for their dismissal."

The fund added that it "may have additional actions filed against it based on similar allegations as those that were made in the putative class actions and the shareholder derivative complaint that have been reported."

--Additional reporting by Tom Zanki. Editing by Janice Carter Brown.

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