New
York Mercantile Exchange Licensing Fee****
Assets
|
Licensing
Fee
|
First
$1,000,000,000
|
0.04%
of NAV
|
After
the first $1,000,000,000
|
0.02%
of NAV
|
****
Fees are calculated on a daily basis (accrued at 1/365 of the applicable
percentage of NAV on that day) and paid on a monthly basis. US12OF is
responsible for its pro rata share of the assets held by USOF, USNG,
US12OF and
USG as well as other funds managed by the General Partner, including US12NG
and USHO, when and if such funds commence operations.
Form
of Units
Registered
Form.
Units
are issued in registered form in accordance with the LP Agreement. The
Administrator has been appointed registrar and transfer agent for the purpose
of
transferring units in certificated form. The Administrator keeps a record
of all
holders of the units in the registry (the “Register”). The General Partner
recognizes transfers of units in certificated form only if done in accordance
with the LP Agreement. The beneficial interests in such units are held
in
book-entry form through participants and/or accountholders in the Depository
Trust Company ("DTC").
Book
Entry.
Individual certificates are not issued for the units. Instead, units are
represented by one or more global certificates, which are deposited by
the
Administrator with DTC and registered in the name of Cede & Co., as
nominee for DTC. The global certificates evidence all of the units outstanding
at any time. Unitholders are limited to (1) participants in DTC such as
banks, brokers, dealers and trust companies ("DTC Participants"), (2) those
who maintain, either directly or indirectly, a custodial relationship with
a DTC
Participant ("Indirect Participants"), and (3) those banks, brokers,
dealers, trust companies and others who hold interests in the units through
DTC
Participants or Indirect Participants, in each case who satisfy the requirements
for transfers of units. DTC Participants acting on behalf of investors
holding
units through such participants’ accounts in DTC will follow the delivery
practice applicable to securities eligible for DTC’s Same-Day Funds Settlement
System. Units are credited to DTC Participants’ securities accounts following
confirmation of receipt of payment.
DTC.
DTC is
a limited purpose trust company organized under the laws of the State of
New
York and is a member of the Federal Reserve System, a “clearing corporation”
within the meaning of the New York Uniform Commercial Code and a “clearing
agency” registered pursuant to the provisions of Section 17A of the Securities
Exchange Act of 1934, as amended (the “Exchange Act”). DTC holds securities for
DTC Participants and facilitates the clearance and settlement of transactions
between DTC Participants through electronic book-entry changes in accounts
of
DTC Participants.
Transfer
of Units
Transfers
of Units Only Through
DTC. The units are only transferable through the book-entry
system
of DTC. Limited partners who are not DTC Participants may transfer their
units
through DTC by instructing the DTC Participant holding their units (or
by
instructing the Indirect Participant or other entity through which their
units
are held) to transfer the units. Transfers are made in accordance with
standard
securities industry practice.
Transfers
of interests in units with DTC will be made in accordance with the usual
rules
and operating procedures of DTC and the nature of the transfer. DTC has
established procedures to facilitate transfers among the participants and/or
accountholders of DTC. Because DTC can only act on behalf of DTC Participants,
who in turn act on behalf of Indirect Participants, the ability of a person
or
entity having an interest in a global certificate to pledge such interest
to
persons or entities that do not participate in DTC, or otherwise take actions
in
respect of such interest, may be affected by the lack of a definitive security
in respect of such interest.
DTC
has
advised us that it will take any action permitted to be taken by a unitholder
(including, without limitation, the presentation of a global certificate
for
exchange) only at the direction of one or more DTC Participants in whose
account
with DTC interests in global certificates are credited and only in respect
of
such portion of the aggregate principal amount of the global certificate
as to
which such DTC Participant or Participants has or have given such
direction.
Transfer/Application
Requirements. All purchasers of US12OF’s units, and potentially
any purchasers of units in the future, who wish to become limited partners
or
other record holders and receive cash distributions, if any, or have certain
other rights, must deliver an executed transfer application in which the
purchaser or transferee must certify that, among other things, he, she
or it
agrees to be bound by US12OF’s LP Agreement and is eligible to purchase US12OF’s
securities. Each purchaser of units must execute a transfer application
and
certification. The obligation to provide the form of transfer application
will
be imposed on the seller of units or, if a purchase of units is made through
an
exchange, the form may be obtained directly through US12OF. Further, the
General
Partner may request each record holder to furnish certain information,
including
that holder’s nationality, citizenship or other related status. A record holder
is a unitholder that is, or has applied to be, a limited partner. An investor
who is not a U.S. resident may not be eligible to become a record holder
or one
of the US12OF’s limited partners if that investor’s ownership would subject
US12OF to the risk of cancellation or forfeiture of any of US12OF’s assets under
any federal, state or local law or regulation. If the record holder fails
to
furnish the information or if the General Partner determines, on the basis
of
the information furnished by the holder in response to the request, that
such
holder is not qualified to become one of US12OF’s limited partners, the General
Partner may be substituted as a holder for the record holder, who will
then be
treated as a non-citizen assignee, and US12OF will have the right to redeem
those securities held by the record holder.
A
transferee’s broker, agent or nominee may complete, execute and deliver a
transfer application and certification. US12OF may, at its discretion,
treat the
nominee holder of a unit as the absolute owner. In that case, the beneficial
holder’s rights are limited solely to those that it has against the nominee
holder as a result of any agreement between the beneficial owner and the
nominee
holder.
A
person
purchasing US12OF’s existing units, who does not execute a transfer application
and certify that the purchaser is eligible to purchase those securities
acquires
no rights in those securities other than the right to resell those securities.
Whether or not a transfer application is received or the consent of the
General
Partner obtained, our units will be securities and will be transferable
according to the laws governing transfers of securities.
Any
transfer of units will not be recorded by the transfer agent or recognized
by
the General Partner unless a completed transfer application is delivered
to the
General Partner or the Administrator. When acquiring units, the transferee
of
such units that completes a transfer application will:
·
be
an
assignee until admitted as a substituted limited partner upon the consent
and
sole discretion of the General Partner and the recording of the assignment
on
the books and records of the partnership;
·
automatically
request admission as a substituted limited partner;
·
agree
to
be bound by the terms and conditions of, and execute, our LP
Agreement;
·
represent
that such transferee has the capacity and authority to enter into our LP
Agreement;
·
grant
powers of attorney to our General Partner and any liquidator of us;
and
·
make
the
consents and waivers contained in our LP Agreement.
An
assignee will become a limited partner in respect of the transferred units
upon
the consent of the General Partner and the recordation of the name of the
assignee on our books and records. Such consent may be withheld in the
sole
discretion of the General Partner.
If
consent of the General Partner is withheld, such transferee shall be an
assignee. An assignee shall have an interest in the partnership equivalent
to
that of a limited partner with respect to allocations and distributions,
including, without limitation, liquidating distributions, of the partnership.
With respect to voting rights attributable to units that are held by assignees,
the General Partner shall be deemed to be the limited partner with respect
thereto and shall, in exercising the voting rights in respect of such units
on
any matter, vote such units at the written direction of the assignee who
is the
record holder of such units. If no such written direction is received,
such
units will not be voted. An assignee shall have no other rights of a limited
partner.
Until
a
unit has been transferred on US12OF's books, we and the transfer agent
may treat
the record holder of the unit as the absolute owner for all purposes, except
as
otherwise required by law or stock exchange regulations.
Withdrawal
of Limited
Partners
As
discussed in the LP Agreement, if the General Partner gives at least fifteen
(15) days’ written notice to a limited partner, then the General Partner may for
any reason, in its sole discretion, require any such limited partner to
withdraw
entirely from the partnership or to withdraw a portion of its partner capital
account. If the General Partner does not give at least fifteen (15) days’
written notice to a limited partner, then it may only require withdrawal
of all
or any portion of the capital account of any limited partner in the following
circumstances: (i) the unitholder made a misrepresentation to the General
Partner in connection with its purchase of units; or (ii) the limited
partner’s ownership of units would result in the violation of any law or
regulations applicable to the partnership or a partner. In these circumstances,
the General Partner without notice may require the withdrawal at any time,
or
retroactively. The limited partner thus designated shall withdraw from
the
partnership or withdraw that portion of its partner capital account specified,
as the case may be, as of the close of business on such date as determined
by
the General Partner. The limited partner thus designated shall be deemed
to have
withdrawn from the partnership or to have made a partial withdrawal from
its
partner capital account, as the case may be, without further action on
the part
of the limited partner and the provisions of the LP Agreement shall
apply.
Calculating
NAV
US12OF’s
NAV is calculated by:
|
·
|
Taking
the current market value of its total
assets
|
|
·
|
Subtracting
any liabilities
|
The
Administrator calculates the NAV of US12OF once each trading day. The NAV
for a
particular trading day is released after 4:15 p.m. New York time. It calculates
the NAV as of the earlier of the close of the NYSE or 4:00 p.m. New York
time.
Trading on the AMEX typically closes at 4:15 p.m. New York time. US12OF
uses the
NYMEX closing price (determined at the earlier of the close of that Exchange
or
2:30 p.m. New York time) for the contracts held on the NYMEX, but calculates
or
determines the value of all other US12OF investments as of the earlier
of the
close of the NYSE or 4:00 p.m. New York time.
In
addition, in order to provide updated information relating to US12OF for
use by
investors and market professionals, the AMEX calculates and disseminates
throughout the trading day an updated indicative fund value. The indicative
fund
value is calculated by using the prior day’s closing NAV per unit of US12OF as a
base and updating that value throughout the trading day to reflect changes
in
the most recently reported trade price for the Benchmark Futures Contracts
on the NYMEX. The prices reported for the active Benchmark Futures Contract
month are adjusted based on the prior day’s spread differential between
settlement values for that contract and the spot month contract. In the
event
that the spot month contract is also the active contract, the last sale
price
for the active contract is not adjusted. The indicative fund value unit
basis
disseminated during AMEX trading hours should not be viewed as an actual
real
time update of the NAV, because the NAV is calculated only once at the
end of
each trading day.
The
indicative fund value is disseminated on a per unit basis every 15 seconds
during regular AMEX trading hours of 9:30 a.m. New York time to 4:15 p.m.
New
York time. The normal trading hours of the NYMEX are 10:00 a.m. New York
time to
2:30 p.m. New York time. This means that there is a gap in time at the
beginning
and the end of each day during which US12OF’s units are traded on the AMEX, but
real-time NYMEX trading prices for oil futures contracts traded on the
NYMEX are
not available. As a result, during those gaps there will be no update to
the
indicative fund value.
The
AMEX
disseminates the indicative fund value through the facilities of CTA/CQ
High
Speed Lines. In addition, the indicative fund value is published on the
AMEX’s
website and is available through on-line information services such as Bloomberg
and Reuters.
Dissemination
of the indicative fund value provides additional information that is not
otherwise available to the public and is useful to investors and market
professionals in connection with the trading of US12OF units on the AMEX.
Investors and market professionals are able throughout the trading day
to
compare the market price of US12OF and the indicative fund value. If the
market
price of US12OF units diverges significantly from the indicative fund value,
market professionals will have an incentive to execute arbitrage trades.
For
example, if US12OF appears to be trading at a discount compared to the
indicative fund value, a market professional could buy US12OF units on
the AMEX
and sell short futures contracts. Such arbitrage trades can tighten the
tracking between the market price of US12OF and the indicative fund value
and
thus can be beneficial to all market participants.
In
addition, other Futures Contracts, Other Crude Oil Related Investments
and Treasuries held by US12OF are valued by the Administrator, using rates
and
points received from client approved third party vendors (such as Reuters
and WM
Company) and advisor quotes. These investments are not included in the
indicative value. The indicative fund value is based on the prior day’s NAV and
moves up and down according solely to changes in the average of the price
of
the Benchmark Futures Contracts.
Creation
and Redemption of
Units
US12OF
creates and redeems units from time to time, but only in one or more Creation
Baskets or Redemption Baskets. The creation and redemption of baskets are
only
made in exchange for delivery to US12OF or the distribution by US12OF of
the
amount of Treasuries and any cash represented by the baskets being created
or
redeemed, the amount of which is based on the combined NAV of the number
of
units included in the baskets being created or redeemed determined as of
4:00
p.m. New York time on the day the order to create or redeem baskets is
properly
received.
Authorized
Purchasers are the only persons that may place orders to create and redeem
baskets. Authorized Purchasers must be (1) registered broker-dealers or
other
securities market participants, such as banks and other financial institutions,
that are not required to register as broker-dealers to engage in securities
transactions as described below, and (2) DTC Participants. To become an
Authorized Purchaser, a person must enter into an Authorized Purchaser
Agreement
with the General Partner. The Authorized Purchaser Agreement provides the
procedures for the creation and redemption of baskets and for the delivery
of
the Treasuries and any cash required for such creations and redemptions.
The
Authorized Purchaser Agreement and the related procedures attached thereto
may
be amended by US12OF, without the consent of any limited partner or unitholder
or Authorized Purchaser. Authorized Purchasers pay a transaction fee of
$1,000
to US12OF for each order they place to create or redeem one or more baskets.
Authorized Purchasers who make deposits with US12OF in exchange for baskets
receive
no fees, commissions or other form of compensation or inducement of any
kind
from either US12OF or the General Partner, and no such person will have
any
obligation or responsibility to the General Partner or US12OF to effect
any sale
or resale of units. As of December 31, 2007, 2 Authorized Purchasers had
entered
into agreements with US12OF to purchase Creation Baskets.
Certain
Authorized Purchasers are expected to have the facility to participate
directly
in the physical crude oil market and the crude oil futures market. In
some
cases, an Authorized Purchaser or its affiliates may from time to time
acquire
crude oil or sell crude oil and may profit in these instances. The General
Partner believes that the size and operation of the crude oil market
make it
unlikely that an Authorized Purchaser’s direct activities in the crude oil or
securities markets will impact the price of crude oil, Futures Contracts,
or the
price of the units.
Each
Authorized Purchaser is required to be registered as a broker-dealer under
the
Exchange Act and is a member in good standing with FINRA, or exempt from
being
or otherwise not required to be licensed as a broker-dealer or a member
of
FINRA, and qualified to act as a broker or dealer in the states or other
jurisdictions where the nature of its business so requires. Certain Authorized
Purchasers may also be regulated under federal and state banking laws and
regulations. Each Authorized Purchaser has its own set of rules and procedures,
internal controls and information barriers as it determines is appropriate
in
light of its own regulatory regime.
Under
the
Authorized Purchaser Agreement, the General Partner has agreed to indemnify
the
Authorized Purchasers against certain liabilities, including liabilities
under
the Securities Act of 1933, as amended, and to contribute to the payments
the
Authorized Purchasers may be required to make in respect of those
liabilities.
The
following description of the procedures for the creation and redemption
of
baskets is only a summary and an investor should refer to the relevant
provisions of the LP Agreement and the form of Authorized Purchaser Agreement
for more detail, each of which is attached as an exhibit to this annual
report
on Form 10-K.
Creation
Procedures
On
any
business day, an Authorized Purchaser may place an order with the Marketing
Agent to create one or more baskets. For purposes of processing purchase
and
redemption orders, a “business day” means any day other than a day when any of
the AMEX, the NYMEX or the NYSE is closed for regular trading. Purchase
orders
must be placed by 12:00 p.m. New York time or the close of regular trading
on
the AMEX, whichever is earlier; except in the case of the initial Authorized
Purchaser’s or any other Authorized Purchaser’s initial order to purchase one or
more Creation Baskets on the first day the baskets are to be offered and
sold,
when such orders shall be placed by 9:00 a.m. New York time on the day
agreed to
by the General Partner and the initial Authorized Purchaser. The day on
which
the Marketing Agent receives a valid purchase order is the purchase order
date.
By
placing a purchase order, an Authorized Purchaser agrees to deposit Treasuries,
cash or a combination of Treasuries and cash with US12OF, as
described below. Prior to the delivery of baskets for a purchase order,
the
Authorized Purchaser must also have wired to the Custodian the non-refundable
transaction fee due for the purchase order. Authorized Purchasers may not
withdraw a creation request.
The
manner by which creations are made is dictated by the terms of the Authorized
Purchaser Agreement. By placing a purchase order, an Authorized Purchaser
agrees
to (1) deposit Treasuries, cash, or a combination of Treasuries and cash
with
the Custodian of US12OF, and (2) enter into or arrange for a block trade,
an
exchange for physical or exchange for swap, or any other over-the-counter
energy
transaction (through itself or a designated acceptable broker) with US12OF
for
the purchase of a number and type of futures contracts at the closing
settlement
price for such contracts on the purchase order date. If an Authorized Purchaser
fails to consummate (1) and (2), the order shall be cancelled. The number
and
type of contracts specified shall be determined by the General Partner,
in its
sole discretion, to meet US12OF’s investment objective and shall be purchased as
a result of the Authorized Purchaser’s purchase of units.
Determination
of Required Deposits
The
total deposit required to create each basket (“Creation Basket Deposit”) is the
amount of Treasuries and/or cash that is in the same proportion to the
total
assets of US12OF (net of estimated accrued but unpaid fees, expenses
and other
liabilities) on the date the order to purchase is accepted as the number
of
units to be created under the purchase order is in proportion to the
total
number of units outstanding on the date the order is received. The General
Partner determines, directly in its sole discretion or in consultation
with the
Administrator, the requirements for Treasuries and the amount of cash,
including
the maximum permitted remaining maturity of a Treasury and proportions
of
Treasury and cash that may be included in deposits to create baskets.
The
Marketing Agent publishes such requirements at the beginning of each
business
day. The amount of cash deposit required is the difference between the
aggregate
market value of the Treasuries required to be included in a Creation
Basket
Deposit as of 4:00 p.m. New York time on the date the order to purchase
is
properly received and the total required deposit.
Delivery
of Required Deposits
An
Authorized Purchaser who places a purchase order is responsible for transferring
to US12OF’s account with the Custodian the required amount of Treasuries and
cash by the end of the third business day following the purchase order
date.
Upon receipt of the deposit amount, the Administrator directs DTC to
credit the
number of baskets ordered to the Authorized Purchaser’s DTC account on the third
business day following the purchase order date. The expense and risk
of delivery
and ownership of Treasuries until such Treasuries have been received
by the
Custodian on behalf of US12OF shall be borne solely by the Authorized
Purchaser.
Because
orders to purchase baskets must be placed by 12:00 p.m., New York time,
but the
total payment required to create a basket during the continuous offering
period
will not be determined until 4:00 p.m., New York time, on the date the
purchase
order is received, Authorized Purchasers will not know the total amount
of the
payment required to create a basket at the time they submit an irrevocable
purchase order for the basket. US12OF’s NAV and the total amount of the payment
required to create a basket could rise or fall substantially between
the time an
irrevocable purchase order is submitted and the time the amount of the
purchase
price in respect thereof is determined.
Rejection
of Purchase Orders
The
General Partner acting by itself or through the Marketing Agent may reject
a
purchase order or a Creation Basket Deposit if:
·
|
it
determines that the investment alternative available to US12OF
at that
time will not enable it to meet its investment
objective;
|
·
|
it
determines that the purchase order or the Creation Basket Deposit
is not
in proper form;
|
·
|
it
believes that the purchase order or the Creation Basket Deposit
would have
adverse tax consequences to US12OF or its
unitholders;
|
·
|
the
acceptance or receipt of the Creation Basket Deposit would,
in the opinion
of counsel to the General Partner, be unlawful;
or
|
·
|
circumstances
outside the control of the General Partner, Marketing Agent
or Custodian
make it, for all practical purposes, not feasible to process
creations of
baskets.
|
None
of the General Partner, Marketing Agent or Custodian will be liable for
the
rejection of any purchase order or Creation Basket
Deposit.
Redemption
Procedures
The
procedures by which an Authorized Purchaser can redeem one or more baskets
mirror the procedures for the creation of baskets. On any business day,
an
Authorized Purchaser may place an order with the Marketing Agent to redeem
one
or more baskets. Redemption orders must be placed by 12:00 p.m. New York
time or
the close of regular trading on the NYMEX, whichever is earlier. A redemption
order so received will be effective on the date it is received in satisfactory
form by the Marketing Agent. The redemption procedures allow Authorized
Purchasers to redeem baskets and do not entitle an individual unitholder
to
redeem any units in an amount less than a Redemption Basket, or to redeem
baskets other than through an Authorized Purchaser. By placing a redemption
order, an Authorized Purchaser agrees to deliver the baskets to be redeemed
through DTC’s book-entry system to US12OF not later than 3:00 p.m. New York time
on the third business day following the effective date of the redemption
order.
Prior to the delivery of the redemption distribution for a redemption order,
the
Authorized Purchaser must also have wired to US12OF’s account at the Custodian
the non-refundable transaction fee due for the redemption order. Authorized
Purchasers may not withdraw a redemption request.
The
manner by which redemptions are made is dictated by the terms of the
Authorized
Purchaser Agreement. By placing a redemption order, an Authorized Purchaser
agrees to (1) deliver the Redemption Basket to be redeemed through DTC’s
book-entry system to US12OF’s account with the Custodian not later than 3:00
p.m. New York time on the third business day following the effective
date of the
redemption order (“Redemption Distribution Date”), and (2) enter into or arrange
for a block trade, an exchange for physical or exchange for swap, or
any other
over-the-counter energy transaction (through itself or a designated acceptable
broker) with US12OF for the sale of a number and type of futures contracts
at
the closing settlement price for such contracts on the redemption order
date. If
an Authorized Purchaser fails to consummate (1) and (2) above, the order
shall
be cancelled. The number and type of contracts specified shall be determined
by
the General Partner, in its sole discretion, to meet US12OF’s investment
objective and shall be sold as a result of the Authorized Purchaser’s sale of
units. Prior to the delivery of the redemption distribution for a redemption
order, the Authorized Purchaser must also have wired to US12OF’s account at the
Custodian the non-refundable transaction fee due for the redemption
order.
Determination
of Redemption Distribution
The
redemption distribution from US12OF consists of a transfer to the redeeming
Authorized Purchaser of an amount of Treasuries and/or cash that is in
the same
proportion to the total assets of US12OF (net of estimated accrued but
unpaid
fees, expenses and other liabilities) on the date the order to redeem
is
properly received as the number of units to be redeemed under the redemption
order is in proportion to the total number of units outstanding on the
date the
order is received. The General Partner, directly or in consultation with
the
Administrator, determines the requirements for Treasuries and the amounts
of
cash, including the maximum permitted remaining maturity of a Treasury,
and the
proportions of Treasuries and cash that may be included in distributions
to
redeem baskets. The Marketing Agent publishes such requirements as of
4:00 p.m.
New York time on the redemption order date.
Delivery
of Redemption Distribution
The
redemption distribution due from US12OF will be delivered to the Authorized
Purchaser by 3:00 p.m. New York time on the third business day following
the
redemption order date if, by 3:00 p.m. New York time on such third business
day,
US12OF’s DTC account has been credited with the baskets to be redeemed. If
US12OF’s DTC account has not been credited with all of the baskets to be
redeemed by such time, the redemption distribution will be delivered
to the
extent of whole baskets received. Any remainder of the redemption distribution
will be delivered on the next business day to the extent of remaining
whole
baskets received if US12OF receives the fee applicable to the extension
of the
redemption distribution date which the General Partner may, from time
to time,
determine and the remaining baskets to be redeemed are credited to US12OF’s DTC
account by 3:00 p.m. New York time on such next business day. Any further
outstanding amount of the redemption order shall be cancelled. Pursuant
to
information from the General Partner, the Custodian will also be authorized
to
deliver the redemption distribution notwithstanding that the baskets
to be
redeemed are not credited to US12OF’s DTC account by 3:00 p.m. New York time on
the third business day following the redemption order date if the Authorized
Purchaser has collateralized its obligation to deliver the baskets through
DTC’s
book entry-system on such terms as the General Partner may from time
to time
determine.
Suspension
or Rejection of Redemption Orders
The
General Partner may, in its discretion, suspend the right of redemption,
or
postpone the redemption settlement date, (1) for any period during which
the
AMEX or the NYMEX is closed other than customary weekend or holiday
closings, or trading on the AMEX or the NYMEX is suspended or restricted,
(2)
for any period during which an emergency exists as a result of which
delivery,
disposal or evaluation of Treasuries is not reasonably practicable, or
(3) for
such other period as the General Partner determines to be necessary for
the
protection of the limited partners. None of the General Partner, the
Marketing
Agent, the Administrator, or the Custodian will be liable to any person
or in
any way for any loss or damages that may result from any such suspension
or
postponement.
The
General Partner will reject a redemption order if the order is not in
proper
form as described in the Authorized Purchaser Agreement or if the fulfillment
of
the order, in the opinion of its counsel, might be unlawful. The General
Partner
may also reject a redemption order if the number of units being redeemed
would
reduce the remaining outstanding units to 100,000 units (i.e., one basket)
or
less, unless the General Partner has reason to believe that the placer
of the
redemption order does in fact possess all the outstanding units and can
deliver
them.
Creation
and Redemption Transaction
Fee
To
compensate US12OF for its expenses in connection with the creation and
redemption of baskets, an Authorized Purchaser is required to pay a transaction
fee to US12OF of $1,000 per order to create or redeem baskets. An order
may
include multiple baskets. The transaction fee may be reduced, increased
or
otherwise changed by the General Partner. The General Partner shall notify
DTC
of any change in the transaction fee and will not implement any increase
in the
fee for the redemption of baskets until 30 days after the date of the
notice.
Tax
Responsibility
Authorized
Purchasers are responsible for any transfer tax, sales or use tax, stamp
tax,
recording tax, value added tax or similar tax or governmental charge applicable
to the creation or redemption of baskets, regardless of whether or not
such tax
or charge is imposed directly on the Authorized Purchaser, and agree to
indemnify the General Partner and US12OF if they are required by law to
pay any
such tax, together with any applicable penalties, additions to tax or interest
thereon.
Secondary
Market
Transactions
As
discussed above, Authorized Purchasers are the only persons that may place
orders to create and redeem baskets. Authorized Purchasers must be registered
broker-dealers or other securities market participants, such as banks and
other
financial institutions that are not required to register as broker-dealers
to
engage in securities transactions. An Authorized Purchaser is under no
obligation to create or redeem baskets, and an Authorized Purchaser is
under no
obligation to offer to the public units of any baskets it does create.
Authorized Purchasers that do offer to the public units from the baskets
they
create will do so at per-unit offering prices that are expected to reflect,
among other factors, the trading price of the units on the AMEX, the NAV
of
US12OF at the time the Authorized Purchaser purchased the Creation Baskets
and
the NAV at the time of the offer of the units to the public, the supply of
and demand for units at the time of sale, and the liquidity of the Futures
Contract market and the market for Other Crude Oil Related Investments.
The
prices of units offered by Authorized Purchasers are expected to fall between
US12OF’s NAV and the trading price of the units on the AMEX at the time of sale.
Units initially comprising the same basket but offered by Authorized Purchasers
to the public at different times may have different offering prices. An
order
for one or more baskets may be placed by an Authorized Purchaser on behalf
of
multiple clients. Authorized Purchasers who make deposits with US12OF in
exchange for baskets receive no fees, commissions or other form of compensation
or inducement of any kind from either US12OF or the General Partner, and
no such
person has any obligation or responsibility to the General Partner or US12OF
to
effect any sale or resale of units. Units are expected to trade in the
secondary
market on the AMEX. Units may trade in the secondary market at prices that
are
lower or higher relative to their NAV per unit. The amount of the discount
or
premium in the trading price relative to the NAV per unit may be influenced
by
various factors, including the number of investors who seek to purchase
or sell
units in the secondary market and the liquidity of the Futures Contracts
market
and the market for Other Crude Oil Related Investments. While the units
trade on the AMEX until 4:15 p.m. New York time, liquidity in the market
for
Futures Contracts and Other Crude Oil Related Investments may be reduced
after
the close of the NYMEX at 2:30 p.m. New York time. As a result, during
this
time, trading spreads, and the resulting premium or discount, on the units
may
widen.
Prior
Performance of US12OF and
Affiliates
PAST
PERFORMANCE IS NOT NECESSARILY
INDICATIVE OF FUTURE RESULTS
Experience
in Raising and Investing
in Funds through
December 31, 2007
Dollar
Amount Offered:
|
$
|
550,000,000
|
|
|
|
Dollar
Amount Raised:
|
$
|
20,127,316
|
|
|
|
Organizational
Expenses*:
|
|
|
SEC
registration fee**:
|
$
|
16,885
|
FINRA registration fees**: |
$ |
75,500 |
AMEX
Listing fee**:
|
$
|
5,000
|
Auditor's
fees and expenses**:
|
$
|
10,700
|
Legal
fees and expenses**:
|
$
|
233,799
|
Printing
expenses:
|
$
|
23,755
|
|
|
|
Length
of Offering:
|
|
Continuous
|
——————
*
Amounts are for organizational and offering expenses incurred in connection
with
the initial public offering on December 6, 2007.
**
Paid
for
by the General Partner in connection with the initial public
offering.
Performance
Capsule
Name
of Commodity Pool:
|
|
US12OF
|
|
Type
of Commodity Pool:
|
|
Exchange
traded security
|
|
Inception
of Trading:
|
|
December
6, 2007
|
|
Aggregate
Gross Capital Subscriptions (from inception through
December 31, 2007):
|
|
$
|
20,126,316
|
|
Total
Net Assets as of December 31, 2007:
|
|
$
|
21,691,479
|
*
|
Initial
NAV Per Unit as of Inception:
|
|
$
|
50.00
|
|
NAV
per Unit as of December 31, 2007:
|
|
$
|
54.23
|
|
Worst
Monthly Percentage Draw-down:
|
|
|
N/A
|
|
Worst
Peak-to-Valley Draw-down:
|
|
|
N/A
|
|
Total
Rate of Return Since Inception:
|
|
|
8.46
|
%
|
* Inclusive
of transactions recorded on a trade date + 1 basis.
Month
|
|
Rates of Return
For the Year 2007
|
|
December
|
|
|
8.46
|
%
|
The
General Partner is also currently the general partner of USOF, USNG
and USG.
Each of the General Partner, USNG, USOF and USG is located in
California.
USOF
is a
publicly traded limited partnership which seeks to have the changes
in
percentage terms of its units' NAV track the changes in the spot
price of light,
sweet crude oil delivered to Cushing, Oklahoma, as measured by the changes
in the price of the futures contract on light, sweet, crude oil traded
on the
NYMEX that is the near month contract to expire, except when the
near month
contract is within two weeks of expiration, in which case the futures
contract
will be the next month contract to expire, less USOF's expenses.
USOF invests in
a mixture of listed crude oil futures contracts, other non-listed
oil related
investments, Treasuries, cash and cash equivalents. USOF began trading
on the
AMEX on April 10, 2006 and is a continuous offering. As of December
31, 2007,
the total amount of money raised by USOF from Authorized Purchasers
was
$6,142,801,106; the total number of Authorized Purchasers was 12;
the number of
baskets purchased by Authorized Purchasers was 1,074; and the aggregate
amount
of units purchased was 107,400,000.
USNG
is a
publicly traded limited partnership which seeks to have the changes
in
percentage terms of its units' NAV track the changes in percentage
terms price of natural gas delivered at the Henry Hub, Louisiana, as
measured by the changes in th eprice of the futures contract on natural
gas
traded on the NYMEX that is the near month contract to expire, except
when the
near month contract is within two weeks of expiration, in which case
it will be
measured by the futures contract that is the next month contract
to expire, less
USNG's expenses. USNG invests in a mixture of listed natural gas
futures
contracts, other natural gas related investments, Treasuries, cash
and cash
equivalents. USNG began trading on the AMEX on April 18, 2007 and
is a
continuous offering. As of December 31, 2007, the total amount of
money raised by USNG from Authorized Purchasers was $1,458,787,976;
the total
number of Authorized Purchasers was 4; the number of baskets purchased
by
Authorized Purchasers was 379; and the aggregate amount of units
purchased was
37,900,000.
USG
is a
publicly traded limited partnership which seeks to have the changes
in
percentage terms of its units’ NAV track the changes in percentage terms of the
price of unleaded gasoline delivered to the New York harbor, as
measured by the
changes in the price of the futures contract on gasoline traded
on the NYMEX,
less USG’s expenses. USG invests in a mixture of listed gasoline
futures contracts, other gasoline related investments, Treasuries,
cash and cash
equivalents. USG began trading on the AMEX on February 26, 2008 and
is a continuous offering. During the year ended December 31, 2007,
USG had not yet commenced investment activities nor issued
units.
Since
the
offering of USOF units to the public on April 10, 2006 to December
31, 2007, the
simple average daily change in the Benchmark Oil Futures Contract
was -0.031%,
while the simple average daily change in the NAV of USOF over the
same time
period was 0.042%. The average daily difference was 0.011% (or 1.1
basis point,
where 1 basis point equals 1/100 of 1%). As a percentage of the daily
movement
of the Benchmark Oil Futures Contract, the average error in daily
tracking by
the NAV was 2.98%, meaning that over this time period USOF’s tracking error was
within the plus or minus 10% range established as its benchmark tracking
goal.
Since
the
offering of USNG units to the public on April 18, 2007 to December
31, 2007, the
simple average daily change in the Benchmark Futures Contract was
-0.154%, while
the simple average daily change in the NAV of USNG over the same
time period was
-0.143%. The average daily difference was 0.012% (or 1.2 basis points,
where 1
basis point equals 1/100 of 1%). As a percentage of the daily movement
of the
Benchmark Futures Contract, the average error in daily tracking by
the NAV was
1.994%, meaning that over this time period USNG’s tracking error was within the
plus or minus 10% range established as its benchmark tracking goal.
There
are
significant differences between investing in USOF and USNG and investing
directly in the futures market. The General Partner’s results with USOF and USNG
may not be representative of results that may be experienced with
a fund
directly investing in futures contracts or other managed funds investing
in
futures contracts. For more information on the performance of USOF
and USNG, see
the Performance Tables below. Since
USG
did not commence investment activities nor issue units during the
year ended
December 31, 2007, performance information has not been included
for
USG.
PAST
PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS
Experience
in Raising and Investing in Funds through December 31, 2007
Dollar
Amount Offered in USOF Offering*:
|
|
$ |
7,094,860,000 |
|
Dollar
Amount Raised in USOF Offering:
|
|
$ |
6,142,801,105 |
|
Organizational
Expenses in USOF Offering:
|
|
|
|
|
SEC
registration fee**:
|
|
$ |
800,474 |
|
FINRA
registration fee**:
|
|
$ |
377,500 |
|
AMEX
listing fee**:
|
|
$ |
5,000 |
|
Auditor’s
fees and expenses**:
|
|
$ |
59,000 |
|
Legal
fees and expenses**:
|
|
$ |
1,249,109 |
|
Printing
expenses**:
|
|
$ |
241,977 |
|
Length
of USOF offering:
|
|
Continuous
|
|
*
|
Reflects
the offering price per unit set forth on the cover page
of the
registration statement registering such units filed with
the SEC.
|
**
|
Through
December 31, 2006, these expenses were paid for by an affiliate
of the
General Partner in connection with the initial public offering.
Following
December 31, 2006, USOF has recorded these expenses.
|
Dollar
Amount Offered in USNG Offering*:
|
|
$ |
3,664,500,000 |
|
Dollar
Amount Raised in USNG Offering:
|
|
$ |
1,458,787,976 |
|
Organizational
Expenses in USNG Offering:
|
|
|
|
|
SEC
registration fee**:
|
|
$ |
104,010 |
|
FINRA
registration fee**:
|
|
$ |
151,000 |
|
AMEX
listing fee**:
|
|
$ |
5,000 |
|
Auditor’s
fees and expenses**:
|
|
$ |
29,000 |
|
Legal
fees and expenses**:
|
|
$ |
526,746 |
|
Printing
expenses**:
|
|
$ |
40,323 |
|
Length
of USNG offering:
|
|
Continuous
|
|
*
|
Reflects
the offering price per unit set forth on the cover page
of the
registration statement registering such units filed with
the SEC.
|
**
|
These
expenses were paid for by the General Partner and USNG.
|
Compensation
to the General Partner and Other Compensation
USOF:
Expenses
Paid by USOF through
December 31, 2007 in dollar terms (unaudited):
Expense
|
|
Amount
in Dollar
Terms
|
|
Amount
Paid to General Partner in USOF Offering:
|
|
$ |
3,622,613 |
|
Amount
Paid in Portfolio Brokerage Commissions in USOF offering:
|
|
$ |
1,184,956 |
|
Other
Amounts Paid in USOF Offering:
|
|
$ |
1,530,281 |
|
Total
Expenses Paid in USOF Offering:
|
|
$ |
6,337,850 |
|
Expenses
Paid by USOF through
December 31, 2007 as a Percentage of Average Daily Net Assets
(unaudited):
Expenses
in USOF Offering:
|
Amount
As a Percentage of Average
Daily Net Assets
|
|
General
Partner:
|
0.50%
annualized
|
|
Portfolio
Brokerage Commissions:
|
0.16%
annualized
|
|
Other
Amounts Paid in USOF Offering
|
0.21%
annualized
|
|
Total
Expense Ratio:
|
0.87%
annualized
|
|
|
USOF
Performance:
|
|
|
Name
of Commodity Pool:
|
USOF
|
|
Type
of Commodity Pool:
|
Exchange
traded security
|
|
Inception
of Trading:
|
April
10, 2006
|
|
Aggregate
Gross Capital Subscriptions (from inception through December
31,
2007):
|
$6,142,801,105
|
|
Total
Net Assets as of December 31, 2007:
|
$485,222,737
|
|
Initial
NAV Per Unit as of Inception:
|
$67.39
|
|
NAV
per Unit as of December 31, 2007:
|
$75.82
|
|
Worst
Monthly Percentage Draw-down:
|
September
2006 (11.71%)
|
|
Worst
Peak-to-Valley Draw-down:
|
June
2006 - January 2007 (30.60%)
|
USNG:
Expenses
Paid by USNG through
December 31, 2007 in dollar terms (unaudited):
Expense
|
|
Amount
in Dollar
Terms
|
|
Amount
Paid to General Partner in USNG Offering:
|
|
$ |
1,239,862 |
|
Amount
Paid in Portfolio Brokerage Commissions in USNG offering:
|
|
$ |
351,310 |
|
Other
Amounts Paid in USNG Offering:
|
|
$ |
454,149 |
|
Total
Expenses Paid in USNG Offering:
|
|
$ |
2,045,321 |
|
Expenses
Paid by USNG through
December31, 2007 as a Percentage of Average Daily Net Assets
(unaudited):
Expenses
in USNG Offering:
|
Amount
As a Percentage of Average
Daily Net Assets
|
General
Partner:
|
0.60%
annualized
|
Portfolio
Brokerage Commissions:
|
0.17%
annualized
|
Other
Amounts Paid in USNG Offering
|
0.22%
annualized
|
Total
Expense Ratio:
|
0.99%
annualized
|
USNG
Performance:
|
|
Name
of Commodity Pool:
|
USNG
|
Type
of Commodity Pool:
|
Exchange
traded security
|
Inception
of Trading:
|
April
18, 2007
|
Aggregate
Gross Capital Subscriptions (from inception through December
31,
2007):
|
$1,458,786,977
|
Total
Net Assets as of December 31, 2007:
|
$593,394,981
|
Initial
NAV Per Unit as of Inception:
|
$50.00
|
NAV
per Unit as of December 31, 2007:
|
$36.18
|
Worst
Monthly Percentage Draw-down:
|
November
2007 (16.16%)
|
Worst
Peak-to-Valley Draw-down:
|
April
2007 - August 2007 (34.74%)
|
COMPOSITE
PERFORMANCE DATA FOR USOF
PAST
PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS
Month
|
|
Rates
of Return For
the Year 2006
|
|
April*
|
|
|
3.47 |
% |
May
|
|
|
(2.91 |
%) |
June
|
|
|
3.16 |
% |
July
|
|
|
(0.50 |
%) |
August
|
|
|
(6.97 |
%) |
September
|
|
|
(11.71 |
%) |
October
|
|
|
(8.46 |
%) |
November
|
|
|
4.73 |
% |
December
|
|
|
(5.21 |
%) |
Annual
Rate of Return (since inception through December 31, 2006)
|
|
|
(23.03 |
%) |
*
Partial from April 10,
2006.
Month
|
|
Rates
of Return For
the Year 2007
|
|
January
|
|
|
(6.55 |
)% |
February
|
|
|
5.63 |
% |
March
|
|
|
4.61 |
% |
April
|
|
|
(4.26 |
)% |
May
|
|
|
(4.91 |
)% |
June
|
|
|
9.06 |
% |
July
|
|
|
10.57 |
% |
August
|
|
|
(4.95 |
)% |
September
|
|
|
12.11 |
% |
October
|
|
|
16.98 |
% |
November
|
|
|
(4.82 |
)% |
December
|
|
|
8.67 |
% |
Annual
Rate of Return (through December 31, 2007)
|
|
|
46.17 |
% |
COMPOSITE
PERFORMANCE DATA FOR USNG
PAST
PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS
Month
|
|
Rates
of Return For
the Year 2007
|
|
April*
|
|
|
4.30 |
% |
May
|
|
|
(0.84 |
)% |
June
|
|
|
(15.90 |
)% |
July
|
|
|
(9.68 |
)% |
August
|
|
|
(13.37 |
)% |
September
|
|
|
12.28 |
% |
October
|
|
|
12.09 |
% |
November
|
|
|
(16.16 |
)% |
December
|
|
|
0.75 |
% |
Annual
Rate of Return (through December 31, 2007)
|
|
|
(27.64 |
)% |
*
Partial
from April 17, 2007.
Draw-down:
Losses experienced over a specified period. Draw-down is measured on
the basis
of monthly returns only and does not reflect intra-month figures.
Worst
Monthly Percentage Draw-down: The largest single month loss sustained
since
inception of trading.
Worst
Peak-to-Valley Draw-down: The largest percentage decline in the NAV
per unit
over the history of the fund. This need not be a continuous decline,
but can be
a series of positive and negative returns where the negative returns
are larger
than the positive returns. Worst Peak-to-Valley Draw-down represents
the greatest percentage decline from any month-end NAV per unit that
occurs
without such month-end NAV per unit being equaled or exceeded as of
a subsequent
month-end. For example, if the NAV per unit declined by $1 in each
of January
and February, increased by $1 in March and declined again by $2 in
April, a
“peak-to-trough drawdown” analysis conducted as of the end of April would
consider that “drawdown” to be still continuing and to be $3 in amount, whereas
if the NAV per unit had increased by $2 in March, the January-February
drawdown
would have ended as of the end of February at the $2 level.
Nicholas
Gerber, the president and CEO of the General Partner, ran the Marc
Stevens
Futures Index Fund over 10 years ago. This fund combined commodity
futures with
equity stock index futures. It was a very small private offering, which
had
under $1 million in assets. The Marc Stevens Futures Index Fund was
a commodity
pool and Mr. Gerber was the CPO. Ameristock Corporation is an affiliate
of the
General Partner and it is a California-based registered investment
advisor
registered under the Investment Advisers Act of 1940, as amended (the
"Advisers
Act") that has been sponsoring and providing portfolio management services
to
mutual funds since 1995. Ameristock Corporation is the investment adviser
to the
Ameristock Mutual Fund, Inc., a mutual fund registered under the Investment
Company Act of 1940, as amended (the "1940 Act") that focuses on large
cap U.S.
equities that has approximately $425 million in assets as of December
31, 2007.
Ameristock
Corporation is also the investment advisor to the Ameristock ETF Trust,
an
open-end management investment company registered under the 1940 Act
that seeks
investment results that correspond to the performance of U.S. Treasury
indices
owned and compiled by Ryan Holdings LLC and Ryan ALM,
Inc.
Investments
The
General Partner applies substantially all of US12OF’s assets toward trading
in Futures Contracts and Other Crude Oil Related Investments, Treasuries,
cash and/or cash equivalents. The General Partner has sole authority
to
determine the percentage of assets that are:
|
·
|
held
on deposit with the futures commission merchant or other
custodian,
|
|
·
|
used
for other investments, and
|
|
·
|
held
in bank accounts to pay current obligations and as
reserves.
|
The
General Partner deposits substantially all of US12OF’s net assets with the
Custodian or other custodian for trading. When US12OF purchases a Futures
Contract and certain exchange traded Other Crude Oil Related Investments,
US12OF
is also required to deposit with the futures commission merchant on behalf
of
the exchange a portion of the value of the contract or other interest
as
security to ensure payment for the obligation under crude oil interests
at
maturity. This deposit is known as “margin.” US12OF invests the remainder of its
assets equal to the difference between the margin deposited and the face
value
of the Futures Contract in Treasuries, cash and/or cash
equivalents.
The
General Partner believes that all entities that hold or trade US12OF’s assets
are based in the United States and are subject to United States
regulations.
Approximately
5% to 10% of US12OF’s assets have normally been committed as margin
for Futures Contracts. However, from time to time, the percentage of assets
committed as margin may be substantially more, or less, than such range.
The
General Partner invests the balance of US12OF’s assets not invested in Crude Oil
Interests or held in margin as reserves to be available for changes in
margin.
All interest income is used for US12OF’s benefit.
The
futures commission merchant, a government agency or a commodity exchange
could
increase margins applicable to US12OF to hold trading positions at any
time.
Moreover, margin is merely a security deposit and has no bearing on the
profit
or loss potential for any positions taken.
US12OF’s
assets are held in segregation pursuant to the CEA and CFTC
regulations.
The
Commodity Interest
Markets
General
The CEA
governs the regulation of commodity interest transactions, markets and
intermediaries. In December 2000, the CEA was amended by the Commodity
Futures
Modernization Act of 2000 (the "CFMA"), which substantially revised the
regulatory framework governing certain commodity interest transactions
and the
markets on which they trade. The CEA, as amended by the CFMA, now provides
for
varying degrees of regulation of commodity interest transactions depending
upon
the variables of the transaction. In general, these variables include
(1) the
type of instrument being traded (e.g., contracts for future delivery,
options,
swaps or spot contracts), (2) the type of commodity underlying the instrument
(distinctions are made between instruments based on agricultural commodities,
energy and metals commodities and financial commodities), (3) the nature
of the
parties to the transaction (retail, eligible contract participant, or
eligible
commercial entity), (4) whether the transaction is entered into on a
principal-to-principal or intermediated basis, (5) the type of market
on which
the transaction occurs, and (6) whether the transaction is subject to
clearing
through a clearing organization. Information regarding commodity interest
transactions, markets and intermediaries, and their associated regulatory
environment, is provided below.
Futures
Contracts
A
futures
contract such as a Futures Contract is a standardized contract traded
on, or
subject to the rules of, an exchange that calls for the future delivery
of a
specified quantity and type of a commodity at a specified time and place.
Futures contracts are traded on a wide variety of commodities, including
agricultural products, bonds, stock indices, interest rates, currencies,
energy
and metals. The size and terms of futures contracts on a particular commodity
are identical and are not subject to any negotiation, other than with
respect to
price and the number of contracts traded between the buyer and
seller.
The
contractual obligations of a buyer or seller may generally be satisfied
by
taking or making physical delivery of the underlying of commodity or
by making
an offsetting sale or purchase of an identical futures contract on the
same or
linked exchange before the designated date of delivery. The difference
between
the price at which the futures contract is purchased or sold and the
price paid
for the offsetting sale or purchase, after allowance for brokerage commissions,
constitutes the profit or loss to the trader. Some futures contracts,
such as
stock index contracts, settle in cash (reflecting the difference between
the
contract purchase/sale price and the contract settlement price) rather
than by
delivery of the underlying commodity.
In
market
terminology, a trader who purchases a futures contract is long in the
market and
a trader who sells a futures contract is short in the market. Before
a trader
closes out his long or short position by an offsetting sale or purchase,
his
outstanding contracts are known as open trades or open positions. The
aggregate
amount of open positions held by traders in a particular contract is
referred to
as the open interest in such contract.
Forward
Contracts
A
forward
contract is a contractual obligation to purchase or sell a specified
quantity of
a commodity at or before a specified date in the future at a specified
price
and, therefore, is economically similar to a futures contract. Unlike
futures
contracts, however, forward contracts are typically traded in the
over-the-counter markets and are not standardized contracts. Forward
contracts
for a given commodity are generally available for various amounts and
maturities
and are subject to individual negotiation between the parties involved.
Moreover, generally there is no direct means of offsetting or closing
out a
forward contract by taking an offsetting position as one would a futures
contract on a U.S. exchange. If a trader desires to close out a forward
contract
position, he generally will establish an opposite position in the contract
but
will settle and recognize the profit or loss on both positions simultaneously
on
the delivery date. Thus, unlike in the futures contract market where
a trader
who has offset positions will recognize profit or loss immediately, in
the
forward market a trader with a position that has been offset at a profit
will
generally not receive such profit until the delivery date, and likewise
a trader
with a position that has been offset at a loss will generally not have
to pay
money until the delivery date. In recent years, however, the terms of
forward
contracts have become more standardized, and in some instances such contracts
now provide a right of offset or cash settlement as an alternative to
making or
taking delivery of the underlying commodity.
The
forward markets provide what has typically been a highly liquid market
for
foreign exchange trading, and in certain cases the prices quoted for
foreign
exchange forward contracts may be more favorable than the prices for
foreign
exchange futures contracts traded on U.S. exchanges. The forward markets
are
largely unregulated. Forward contracts are, in general, not cleared
or
guaranteed by a third party. Commercial banks participating in trading
foreign
exchange forward contracts often do not require margin deposits, but
rely upon
internal credit limitations and their judgments regarding the creditworthiness
of their counterparties. In recent years, however, many over-the-counter
market
participants in foreign exchange trading have begun to require that
their
counterparties post margin.
Further,
as the result of the CFMA, over-the-counter derivative instruments such
as
forward contracts and swap agreements (and options on forwards and physical
commodities) may begin to be traded on lightly-regulated exchanges or
electronic
trading platforms that may, but are not required to, provide for clearing
facilities. Exchanges and electronic trading platforms on which over-the-counter
instruments may be traded and the regulation and criteria for that trading
are
more fully described below under “Futures Exchanges and Clearing Organizations.”
Nonetheless, absent a clearing facility, US12OF’s trading in foreign exchange
and other forward contracts is exposed to the creditworthiness of the
counterparties on the other side of the trade.
Options
on Futures
Contracts
Options
on futures contracts are standardized contracts traded on an exchange.
An option
on a futures contract gives the buyer of the option the right, but not
the
obligation, to take a position at a specified price (the striking, strike,
or
exercise price) in the underlying futures contract or underlying interest.
The
buyer of a call option acquires the right, but not the obligation, to
purchase
or take a long position in the underlying interest, and the buyer of
a put
option acquires the right, but not the obligation, to sell or take a
short
position in the underlying interest.
The
seller, or writer, of an option is obligated to take a position in the
underlying interest at a specified price opposite to the option buyer
if the
option is exercised. Thus, the seller of a call option must stand ready
to take
a short position in the underlying interest at the strike price if the
buyer
should exercise the option. The seller of a put option, on the other
hand, must
stand ready to take a long position in the underlying interest at the
strike
price.
A
call
option is said to be in-the-money if the strike price is below current
market
levels and out-of-the-money if the strike price is above current market
levels.
Conversely, a put option is said to be in-the-money if the strike price
is above
the current market levels and out-of-the-money if the strike price is
below
current market levels.
Options
have limited life spans, usually tied to the delivery or settlement date
of the
underlying interest. Some options, however, expire significantly in advance
of
such date. The purchase price of an option is referred to as its premium,
which
consists of its intrinsic value (which is related to the underlying market
value) plus its time value. As an option nears its expiration date, the
time
value shrinks and the market and intrinsic values move into parity. An
option
that is out-of-the-money and not offset by the time it expires becomes
worthless. On certain exchanges, in-the-money options are automatically
exercised on their expiration date, but on others unexercised options
simply
become worthless after their expiration date.
Regardless
of how much the market swings, the most an option buyer can lose is the
option
premium. The option buyer deposits his premium with his broker, and the
money
goes to the option seller. Option sellers, on the other hand, face risks
similar
to participants in the futures markets. For example, since the seller
of a call
option is assigned a short futures position if the option is exercised,
his risk
is the same as someone who initially sold a futures contract. Because
no one can
predict exactly how the market will move, the option seller posts margin
to
demonstrate his ability to meet any potential contractual
obligations.
Options
on Forward Contracts or
Commodities
Options
on forward contracts or commodities operate in a manner similar to
options on
futures contracts. An option on a forward contract or commodity gives
the buyer
of the option the right, but not the obligation, to take a position
at a
specified price in the underlying forward contract or commodity. However,
similar to forward contracts, options on forward contracts or on commodities
are
individually negotiated contracts between counterparties and are typically
traded in the over-the-counter market. Therefore, options on forward
contracts
and physical commodities possess many of the same characteristics of
forward
contracts with respect to offsetting positions and credit risk that
are
described above.
Swap
Contracts
Swap
transactions generally involve contracts between two parties to exchange
a
stream of payments computed by reference to a notional amount and the
price of
the asset that is the subject of the swap. Swap contracts are principally
traded
off-exchange, although recently, as a result of regulatory changes
enacted as
part of the CFMA, certain swap contracts are now being traded in electronic
trading facilities and cleared through clearing organizations.
Swaps
are
usually entered into on a net basis, that is, the two payment streams
are netted
out in a cash settlement on the payment date or dates specified in
the
agreement, with the parties receiving or paying, as the case may be,
only the
net amount of the two payments. Swaps do not generally involve the
delivery of
underlying assets or principal. Accordingly, the risk of loss with
respect to
swaps is generally limited to the net amount of payments that the party
is
contractually obligated to make. In some swap transactions one or both
parties
may require collateral deposits from the counterparty to support that
counterparty’s obligation under the swap agreement. If the counterparty to such
a swap defaults, the risk of loss consists of the net amount of payments
that
the party is contractually entitled to receive less any collateral deposits
it is holding.
Block
Trading
Block
Trading refers to privately negotiated futures or option transactions
executed
apart from the public auction market. A block transaction may be
executed either
on or off the exchange trading floor but is still reported to and
cleared by the
exchange.
Exchange
for Physical
A
technique (originated in physical commodity markets) whereby a position
in the
underlying subject of a derivatives contract is traded for a futures
position.
In financial futures markets, the EFP bypasses any cash settlement
mechanism
that is built into the contract and substitutes physical settlement.
EFPs are
used primarily to adjust underlying cash market positions at a low
trading cost.
An EFP by itself will not change either party’s net risk position materially,
but EFPs are often used to set up a subsequent trade which will modify
the
investor’s market risk exposure at low cost.
Exchange
for Swap
An
Exchange For Swap (“EFS”) is an off market transaction which involves the
swapping (or exchanging) of an over-the-counter (OTC) position for
a futures
position. The OTC transaction must be for the same or similar quantity
or amount
of a specified commodity, or a substantially similar commodity or
instrument.
The OTC side of the EFS can include swaps, swap options, or other
instruments
traded in the OTC market.
In
order
that an EFS transaction can take place, the OTC side and futures
components must
be “substantially similar” in terms of either value and or quantity. The net
result is that the OTC position (and the inherent counterparty credit
exposure)
is transferred from the OTC market to the futures market. EFSs can
also work in
reverse, where a futures position can be reversed and transferred
to the OTC
market.
Participants
The
two
broad classes of persons who trade commodities are hedgors and speculators.
Hedgors include financial institutions that manage or deal in interest
rate-sensitive instruments, foreign currencies or stock portfolios,
and
commercial market participants, such as farmers and manufacturers,
that market
or process commodities. Hedging is a protective procedure designed
to lock in
profits that could otherwise be lost due to an adverse movement in
the
underlying commodity, for example, the adverse price movement between
the time a
merchandiser or processor enters into a contract to buy or sell a raw
or
processed commodity at a certain price and the time he must perform
the
contract. In such a case, at the time the hedgor contracts to physically
sell
the commodity at a future date he will simultaneously buy a futures
or forward
contract for the necessary equivalent quantity of the commodity. At
the time for
performance of the contract, the hedgor may accept delivery under his
futures
contract and sell the commodity quantity as required by his physical
contract or
he may buy the actual commodity, sell if under the physical contract
and close
out his position by making an offsetting sale of a futures
contract.
The
commodity interest markets enable the hedgor to shift the risk of price
fluctuations. The usual objective of the hedgor is to protect the profit
that he
expects to earn from farming, merchandising, or processing operations
rather
than to profit from his trading. However, at times the impetus for
a hedge
transaction may result in part from speculative objectives.
Unlike
the hedgor, the speculator generally expects neither to make nor take
delivery
of the underlying commodity. Instead, the speculator risks his capital
with the
hope of making profits from price fluctuations in the commodities.
The
speculator is, in effect, the risk bearer who assumes the risks that
the hedgor
seeks to avoid. Speculators rarely make or take delivery of the underlying
commodity; rather they attempt to close out their positions prior to
the
delivery date. Because the speculator may take either a long or short
position
in commodities, it is possible for him to make profits or incur losses
regardless of whether prices go up or down.
Futures
Exchanges and Clearing
Organizations
Futures
exchanges provide centralized market facilities in which multiple persons
have
the ability to execute or trade contracts by accepting bids and offers
from
multiple participants. Futures exchanges may provide for execution
of trades at
a physical location utilizing trading pits and/or may provide for trading
to be
done electronically through computerized matching of bids and offers
pursuant to
various algorithms. Members of a particular exchange and the trades
executed on
such exchange are subject to the rules of that exchange. Futures exchanges
and
clearing organizations are given reasonable latitude in promulgating
rules and
regulations to control and regulate their members. Examples of regulations
by
exchanges and clearing organizations include the establishment of initial
margin
levels, rules regarding trading practices, contract specifications,
speculative
position limits, daily price fluctuation limits, and execution and
clearing
fees.
U.S.
Futures
Exchanges
Futures
exchanges in the United States are subject to varying degrees of regulation
by
the CFTC based on their designation as one of the following: a designated
contract market, a derivatives transaction execution facility, an exempt
board
of trade or an electronic trading facility.
A
designated contract market is the most highly regulated level of futures
exchange. Designated contract markets may offer products to retail
customers on
an unrestricted basis. To be designated as a contract market, the exchange
must
demonstrate that it satisfies specified general criteria for designation,
such
as having the ability to prevent market manipulation, rules and procedures
to
ensure fair and equitable trading, position limits, dispute resolution
procedures, minimization of conflicts of interest and protection of
market
participants. Among the principal designated contract markets in the
United
States are the Chicago Board of Trade, the Chicago Mercantile Exchange
and the
NYMEX. Each of the designated contract markets in the United States
must provide
for the clearance and settlement of transactions with a CFTC-registered
derivatives clearing organization.
A
derivatives transaction execution facility (a "DTEF"), is a new type
of exchange
that is subject to fewer regulatory requirements than a designated
contract
market but is subject to both commodity interest and participant limitations.
DTEFs limit access to eligible traders that qualify as either eligible
contract
participants or eligible commercial entities for futures and option
contracts on
commodities that have a nearly inexhaustible deliverable supply, are
highly
unlikely to be susceptible to the threat of manipulation, or have no
cash
market, security futures products, and futures and option contracts
on
commodities that the CFTC may determine, on a case-by-case basis, are
highly
unlikely to be susceptible to the threat of manipulation. In addition,
certain
commodity interests excluded or exempt from the CEA, such as swaps,
etc. may be
traded on a DTEF. There is no requirement that a DTEF use a clearing
organization, except with respect to trading in security futures contracts,
in
which case the clearing organization must be a securities clearing
agency.
However, if futures contracts and options on futures contracts on a
DTEF are
cleared, then it must be through a CFTC-registered derivatives clearing
organization, except that some excluded or exempt commodities traded
on a DTEF
may be cleared through a clearing organization other than one registered
with
the CFTC.
An
exempt
board of trade is also a newly designated form of exchange. An exempt
board of
trade is substantially unregulated, subject only to CFTC anti-fraud
and
anti-manipulation authority. An exempt board of trade is permitted
to trade
futures contracts and options on futures contracts provided that the
underlying
commodity is not a security or securities index and has an inexhaustible
deliverable supply or no cash market. All traders on an exempt board
of trade
must qualify as eligible contract participants. Contracts deemed eligible
to be
traded on an exempt board of trade include contracts on interest rates,
exchange
rates, currencies, credit risks or measures, debt instruments, measures
of
inflation, or other macroeconomic indices or measures. There is no
requirement
that an exempt board of trade use a clearing organization. However,
if contracts
on an exempt board of trade are cleared, then it must be through a
CFTC-registered derivatives clearing organization. A board of trade
electing to
operate as an exempt board of trade must file a written notification
with the
CFTC.
An
electronic trading facility is a new form of exchange that operates
by means of
an electronic or telecommunications network and maintains an automated
audit
trail of bids, offers, and the matching of orders or the execution
of
transactions on the electronic trading facility. The CEA does not apply
to, and
the CFTC has no jurisdiction over, transactions on an electronic trading
facility in certain excluded commodities that are entered into between
principals that qualify as eligible contract participants, subject
only to CFTC
anti-fraud and anti-manipulation
authority. In general, excluded commodities include interest rates,
currencies,
securities, securities indices or other financial, economic or commercial
indices or measures.
The
General Partner intends to monitor the development of and opportunities
and
risks presented by the new less-regulated exchanges and exempt boards
and may,
in the future, allocate a percentage of US12OF’s assets to trading in products
on these exchanges. Provided US12OF maintains assets exceeding $5 million,
US12OF would qualify as an eligible contract participant and thus would
be able
to trade on such exchanges.
Non-U.S.
Futures
Exchanges
Non-U.S.
futures exchanges differ in certain respects from their U.S. counterparts.
Importantly, non-U.S. futures exchanges are not subject to regulation
by the
CFTC, but rather are regulated by their home country regulator. In
contrast to
U.S. designated contract markets, some non-U.S. exchanges are principals’
markets, where trades remain the liability of the traders involved,
and the
exchange or an affiliated clearing organization, if any, does not become
substituted for any party. Due to the absence of a clearing system,
such
exchanges are significantly more susceptible to disruptions. Further,
participants in such markets must often satisfy themselves as to the
individual
creditworthiness of each entity with which they enter into a trade.
Trading on
non-U.S. exchanges is often in the currency of the exchange’s home jurisdiction.
Consequently, US12OF is subject to the additional risk of fluctuations
in the
exchange rate between such currencies and U.S. dollars and the possibility
that
exchange controls could be imposed in the future. Trading on non-U.S.
exchanges
may differ from trading on U.S. exchanges in a variety of ways and,
accordingly,
may subject US12OF to additional risks.
Accountability
Levels
and Position Limits
The
CFTC
and U.S. designated contract markets have established accountability
levels and
position limits on the maximum net long or net short futures contracts in
commodity interests that any person or group of persons under common
trading control (other than a hedgor, which US12OF is not) may hold,
own or
control. Among the purposes of accountability levels and position limits
is to
prevent a corner or squeeze on a market or undue influence on prices
by any
single trader or group of traders. The position limits currently established
by
the CFTC apply to certain agricultural commodity interests, such as
grains
(oats, barley, and flaxseed), soybeans, corn, wheat, cotton, eggs,
rye, and
potatoes, but not to interests in energy products. In addition, U.S.
exchanges
may set accountability levels and position limits for all commodity
interests
traded on that exchange. For example, the current accountability level
for
investments at any one time in crude oil Futures Contracts (including
investments in the Benchmark Futures Contract) on the NYMEX is 20,000
contracts. The NYMEX also imposes position limits on contracts held
in the last
few days of trading in the near month contract to expire. Certain exchanges
or
clearing organizations also set limits on the total net positions that
may be
held by a clearing broker. In general, no position limits are in effect
in
forward or other over-the-counter contract trading or in trading on
non-U.S.
futures exchanges, although the principals with which US12OF and the
clearing
brokers may trade in such markets may impose such limits as a matter
of credit
policy. For purposes of determining accountability levels and position
limits
US12OF’s commodity interest positions will not be attributable to investors
in
their own commodity interest trading.
Daily
Price
Limits
Most
U.S.
futures exchanges (but generally not non-U.S. exchanges) limit the amount
of fluctuation in some futures contract or options on a futures contract
prices
during a single trading period by regulations. These regulations specify
what
are referred to as daily price fluctuation limits or more commonly,
daily
limits. The daily limits establish the maximum amount that the price
of a
futures or options on futures contract may vary either up or down from
the
previous day’s settlement price. Once the daily limit has been reached in a
particular futures or option on a futures contract, no trades may be made
at a price beyond the limit. Positions in the futures or options contract
may
then be taken or liquidated, if at all, only at inordinate expense
or if traders
are willing to effect trades at or within the limit during the period
for
trading on such day. Because the daily limit rule governs price movement
only
for a particular trading day, it does not limit losses and may in fact
substantially increase losses because it may prevent the liquidation
of
unfavorable positions. Futures contract prices have occasionally moved
to the daily limit for several consecutive trading days, thus preventing
prompt liquidation of positions and subjecting the trader to substantial
losses
for those days. The concept of daily price limits is not relevant to
over-the-counter contracts, including forwards and swaps, and thus
such limits
are not imposed by banks and others who deal in those markets.
In
contrast, the NYMEX does not impose daily limits but rather limits
the amount of
price fluctuation for Futures Contracts. For example, the NYMEX imposes
a
$10.00 per barrel ($10,000 per contract) price fluctuation limit for crude
oil Futures Contracts. This limit is initially based off of the previous
trading day’s settlement price. If any Futures Contract is traded, bid, or
offered at the limit for five minutes, trading is halted for five minutes.
When
trading resumes it begins at the point where the limit was imposed
and the limit
is reset to be $10.00 per barrel in either direction of that point.
If another
halt were triggered, the market would continue to be expanded by $10.00
per
barrel in either direction after each successive five-minute trading
halt. There
is no maximum price fluctuation limit during any one trading
session.
Commodity
Prices
Commodity
prices are volatile and, although ultimately determined by the interaction
of
supply and demand, are subject to many other influences, including
the
psychology of the marketplace and speculative assessments of future
world and
economic events. Political climate, interest rates, treaties, balance
of
payments, exchange controls and other governmental interventions as
well as
numerous other variables affect the commodity markets, and even with
comparatively complete information it is impossible for any trader
to predict
reliably commodity prices.
Regulation
Futures
exchanges in the United States are subject to varying degrees of regulation
under the CEA depending on whether such exchange is a designated contract
market, DTEF, exempt board of trade or electronic trading facility.
Derivatives
clearing organizations are also subject to the CEA and CFTC regulation.
The CFTC
is the governmental agency charged with responsibility for regulation
of futures
exchanges and commodity interest trading conducted on those exchanges.
The
CFTC’s function is to implement the CEA’s objectives of preventing price
manipulation and excessive speculation and promoting orderly and efficient
commodity interest markets. In addition, the various exchanges and
clearing
organizations themselves exercise regulatory and supervisory authority
over
their member firms.
The
CFTC
possesses exclusive jurisdiction to regulate the activities of CPOs
and
commodity trading advisors and has adopted regulations with respect
to the
activities of those persons and/or entities. Under the CEA, a registered
CPO,
such as the General Partner, is required to make annual filings with
the CFTC
describing its organization, capital structure, management and controlling
persons. In addition, the CEA authorizes the CFTC to require and review
books
and records of, and documents prepared by, registered CPOs. Pursuant
to this
authority, the CFTC requires CPOs to keep accurate, current and orderly
records
for each pool that they operate. The CFTC may suspend the registration
of
a CPO (1) if the CFTC finds that the operator’s trading practices tend to
disrupt orderly market conditions, (2) if any controlling person of
the operator
is subject to an order of the CFTC denying such person trading privileges
on any
exchange, and (3) in certain other circumstances. Suspension, restriction
or
termination of the General Partner’s registration as a CPO would prevent it,
until that registration were to be reinstated, from managing US12OF,
and might
result in the termination of US12OF. US12OF itself is not required
to be
registered with the CFTC in any capacity.
The
CEA
gives the CFTC similar authority with respect to the activities of
commodity
trading advisors. If a trading advisor’s commodity trading advisor registration
were to be terminated, restricted or suspended, the trading advisor
would be
unable, until the registration were to be reinstated, to render trading
advice
to US12OF.
The
CEA
requires all futures commission merchants, such as US12OF’s clearing brokers, to
meet and maintain specified fitness and financial requirements, to
segregate
customer funds from proprietary funds and account separately for all
customers’
funds and positions, and to maintain specified books and records open
to
inspection by the staff of the CFTC. The CFTC has similar authority
over
introducing brokers, or persons who solicit or accept orders for commodity
interest trades but who do not accept margin deposits for the execution
of
trades. The CEA authorizes the CFTC to regulate trading by futures
commission
merchants and by their officers and directors, permits the CFTC to
require
action by exchanges in the event of market emergencies, and establishes
an
administrative procedure under which customers may institute complaints
for
damages arising from alleged violations of the CEA. The CEA also gives
the
states powers to enforce its provisions and the regulations of the
CFTC.
Pursuant
to authority in the CEA, the NFA has been formed and registered with
the CFTC as
a registered futures association. At the present time, the NFA is the
only
self-regulatory organization for commodity interest professionals,
other than
futures exchanges. The CFTC has delegated to the NFA responsibility
for the
registration of commodity trading advisors, CPOs, futures commission
merchants,
introducing brokers, and their respective associated persons and floor
brokers.
The General Partner, each trading advisor, the selling agents and the
clearing
brokers are members of the NFA. As such, they are subject to NFA standards
relating to fair trade practices, financial condition and consumer
protection.
US12OF itself is not required to become a member of the NFA. As the
self-regulatory body of the commodity interest industry, the NFA promulgates
rules governing the conduct of professionals and disciplines those
professionals
that do not comply with these rules. The NFA also arbitrates disputes
between
members and their customers and conducts registration and fitness screening
of
applicants for membership and audits of its existing members.
The
regulations of the CFTC and the NFA prohibit any representation by
a person
registered with the CFTC or by any member of the NFA, that registration
with the
CFTC, or membership in the NFA, in any respect indicates that the CFTC
or the
NFA, as the case may be, has approved or endorsed that person or that
person’s
trading program or objectives. The registrations and memberships of
the parties
described in this summary must not be considered as constituting any
such
approval or endorsement. Likewise, no futures exchange has given or
will give
any similar approval or endorsement.
The
regulation of commodity interest trading in the United States and other
countries is an evolving area of the law. The various statements made
in this
summary are subject to modification by legislative action and changes
in the
rules and regulations of the CFTC, the NFA, the futures exchanges,
clearing
organizations and other regulatory bodies.
The
function of the CFTC is to implement the objectives of the CEA of preventing
price manipulation and other disruptions to market integrity, avoiding
systemic
risk, preventing fraud and promoting innovation, competition and financial
integrity of transactions. As mentioned above, this regulation, among
other
things, provides that the trading of commodity interest contracts generally
must
be upon exchanges designated as contract markets or DTEFs and that
all trading
on those exchanges must be done by or through exchange members. Under
the CFMA,
commodity interest trading in some commodities between sophisticated
persons may
be traded on a trading facility not regulated by the CFTC. As a general
matter,
trading in spot contracts, forward contracts, options on forward contracts
or
commodities, or swap contracts between eligible contract participants
is not
within the jurisdiction of the CFTC and may therefore be effectively
unregulated. The trading advisors may engage in those transactions
on behalf of
US12OF in reliance on this exclusion from regulation.
In
general, the CFTC does not regulate the interbank and forward foreign
currency
markets with respect to transactions in contracts between certain sophisticated
counterparties such as US12OF or between certain regulated institutions
and
retail investors. Although U.S. banks are regulated in various ways
by the
Federal Reserve Board, the Comptroller of the Currency and other U.S.
federal
and state banking officials, banking authorities do not regulate the
forward
markets.
While
the
U.S. government does not currently impose any restrictions on the movements
of
currencies, it could choose to do so. The imposition or relaxation
of exchange
controls in various jurisdictions could significantly affect the market
for that
and other jurisdictions’ currencies. Trading in the interbank market also
exposes US12OF to a risk of default since failure of a bank with which
US12OF
had entered into a forward contract would likely result in a default
and thus
possibly substantial losses to US12OF.
The
CFTC
is prohibited by statute from regulating trading on non-U.S. futures
exchanges
and markets. The CFTC, however, has adopted regulations relating to
the
marketing of non-U.S. futures contracts in the United States. These
regulations
permit certain contracts traded on non-U.S. exchanges to be offered
and sold in
the United States.
Commodity
Margin
Brokerage
firms, such as US12OF’s clearing brokers, carrying accounts for traders in
commodity interest contracts may not accept lower, and generally require
higher,
amounts of margin as a matter of policy to further protect themselves.
The
clearing brokers require US12OF to make margin deposits equal to exchange
minimum levels for all commodity interest contracts. This requirement
may be
altered from time to time in the clearing brokers’ discretion.
Trading
in the over-the-counter markets where no clearing facility is provided
generally
does not require margin but generally does require the extension of
credit
between counterparties.
When
a
trader purchases an option, there is no margin requirement; however,
the option
premium must be paid in full. When a trader sells an option, on the
other hand,
he or she is required to deposit margin in an amount determined by
the margin
requirements established for the underlying interest and, in addition,
an amount
substantially equal to the current premium for the option. The margin
requirements imposed on the selling of options, although adjusted to
reflect the
probability that out-of-the-money options will not be exercised, can
in fact be
higher than those imposed in dealing in the futures markets directly.
Complicated margin requirements apply to spreads and conversions, which
are
complex trading strategies in which a trader acquires a mixture of
options
positions and positions in the underlying interest.
Margin
requirements are computed each day by a trader’s clearing broker. When the
market value of a particular open commodity interest position changes
to a point
where the margin on deposit does not satisfy maintenance margin requirements,
a
margin call is made by the broker. If the margin call is not met within
a
reasonable time, the broker may close out the trader’s position. With respect to
US12OF’s trading, US12OF (and not its investors personally) is subject to
margin
calls.
Finally,
many major U.S. exchanges have passed certain cross margining arrangements
involving procedures pursuant to which the futures and options positions
held in
an account would, in the case of some accounts, be aggregated and margin
requirements would be assessed on a portfolio basis, measuring the
total risk of
the combined positions.
The
risk
factors should be read in connection with the other information
included in this
annual report on Form 10-K, including Management’s Discussion and Analysis of
Financial Condition and Results of Operations and US12OF’s condensed financial
statements and the related notes.
Investing
in Crude Oil Interests subjects US12OF to the risks of the crude
oil industry
and this could result in large fluctuations in the price of US12OF’s
units.
US12OF
is
subject to the risks and hazards of the crude oil industry because
it invests in
oil interests. The risks and hazards that are inherent in the
oil industry may
cause the price of oil to widely fluctuate. If US12OF’s units accurately track
the percentage changes in the Benchmark Futures Contracts or
the spot price of
light, sweet crude oil, then the price of its units may also
fluctuate.
The
risks
of crude oil drilling and production activities include the
following:
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no
commercially productive crude oil or natural gas reservoirs
will be
found;
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crude
oil and natural gas drilling and production activities
may be shortened,
delayed or canceled;
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the
ability of an oil producer to develop, produce and
market reserves may be
limited by:
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political
conflicts, including war,
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compliance
with governmental requirements,
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mechanical
difficulties or shortages or delays in the delivery
of drilling rigs and
other equipment;
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decisions
of the cartel of oil producing countries (e.g., OPEC),
to produce more or
less oil;
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increases
in oil production due to price rises may make it more
economical to
extract oil from additional sources and may later temper
further oil price
increases; and
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economic
activity of users, as certain economies expand, oil
consumption and prices
increase (e.g., China, India) and as economies contract
(in a recession or
depression), oil demand and prices
fall.
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The
crude
oil industry experiences numerous operating risks. These operating
risks include
the risk of fire, explosions, blow-outs, pipe failure, abnormally
pressured
formations and environmental hazards. Environmental hazards include
oil spills,
natural gas leaks, ruptures and discharges of toxic gases.
Crude
oil
operations also are subject to various U.S. federal, state and
local regulations
that materially affect operations. Matters regulated include
discharge permits
for drilling operations, drilling and abandonment bonds, reports
concerning
operations, the spacing of wells and pooling of properties and
taxation. At
various times, regulatory agencies have imposed price controls
and limitations
on production. In order to conserve supplies of crude oil and
natural gas, these
agencies have restricted the rates of flow of crude oil and natural
gas wells
below actual production capacity. Federal, state, and local laws
regulate
production, handling, storage, transportation and disposal of
crude oil and
natural gas, by-products from crude oil and natural gas and other
substances and
materials produced or used in connection with crude oil and natural
gas
operations.
The
price of US12OF’s units may be influenced by factors such as the supply and
demand for crude oil and the supply and demand for US12OF’s units. This may
cause the units to trade at a price that is above or below US12OF’s NAV per
unit. Accordingly, changes in the price of units may substantially
vary from
changes in the price of light, sweet crude oil. If this variation
occurs, then
investors may not be able to effectively use US12OF as a way
to hedge against
crude oil-related losses or as a way to indirectly invest in
crude
oil.
While
it
is expected that the trading prices of the units will fluctuate
in accordance
with the changes in US12OF’s NAV, the prices of units may also be influenced by
other factors, including the supply and demand for crude oil
and the units.
There is no guarantee that the units will not trade at appreciable
discounts
from, and/or premiums to, US12OF’s NAV. This could cause the changes in the
price of the units to substantially vary from the changes in
the price of light,
sweet crude oil. This may be harmful to investors because if
changes in the
price of units vary substantially from changes in the Benchmark
Futures Contract
or the spot price of light, sweet crude oil, then investors may
not be able to
effectively use US12OF as a way to hedge the risk of losses in
their crude
oil-related transactions or as a way to indirectly invest in
crude oil.
Changes
in US12OF’s NAV may not correlate with changes in the price of the Benchmark
Futures Contracts. If this were to occur, investors may not be
able to
effectively use US12OF as a way to hedge against crude oil-related
losses or as
a way to indirectly invest in crude oil.
The
General Partner will endeavor to invest US12OF’s assets as fully as possible in
Futures Contracts and Other Crude Oil-Related Investments so that
the changes in
percentage terms in the NAV will closely correlate with the changes
in
percentage terms in the price of the Benchmark Futures Contracts.
However,
changes in US12OF’s NAV may not correlate with changes in the price of the
Benchmark Futures Contracts for several reasons as set forth below:
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US12OF
(i) may not be able to buy/sell the exact amount of Futures
Contracts and
Other Crude Oil-Related Investments to have a perfect
correlation with
NAV; (ii) may not always be able to buy and sell Futures
Contracts or
Other Crude Oil-Related Investments at the market price;
(iii) may not
experience a perfect correlation between the Benchmark
Futures Contract
and the underlying investments in Futures Contracts,
Other Crude
Oil-Related Investments and Treasuries, cash and/or cash
equivalents; and
(iv) is required to pay fees, including brokerage fees
and the management
fee, which will have an effect on the
correlation.
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Supply
and demand for crude oil may cause the changes in the
market price of the
Benchmark Futures Contracts to vary from changes in US12OF’s NAV if US12OF
has fully invested in Futures Contracts that do not reflect
such supply
and demand and it is unable to replace such contracts
with Futures
Contracts that do reflect such supply and
demand.
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US12OF
plans to buy only as many Futures Contracts and Other
Crude Oil-Related
Investments that it can to get the changes in percentage
terms of the NAV
as close as possible to the changes in percentage terms
in the price of
the Benchmark Futures Contracts. The remainder of its
assets will be
invested in Treasuries, cash and/or cash equivalents
and will be used to
satisfy initial margin and additional margin requirements,
if any, and to
otherwise support its investments in Crude Oil Interests.
Investments in
Treasuries, cash and/or cash equivalents, both directly
and as margin,
will provide rates of return that will vary from changes
in the value of
the price of light, sweet crude oil and the price of
the Benchmark Futures
Contract.
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In
addition, because US12OF will incur certain expenses
in connection with
its investment activities, and will hold most of its
assets in more liquid
short-term securities for margin and other liquidity
purposes and for
redemptions that may be necessary on an ongoing basis,
the General Partner
will not be able to fully invest US12OF’s assets in Futures Contracts or
Other Crude Oil-Related Investments and there cannot
be perfect
correlation between changes in US12OF’s NAV and changes in the price of
the Benchmark Futures Contracts.
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As
US12OF grows, there may be more or less correlation.
For example, if
US12OF only has enough money to buy three Benchmark Futures
Contracts and
it needs to buy four contracts to track the price of
light, sweet crude
oil then the correlation will be lower, but if it buys
20,000 Benchmark
Futures Contracts and it needs to buy 20,001 contracts
then the
correlation will be higher. At certain asset levels,
US12OF may be limited
in its ability to purchase the Benchmark Futures Contracts
or other
Futures Contracts due to accountability levels imposed
by the relevant
exchanges. To the extent that US12OF invests in these
other Futures
Contracts or Other Crude Oil-Related Investments, the
correlation with the
Benchmark Futures Contracts may be lower. If US12OF is
required to invest
in other Futures Contracts and Other Crude Oil-Related
Investments that
are less correlated with the Benchmark Futures Contracts,
US12OF would
likely invest in over-the-counter contracts to increase
the level of
correlation of US12OF’s assets. Over-the-counter contracts entail certain
risks described below under “Over-the-Counter Contract
Risk.”
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US12OF
anticipates that it will invest in equal amounts of each
of the Benchmark
Futures Contracts. Certain months of these futures contracts
may have less
liquidity and availability than other months of these
future contracts.
The inability to purchase and hold the Benchmark Futures
Contracts in
equal amounts may cause less correlation between the
units’ NAV and the
average of the prices of the Benchmark Futures
Contracts.
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US12OF
may not be able to buy the exact number of Futures Contracts
and Other
Crude Oil-Related Investments to have a perfect correlation
with the
Benchmark Futures Contracts if the purchase price of
Futures Contracts
required to be fully invested in such contracts is higher
than the
proceeds received for the sale of a Creation Basket on
the day the basket
was sold. In such case, US12OF could not invest the entire
proceeds from
the purchase of the Creation Basket in such futures contracts
(for
example, assume US12OF receives $4,000,000 for the sale
of a Creation
Basket and assume that the average of the prices of the
Futures Contracts
for crude oil that reflects the prices of the Benchmark
Futures Contracts
is $65.94, then US12OF could only invest in Futures Contracts
with an
aggregate value of $3,956,700), US12OF would be required
to invest a
percentage of the proceeds in Treasuries to be deposited
as margin with
the futures commission merchant through which the contract
was purchased.
The remainder of the purchase price for the Creation
Basket would remain
invested in Treasuries, cash and/or cash equivalents
as determined by the
General Partner from time to time based on factors such
as potential calls
for margin or anticipated redemptions. If the trading
market for Futures
Contracts is suspended or closed, US12OF may not be able
to purchase these
investments at the last reported price for such
investments.
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US12OF
may make use of “mini” contracts as a way of investing a dollar amount in
contracts that may more closely match the dollar amount
of net assets of
the fund. However, even the use of mini contracts does
not completely
eliminate the risk that US12OF will not be able to buy
or sell the exact
number of Futures Contracts necessary. In addition there
is a risk that
because of the size and relative liquidity of such contracts
when compared
to standard size Futures Contracts such as the Benchmark
Futures
Contracts, the price of a smaller contract for a particular
month may not
equate to the Benchmark Futures Contract for the same
month, which could
cause the change in the US12OF’s per unit price and NAV to vary from
changes in the average price of the Benchmark Futures
Contracts.
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If
changes in US12OF’s NAV do not correlate with changes in the price of the
Benchmark Futures Contracts, then investing in US12OF may not be
an effective
way to hedge against crude oil-related losses or indirectly invest
in crude
oil.
The
Benchmark Futures Contracts may not correlate with the price of
light, sweet
crude oil and this could cause the changes in the price of units
to
substantially vary from changes in the price of light, sweet crude
oil. If this
were to occur, then investors may not be able to effectively use
US12OF as a way
to hedge against crude oil-related losses or as a way to indirectly
invest in
crude oil.
When
using the Benchmark Futures Contracts as a strategy to track the
price of light,
sweet crude oil, at best the correlation between changes in prices
of such Crude
Oil Interests and the delivery price of crude oil can be only approximate.
The
degree of imperfection of correlation depends upon circumstances
such as
variations in the speculative crude oil market, supply of and demand
for such
Crude Oil Interests and technical influences in futures trading.
If there is a
weak correlation between the Crude Oil Interests and the price
of light, sweet
crude oil, then the price of units may not accurately track the
price of light,
sweet crude oil and investors may not be able to effectively use
US12OF as a way
to hedge the risk of losses in their crude oil-related transactions
or as a way
to indirectly invest in crude oil.
US12OF
may experience a loss if it is required to sell Treasuries at a
price lower than
the price at which they were acquired.
The
value
of Treasuries generally moves inversely with movements in interest
rates. If
US12OF is required to sell Treasuries at a price lower than the
price at which
they were acquired, US12OF will experience a loss. This loss may
adversely
impact the price of the units and may decrease the correlation
between the price
of the units, the price of the Benchmark Futures Contracts and
Other Crude
Oil-Related Investments, and the delivery price of light, sweet
crude
oil.
Certain
of US12OF’s investments could be illiquid which could cause large losses
to
investors at any time or from time to time.
At
any
given time, US12OF may own 12 different monthly crude oil contracts
which have
differing expiration schedules. The amount of liquidity in the
crude oil futures
market for each of those months will vary. In some cases certain
of those months
may have relatively small amounts of open interest and daily trading
volume. As
a result, US12OF may not always be able to liquidate its positions
in its
investments at the desired price. It is difficult to execute a
trade at a
specific price when there is a relatively small volume of buy and
sell orders in
a market. A market disruption, such as a foreign government taking
political
actions that disrupt the market in its currency, its crude oil
production or
exports, or in another major export, can also make it difficult
to liquidate a
position. Alternatively, limits imposed by futures exchanges or
other regulatory
organizations, such as accountability levels, position limits and
price
fluctuation limits, may contribute to a lack of liquidity with
respect to some
Crude Oil Interests.
Unexpected
market illiquidity may cause major losses to investors at any time
or from time
to time. In addition, US12OF does not intend at this time to establish
a credit
facility, which would provide an additional source of liquidity
and instead will
rely only on the Treasuries, cash and/or cash equivalents that
it holds. The
anticipated large value of the positions in Futures Contracts that
the General
Partner will acquire or enter into for US12OF increases the risk
of illiquidity.
Other Crude Oil-Related Investments that US12OF invests in, such
as negotiated
over-the-counter contracts, may have a greater likelihood of being
illiquid
since they are contracts between two parties that take into account
not only
market risk, but also the relative credit, tax, and settlement
risks under such
contracts. Such contracts also have limited transferability that
results from
such risks and from the contract’s express limitations.
Because
both Futures Contracts and Other Crude Oil-Related Investments
may be illiquid,
US12OF’s Crude Oil Interests may be more difficult to liquidate at favorable
prices in periods of illiquid markets and losses may be incurred
during the
period in which positions are being liquidated.
If
the nature of hedgors and speculators in futures markets has shifted
such that
crude oil purchasers are the predominant hedgors in the market,
US12OF might
have to reinvest at higher futures prices or choose Other Crude
Oil-Related
Investments.
The
changing nature of the hedgors and speculators in the crude oil
market will
influence whether futures prices are above or below the expected
future spot
price. In order to induce speculators to take the corresponding
long side of the
same futures contract, crude oil producers must generally be willing
to sell
futures contracts at prices that are below expected future spot
prices.
Conversely, if the predominant hedgors in the futures market are
the purchasers
of the crude oil who purchase futures contracts to hedge against
a rise in
prices, then speculators will only take the short side of the futures
contract
if the futures price is greater than the expected future spot price
of crude
oil. This can have significant implications for US12OF when it
is time to
reinvest the proceeds from a maturing Futures Contract into a new
Futures
Contract.
While
US12OF does not intend to take physical delivery of crude oil
under its Futures
Contracts, physical delivery under such contracts impacts the
value of the
contracts.
While
it
is not the current intention of US12OF to take physical delivery
of crude oil
under its Futures Contracts, futures contracts are not required
to be
cash-settled and it is possible to take delivery under these
contracts. Storage
costs associated with purchasing crude oil could result in
costs and other
liabilities that could impact the value of Futures Contracts
or Other Crude
Oil-Related Investments. Storage costs include the time value
of money invested
in crude oil as a physical commodity plus the actual costs
of storing the crude
oil less any benefits from ownership of crude oil that are
not obtained by the
holder of a futures contract. In general, Futures Contracts
have a one-month
delay for contract delivery and the back month (the back month
is any future
delivery month other than the spot month) includes storage
costs. To the extent
that these storage costs change for crude oil while US12OF
holds Futures
Contracts or Other Crude Oil-Related Investments, the value
of the Futures
Contracts or Other Crude Oil-Related Investments, and therefore
US12OF’s NAV,
may change as well. Because it holds Futures Contracts that
will mature up to 13
months later than the spot or current month, US12OF’s NAV will be impacted more
from the changes in storage costs than would the NAV of a fund
that holds more
current futures contracts.
The
price relationship between the near month contract and the
other monthly
contracts that compose the Benchmark Futures Contracts will
vary and may impact
both the total return over time of US12OF’s NAV, as well as the degree to which
its total return tracks other crude oil price indices’ total
returns.
The
Benchmark Futures Contracts consist of the near month contract
to expire and the
contracts for the following eleven months, except during the
last two weeks of
the current month when the near month contract is sold and
replaced by the
futures contract for the thirteenth month following the current
month. In the
event of a crude oil futures market where near month contracts
trade at a higher
price than the price of contracts that expire later in time,
a situation
described as “backwardation” in the futures market, then absent the impact of
the overall movement in crude oil prices the value of the benchmark
contract
would tend to rise as it approaches expiration. As a result
the total return of
the Benchmark Futures Contract would tend to track higher.
Conversely, in the
event of a crude oil futures market where near month contracts
trade at a lower
price than the price of contracts that expire later in time,
a situation
described as “contango” in the futures market, then absent the impact of the
overall movement in crude oil prices the value of the benchmark
contract would
tend to decline as it approaches expiration. As a result the
total return of the
Benchmark Futures Contract would tend to track lower. When
compared to total
return of other price indices, such as the spot price of crude
oil, the impact
of backwardation and contango may lead the total return of
US12OF’s NAV to vary
significantly. In the event of a prolonged period of contango,
and absent the
impact of rising or falling crude oil prices, this could have
a significant
negative impact on US12OF’s NAV and total return. Furthermore, a portfolio that
consists of twelve different monthly contracts, ranging in
a “strip” from the
first month to the twelfth month, will be impacted differently
by contango and
backwardation than a portfolio that consists of just the first
month
contract.
Because
US12OF’s portfolio will typically hold as many as 12 different crude
oil futures
contracts at all times, it may be more expensive for US12OF
to buy or sell
futures contracts for its portfolio.
Because
US12OF will typically hold as many as 12 different futures
contracts at any one
time, the cost of trading a large number of different contracts
could be greater
than the cost of trading the same dollar amount using just
one contract. In
addition, the bid/ask spread for buying these different contracts
could also on
average be greater than the bid/ask spread for buying a single
futures contract
month. This could make it more expensive for US12OF to invest
compared to
investing in a single monthly contract. Wider bid/ask spreads
and/or higher
commission or brokerage costs would negatively impact an investor’s investment
returns in US12OF.
Because
US12OF’s portfolio will typically hold as many as 12 different crude
oil futures
contracts at all times, firms that make a market in the units
will also need to
hold multiple contracts when hedging their inventories of units
and when
creating or redeeming baskets. This could lead to the units
of US12OF trading at
wider bid/ask spreads in the secondary market than an exchange
traded security
holding crude oil futures that uses a fewer number of futures
contracts at any
given time.
Brokerage
firms or other market participants that make a secondary market
in the units of
US12OF may do so by simultaneously hedging their positions
by being long, or
short, the same Futures Contracts that US12OF holds in its
portfolio. The cost
to brokerage firms or other market participants in putting
on and taken off
these hedges is one of the factors that determine the size
of the bid/ask spread
they quote on a security such as US12OF. Because US12OF will
typically hold as
many as 12 different futures contracts at any one time, the
brokerage firms or
other market participants will also find themselves having
to trade a number of
different contracts as well. The cost of trading a large number
of different
contracts may be greater than the cost of trading the same
dollar amount using
just one contract. As a result, the bid/ask spread for US12OF
may be wider than
the bid/ask spread for an exchange traded security investing
in a fewer number
of futures contracts at any given time. The wider bid/ask spread
may negatively
impact an investor’s investment returns in US12OF.
Regulation
of the commodity interests and energy markets is extensive and
constantly
changing; future regulatory developments are impossible to predict
but may
significantly and adversely affect US12OF.
The
regulation of commodity interest transactions in the United
States is a rapidly
changing area of law and is subject to ongoing modification
by governmental and
judicial action. In addition, various national governments
have expressed
concern regarding the disruptive effects of speculative trading
in the energy
markets and the need to regulate the derivatives markets in
general. The effect
of any future regulatory change on US12OF is impossible to
predict, but could be
substantial and adverse.
If
an investor invests in US12OF for purposes of hedging, it might
be subject to
several risks including the possibility of losing the benefit
of favorable
market movement.
While
US12OF does not intend to engage in hedging strategies, participants
in the
crude oil or in other industries may use US12OF as a vehicle
to hedge the risk
of losses in their crude oil-related transactions. There are
several risks in
connection with using US12OF as a hedging device. While hedging
can provide
protection against an adverse movement in market prices, it
can also preclude a
hedgor’s opportunity to benefit from a favorable market movement.
In a hedging
transaction, the hedgor may be concerned that the hedged item
will increase in
price, but must recognize the risk that the price may instead
decline and if
this happens he will have lost his opportunity to profit from
the change in
price because the hedging transaction will result in a loss
rather than a gain.
Thus, the hedgor foregoes the opportunity to profit from favorable
price
movements.
In
addition, if the hedge is not a perfect one, the hedgor can
lose on the hedging
transaction and not realize an offsetting gain in the value
of the underlying
item being hedged.
When
using futures contracts as a hedging technique, at best, the
correlation between
changes in prices of futures contracts and of the items being
hedged can be only
approximate. The degree of imperfection of correlation depends
upon
circumstances such as: variations in speculative markets, demand
for futures and
for crude oil products, technical influences in futures trading,
and differences
between anticipated energy costs being hedged and the instruments
underlying the
standard futures contracts available for trading. Even a well-conceived
hedge
may be unsuccessful to some degree because of unexpected market
behavior as well
as the expenses associated with creating the hedge.
In
addition, using an investment in US12OF as a hedge for changes
in energy costs
(e.g.,
investing in
crude oil, heating oil, gasoline, natural gas or other fuels,
or electricity)
may not correlate because changes in the spot price of crude
oil may vary from
changes in energy costs because the spot price may not be at
the same rate as
changes in the price of other energy products, and, in any
case, the price of
crude oil does not reflect the refining, transportation, and
other costs that
may impact the hedgor’s energy costs.
An
investment in US12OF may provide investors little or no diversification
benefits. Thus, in a declining market, US12OF may have no gains
to offset an
investor’s losses from other investments, and an investor may suffer
losses on its investment in US12OF at the same time
it incurs losses with respect to other asset classes.
Historically,
Futures Contracts and Other Crude Oil-Related Investments have
generally been
non-correlated to the performance of other asset classes such
as stocks and
bonds. Non-correlation means that there is a low statistically
valid
relationship between the performance of futures and other commodity
interest
transactions, on the one hand, and stocks or bonds, on the
other hand. However,
there can be no assurance that such non-correlation will continue
during future
periods. If, contrary to historic patterns, US12OF’s performance were to move in
the same general direction as the financial markets, an investor
will obtain
little or no diversification benefits from an investment in
the units. In such a
case, US12OF may have no gains to offset an investor’s losses from other
investments, and an investor may suffer losses on its investment
in US12OF at
the same time it incurs losses with respect to other investments.
Variables
such as drought, floods, weather, embargoes, tariffs and other
political events
may have a larger impact on crude oil prices and crude oil-linked
instruments,
including Futures Contracts and Other Crude Oil-Related Investments,
than on
traditional securities. These additional variables may create
additional
investment risks that subject US12OF’s investments to greater volatility than
investments in traditional securities.
Non-correlation
should not be confused with negative correlation, where the
performance of two
asset classes would be opposite of each other. There is no
historic evidence
that the spot price of crude oil and prices
of
other financial assets, such as stocks and bonds, are negatively
correlated. In
the absence of negative correlation, US12OF cannot be expected
to be
automatically profitable during unfavorable periods for the
stock market, or
vice versa.
US12OF
is not a registered investment company so investors do not
have the protections
of the 1940 Act.
US12OF
is
not an investment company subject to the 1940 Act. Accordingly,
investors do not
have the protections afforded by that statute which, for example,
requires
investment companies to have a majority of disinterested directors
and regulates
the relationship between the investment company and its investment
manager.
US12OF
has no operating history so there is no performance history
to serve as a basis
for an investor to evaluate an investment in US12OF.
US12OF
is
new and has no operating history. Therefore, an investor does
not have the
benefit of reviewing the past performance of US12OF as a basis
for an investor
to evaluate an investment in US12OF. The General Partner’s current experience
involves managing USOF, an exchange traded security that invests primarily
in Futures Contracts for light, sweet crude oil, Treasuries,
cash and/or cash
equivalents. However, USOF has a different Benchmark Futures
Contract than
US12OF. USOF’s Benchmark Futures Contract consists of a single contract
which is
the contract nearest to expiration (unless that contract is
within two weeks of
expiration in which case it is the next nearest month to expiration).
The use of
a single contract as its benchmark means that the General Partner’s experience
with USOF may not be directly applicable to US12OF.
The
General Partner’s current experience also involves managing USNG, an
exchange traded security that invests primarily in Futures
Contracts for natural
gas, Treasuries, cash and/or cash equivalents. However,
there are significant
differences between the natural gas futures market and
that of crude oil
futures. The General Partner’s results with USNG may not be representative of
results that may be experienced with a fund investing in
crude oil
futures.
The
General Partner’s current experience also
involves managing USG, an exchange traded security that
invests primarily in
Futures Contracts for gasoline, cash and/or cash
equivalents. However, there are significant differences between the
gasoline futures market and that of crude oil futures. The General
Partner’s results with USG may not be representative of results
that may be
experienced with a fund investing in crude oil futures.
The
General Partner is leanly staffed and relies heavily on key
personnel to manage
trading activities.
In
managing and directing the day-to-day activities and affairs
of US12OF, the
General Partner relies heavily on Messrs. Nicholas Gerber, John Love
and John Hyland. If Messrs. Gerber, Love or Hyland were to leave
or be unable to carry out their present responsibilities, it
may have an adverse
effect on the management of US12OF. Furthermore, Messrs. Gerber,
Hyland
and Love currently are involved in the management of USOF, USNG
and
USG and the General Partner is currently in the process of registering
two
other exchange traded securities, USHO and US12NG. Messrs.
Gerber and Love
are also employed by Ameristock Corporation, a registered investment
adviser
that manages a public mutual fund. It is estimated that Mr.
Gerber will spend
approximately 50% of his time on US12OF, USNG, USOF, USG, USHO and
US12NG matters. Mr. Love will spend approximately 95% of his time
on
US12OF, USNG, USOF, USG, USHO and US12NG matters and Mr. Hyland will spend
approximately 75% of his time on US12OF, USNG, USOF, USG, USHO and
US12NG matters. To the extent that the General Partner establishes
additional funds, even greater demands will be placed on Messrs.
Gerber, Love and Hyland, as well as the other officers of the General
Partner, including Mr. Mah, the Chief Financial Officer, and
its Board of
Directors.
Accountability
levels, position limits, and daily price fluctuation limits
set by the exchanges
have the potential to cause a tracking error, which could cause
the price of
units to substantially vary from the price of the Benchmark
Futures Contracts
and prevent an investor from being able to effectively use
US12OF as a way to
hedge against crude oil-related losses or as a way to indirectly
invest in crude
oil.
U.S.
designated contract markets such as the NYMEX have established
accountability
levels and position limits on the maximum net long or net short
futures
contracts in commodity interests that any person or group of
persons under
common trading control (other than as a hedge, which an investment
in US12OF is
not) may hold, own or control. For example, the current accountability
level for
investments at any one time in the Benchmark Futures Contract is 20,000.
While this is not a fixed ceiling, it is a threshold above
which the NYMEX may
exercise greater scrutiny and control over an investor, including
limiting an
investor to holding no more than 20,000 Benchmark Futures Contracts.
With regard
to position limits, the NYMEX limits an investor from holding
more than 3,000
net futures in the last 3 days of trading in the near month
contract to
expire.
In
addition to accountability levels and position limits, the
NYMEX also sets daily
price fluctuation limits on the Benchmark Futures Contracts.
The daily price
fluctuation limit establishes the maximum amount that the price
of a futures
contract may vary either up or down from the previous day’s settlement price.
Once the daily price fluctuation limit has been reached in
a particular Futures
Contract, no trades may be made at a price beyond that limit.
For
example, the NYMEX imposes a $10.00 per barrel ($10,000 per
contract) price
fluctuation limit for the Benchmark Futures Contracts. This
limit is initially
based off of the previous trading day’s settlement price. If any Benchmark
Futures Contract is traded, bid, or offered at the limit for
five minutes,
trading is halted for five minutes. When trading resumes it
begins at the point
where the limit was imposed and the limit is reset to be $10.00
per barrel in
either direction of that point. If another halt were triggered,
the market would
continue to be expanded by $10.00 per barrel in either direction
after each
successive five-minute trading halt. There is no maximum price
fluctuation limit
during any one trading session.
All
of
these limits may potentially cause a tracking error between
the price of the
units and the price of the Benchmark Futures Contracts. This
may in turn prevent
an investor from being able to effectively use US12OF as a
way to hedge against
crude oil-related losses or as a way to indirectly invest in
crude
oil.
US12OF
is
not limiting the size of the offering and is committed to utilizing
substantially all of its proceeds to purchase Futures Contracts
and Other Crude
Oil-Related Investments. If US12OF encounters accountability
levels, position
limits, or price fluctuation limits for crude oil contracts
on the NYMEX, it may
then, if permitted under applicable regulatory requirements,
purchase Futures
Contracts on the ICE Futures (formerly, the International Petroleum
Exchange) or
other exchanges that trade listed crude oil futures. The Futures
Contracts
available on the ICE Futures are comparable to the contracts
on the NYMEX, but
they may have different underlying commodities, sizes, deliveries,
and
prices.
There
are technical and fundamental risks inherent in the trading
system the General
Partner intends to employ.
The
General Partner’s trading system is quantitative in nature and it is possible
that the General Partner might make a mathematical error. In
addition, it is
also possible that a computer or software program may malfunction
and cause an
error in computation.
US12OF
and the General Partner may have conflicts of interest, which
may permit them to
favor their own interests to the detriment of an investor.
US12OF
and the General Partner may have inherent conflicts to the
extent the General
Partner attempts to maintain US12OF’s asset size in order to preserve its fee
income and this may not always be consistent with US12OF’s objective of having
the value of its unit’s NAV track changes in the price of the Benchmark Futures
Contracts. The General Partner’s officers, directors and employees do not devote
their time exclusively to US12OF. These persons are directors,
officers or
employees of other entities that may compete with US12OF for
their services.
They could have a conflict between their responsibilities to
US12OF and to those
other entities.
In
addition, the General Partner’s principals, officers, directors or employees may
trade futures and related contracts for their own account.
A conflict of
interest may exist if their trades are in the same markets
and at the same time
as US12OF trades using the clearing broker to be used by US12OF.
A potential
conflict also may occur if the General Partner’s principals, officers, directors
or employees trade their accounts more aggressively or take
positions in their
accounts which are opposite, or ahead of, the positions taken
by
US12OF.
The
General Partner has sole current authority to manage the investments
and
operations of US12OF, and this may allow it to act in a way
that furthers its
own interests which may create a conflict with the best interests
of an
investor. Limited partners have limited voting control, which
will limit the
ability to influence matters such as amendment of the LP Agreement,
change in
US12OF’s basic investment policy, dissolution of this fund, or the
sale or
distribution of US12OF’s assets.
The
General Partner serves as the general partner of each of USOF,
USNG, USG, USHO
and US12NG, as well as US12OF. The General Partner may have a conflict
to the extent that its trading decisions for US12OF may be
influenced by the
effect they would have on the other funds it manages. These
trading decisions
may be influenced since the General Partner also serves as
the general partner
for all of the funds, and is required to meet all of the funds’ investment
objectives as well as US12OF’s. If the General Partner believes that a trading
decision it made on behalf of US12OF might (i) impede its other
funds from
reaching their investment objectives, or (ii) improve the likelihood
of meeting
its other funds’ objectives, then the General Partner may choose to change its
trading decision for US12OF, which could either impede or improve
the
opportunity for US12OF from meeting its investment objective.
In addition, the
General Partner is required to indemnify the officers and directors
of its other
funds if the need for indemnification arises. This potential
indemnification
will cause the General Partner’s assets to decrease. If the General Partner’s
other sources of income are not sufficient to compensate for
the
indemnification, then the General Partner may terminate and
an investor could
lose its investment.
Unitholders
may only vote on the removal of the General Partner and limited
partners have
only limited voting rights. Unitholders and limited partners
will not
participate in the management of US12OF and do not control
the General Partner
so they will not have influence over basic matters that affect
US12OF.
Unitholders
that have not applied to become limited partners have no voting
rights, other
than to remove the General Partner. Limited partners will have
limited voting
rights with respect to US12OF’s affairs. Unitholders may remove the General
Partner only if 66 and 2/3% of the unitholders elect to do
so. Unitholders and
limited partners will not be permitted to participate in the
management or
control of US12OF or the conduct of its business. Unitholders
and limited
partners must therefore rely upon the duties and judgment of
the General Partner
to manage US12OF’s affairs.
The
General Partner may manage a large amount of assets and this
could affect
US12OF’s ability to trade profitably.
Increases
in assets under management may affect trading decisions. In
general, the General
Partner does not intend to limit the amount of assets of US12OF that it
may
manage. The more assets the General Partner manages, the more
difficult it may
be for it to trade profitably because of the difficulty of
trading larger
positions without adversely affecting prices and performance
and of managing
risk associated with larger positions.
US12OF
could terminate at any time and cause the liquidation and potential
loss of an
investor’s investment and could upset the overall maturity and timing
of
an investor’s investment portfolio.
US12OF
may terminate at any time, regardless of whether US12OF has
incurred losses,
subject to the terms of the LP Agreement. In particular, unforeseen
circumstances, including the death, adjudication of incompetence,
bankruptcy,
dissolution, or removal of the General Partner could cause
US12OF to terminate
unless a majority interest of the limited partners within 90
days of the event
elects to continue the partnership and appoints a successor
general partner.
However, no level of losses will require the General Partner
to terminate
US12OF. US12OF’s termination would cause the liquidation and potential loss
of
an investor’s investment. Termination could also negatively affect the
overall
maturity and timing of an investor’s investment portfolio.
Limited
partners may not have limited liability in certain circumstances,
including
potentially having liability for the return of wrongful
distributions.
Under
Delaware law, a limited partner might be held liable for our
obligations as if
it were a General Partner if the limited partner participates
in the control of
the partnership’s business and the persons who transact business with the
partnership think the limited partner is the General Partner.
A
limited
partner will not be liable for assessments in addition to its
initial capital
investment in any of our capital securities representing
units. However, a limited partner may be required to repay to us any
amounts wrongfully returned or distributed to it under some
circumstances. Under
Delaware law, US12OF may not make a distribution to limited
partners if the
distribution causes our liabilities (other than liabilities
to partners on
account of their partnership interests and nonrecourse liabilities)
to exceed
the fair value of our assets. Delaware law provides that a
limited partner who
receives such a distribution and knew at the time of the distribution
that the
distribution violated the law will be liable to the limited
partnership for the
amount of the distribution for three years from the date of
the
distribution.
With
adequate notice, a limited partner may be required to withdraw
from the
partnership for any reason.
If
the
General Partner gives at least fifteen (15) days’ written notice to a limited
partner, then the General Partner may for any reason, in its
sole discretion,
require any such limited partner to withdraw entirely from
the partnership or to
withdraw a portion of its partner capital account. The General
Partner may
require withdrawal even in situations where the limited partner
has complied
completely with the provisions of the LP Agreement.
US12OF’s
existing units are, and any units US12OF issues in the future
will be, subject
to restrictions on transfer. Failure to satisfy these requirements
will preclude
an investor from being able to have all the rights of a limited
partner.
No
transfer of any unit or interest therein may be made if such
transfer would (a)
violate the then applicable federal or state securities laws
or rules and
regulations of the SEC, any state securities commission, the
CFTC or any other
governmental authority with jurisdiction over such transfer,
or (b) cause US12OF
to be taxable as a corporation or affect US12OF’s existence or qualification as
a limited partnership. In addition, investors may only become
limited partners
if they transfer their units to purchasers that meet certain
conditions outlined
in the LP Agreement, which provides that each record holder
or limited partner
or unitholder applying to become a limited partner (each a
record holder) may be
required by the General Partner to furnish certain information,
including that
holder’s nationality, citizenship or other related status. A transferee
who is
not a U.S. resident may not be eligible to become a record
holder or a limited
partner if its ownership would subject US12OF to the risk of
cancellation or
forfeiture of any of its assets under any federal, state or
local law or
regulation. All purchasers of US12OF’s units, who wish to become limited
partners or record holders, and receive cash distributions,
if any, or have
certain other rights, must deliver an executed transfer application
in which the
purchaser or transferee must certify that, among other things,
he, she or it
agrees to be bound by US12OF’s LP Agreement and is eligible to purchase US12OF’s
securities. Any transfer of units will not be recorded by the
transfer agent or
recognized by us unless a completed transfer application is
delivered to the
General Partner or the Administrator. A person purchasing US12OF’s existing
units, who does not execute a transfer application and certify
that the
purchaser is eligible to purchase those securities acquires
no rights in those
securities other than the right to resell those securities.
Whether or not a
transfer application is received or the consent of the General
Partner obtained,
our units will be securities and will be transferable according
to the laws
governing transfers of securities. See “Transfer of Units.”
US12OF
does not expect to make cash distributions.
The
General Partner intends to re-invest any realized gains in
Crude Oil Interests
rather than distributing cash to limited partners. Therefore,
unlike mutual
funds, commodity pools or other investment pools that actively
manage their
investments in an attempt to realize income and gains from
their investing
activities and distribute such income and gains to their investors,
US12OF
generally does not expect to distribute cash to limited partners.
An investor
should not invest in US12OF if it will need cash distributions
from US12OF to
pay taxes on its share of income and gains of US12OF, if any,
or for any other
reason. Although US12OF does not intend to make cash distributions,
the income
earned from its investments held directly or posted as margin
may reach levels
that merit distribution, e.g., at levels where such income
is not necessary to
support its underlying investments in crude oil interests and
an investor
adversely reacts to being taxed on such income without receiving
distributions
that could be used to pay such tax. If this income becomes
significant then cash
distributions may be made.
There
is a risk that US12OF will not earn trading gains sufficient
to compensate for
the fees and expenses that it must pay and as such US12OF may
not earn any
profit.
US12OF
pays brokerage charges of approximately 0.016% (including futures
commission
merchant fees of $4.00 per buy or sell), any licensing fees
for the use of
intellectual property, registration fees with the SEC, FINRA,
or other
regulatory agency in connection with offers and sales of the
units subsequent to
the initial offering of the units including the legal, printing,
accounting and
other expenses associated therewith. US12OF also pays the fees
and expenses,
including directors and officers liability insurance, of the
independent
directors, management fees of 0.60% of NAV on its average net
assets, tax
accounting and reporting costs and over-the-counter spreads
and extraordinary
expenses (i.e.
expenses
not in the ordinary course of business, including the indemnification
of any
person against liabilities and obligations to the extent permitted
by law and
required under the LP Agreement and under agreements entered
into by the General
Partner on US12OF’s behalf and the bringing and defending of actions at law or
in equity and otherwise engaging in the conduct of litigation
and the incurring
of legal expenses and the settlement of claims and litigation)
that cannot be
quantified. These fees and expenses must be paid in all cases
regardless of
whether US12OF’s activities are profitable. Accordingly, US12OF must earn
trading gains sufficient to compensate for these fees and expenses
before it can
earn any profit.
US12OF,
to date, has depended upon the General Partner to pay all its
expenses. If this
offering of units does not raise sufficient funds to pay US12OF’s future
expenses, the General Partner no longer pays such expenses
and no other source
of funding of expenses is found, US12OF will terminate and
an investor may lose
all or part of its investment.
To
date,
all of US12OF’s expenses have been funded by the General Partner. If the
General
Partner and US12OF are unsuccessful in raising sufficient funds
to cover its
expenses or in locating any other source of funding, US12OF
will terminate and
an investor may lose all or part of its investment.
US12OF
may incur higher fees and expenses upon renewing existing or
entering into new
contractual relationships.
The
clearing arrangements between the clearing brokers and US12OF
generally are
terminable by the clearing brokers once the clearing broker
has given US12OF
notice. Upon termination, the General Partner may be required
to renegotiate or
make other arrangements for obtaining similar services if US12OF
intends to
continue trading in Futures Contracts or Other Crude Oil-Related
Investments at
its present level of capacity. The services of any clearing
broker may not be
available, or even if available, these services may not be
available on the
terms as favorable as those of the expired or terminated clearing
arrangements.
US12OF
may miss certain trading opportunities because it will not
receive the benefit
of the expertise of independent trading advisors.
The
General Partner does not employ trading advisors for US12OF;
however, it
reserves the right to employ them in the future. The only advisor
to US12OF is
the General Partner. A lack of independent trading advisors
may be
disadvantageous to US12OF because it will not receive the benefit
of a trading
advisor’s expertise.
An
unanticipated number of redemption requests during a short
period of time could
have an adverse effect on the NAV of US12OF.
If
a
substantial number of requests for redemption of Redemption
Baskets are received
by US12OF during a relatively short period of time, US12OF
may not be able to
satisfy the requests from US12OF’s assets not committed to trading. As a
consequence, it could be necessary to liquidate positions in
US12OF’s trading
positions before the time that the trading strategies would
otherwise dictate
liquidation.
The
failure or bankruptcy of a clearing broker could result in
a substantial loss of
US12OF’s assets.
Under
CFTC regulations, a clearing broker maintains customers’ assets in a bulk
segregated account. If a clearing broker fails to do so, or
is unable to satisfy
a substantial deficit in a customer account, its other customers
may be subject
to risk of a substantial loss of their funds in the event of
that clearing
broker’s bankruptcy. In that event, the clearing broker’s customers, such as
US12OF, are entitled to recover, even in respect of property
specifically
traceable to them, only a proportional share of all property
available for
distribution to all of that clearing broker’s customers. US12OF also may be
subject to the risk of the failure of, or delay in performance
by, any exchanges
and markets and their clearing organizations, if any, on which
commodity
interest contracts are traded.
From
time
to time, the clearing brokers may be subject to legal or regulatory
proceedings
in the ordinary course of their business. A clearing broker’s involvement in
costly or time-consuming legal proceedings may divert financial
resources or
personnel away from the clearing broker’s trading operations, which could impair
the clearing broker’s ability to successfully execute and clear US12OF’s
trades.
Third
parties may infringe upon or otherwise violate intellectual
property rights or
assert that the General Partner has infringed or otherwise
violated their
intellectual property rights, which may result in significant
costs and diverted
attention.
Third
parties may utilize US12OF’s intellectual property or technology, including the
use of its business methods, trademarks and trading program
software, without
permission. The General Partner has a patent pending for US12OF’s business
method and it is registering its trademarks. US12OF does not
currently have any
proprietary software. However, if it obtains proprietary software
in the future,
then any unauthorized use of US12OF’s proprietary software and other technology
could also adversely affect its competitive advantage. US12OF
may have
difficulty monitoring unauthorized uses of its patents, trademarks,
proprietary
software and other technology. Also, third parties may independently
develop
business methods, trademarks or proprietary software and other
technology
similar to that of the General Partner or claim that the General
Partner has
violated their intellectual property rights, including their
copyrights,
trademark rights, trade names, trade secrets and patent rights.
As a result, the
General Partner may have to litigate in the future to protect
its trade secrets,
determine the validity and scope of other parties’ proprietary rights, defend
itself against claims that it has infringed or otherwise violated
other parties’
rights, or defend itself against claims that its rights are
invalid. Any
litigation of this type, even if the General Partner is successful
and
regardless of the merits, may result in significant costs,
divert its resources
from US12OF, or require it to change its proprietary software
and other
technology or enter into royalty or licensing agreements. See
“Legal Risks”
below.
The
success of US12OF depends on the ability of the General Partner to accurately
implement trading systems, and any failure to do so could subject US12OF
to
losses on such transactions.
The
General Partner anticipates using mathematical formulas built into a generally
available spreadsheet program to decide whether it should buy or sell Crude
Oil
Interests each day. Specifically, the General Partner anticipates using
the
spreadsheet to make mathematical calculations and to monitor positions
in Crude
Oil Interests and Treasuries and correlations to the Benchmark Futures
Contracts. The General Partner must accurately process the spreadsheets’ outputs
and execute the transactions called for by the formulas. In addition, US12OF
relies on the General Partner to properly operate and maintain its computer
and
communications systems. Execution of the formulas and operation of the
systems
are subject to human error. Any failure, inaccuracy or delay in implementing
any
of the formulas or systems and executing US12OF’s transactions could impair its
ability to achieve US12OF’s investment objective. It could also result in
decisions to undertake transactions based on inaccurate or incomplete
information. This could cause substantial losses on transactions.
US12OF
may experience substantial losses on transactions if the computer or
communications system fails.
US12OF’s
trading activities, including its risk management, depend on the integrity
and
performance of the computer and communications systems supporting them.
Extraordinary transaction volume, hardware or software failure, power or
telecommunications failure, a natural disaster or other catastrophe could
cause
the computer systems to operate at an unacceptably slow speed or even fail.
Any
significant degradation or failure of the systems that the General Partner
uses
to gather and analyze information, enter orders, process data, monitor
risk
levels and otherwise engage in trading activities may result in substantial
losses on transactions, liability to other parties, lost profit opportunities,
damages to the General Partner’s and US12OF’s reputations, increased operational
expenses and diversion of technical resources.
If
the computer and communications systems are not upgraded, US12OF’s financial
condition could be harmed.
The
development of complex computer and communications systems and new technologies
may render the existing computer and communications systems supporting
US12OF’s
trading activities obsolete. In addition, these computer and communications
systems must be compatible with those of third parties, such as the systems
of
exchanges, clearing brokers and the executing brokers. As a result, if
these
third parties upgrade their systems, the General Partner will need to make
corresponding upgrades to continue effectively its trading activities.
US12OF’s
future success will depend on US12OF’s ability to respond to changing
technologies on a timely and cost-effective basis.
US12OF
depends on the reliable performance of the computer and communications
systems
of third parties, such as brokers and futures exchanges, and may experience
substantial losses on transactions if they fail.
US12OF
depends on the proper and timely function of complex computer and communications
systems maintained and operated by the futures exchanges, brokers and other
data
providers that the General Partner uses to conduct trading activities.
Failure
or inadequate performance of any of these systems could adversely affect
the
General Partner’s ability to complete transactions, including its ability to
close out positions, and result in lost profit opportunities and significant
losses on commodity interest transactions. This could have a material adverse
effect on revenues and materially reduce US12OF’s available capital. For
example, unavailability of price quotations from third parties may make
it
difficult or impossible for the General Partner to use its proprietary
software
that it relies upon to conduct its trading activities. Unavailability of
records
from brokerage firms may make it difficult or impossible for the General
Partner
to accurately determine which transactions have been executed or the details,
including price and time, of any transaction executed. This unavailability
of
information also may make it difficult or impossible for the General Partner
to
reconcile its records of transactions with those of another party or to
accomplish settlement of executed transactions.
The
occurrence of a terrorist attack, or the outbreak, continuation or expansion
of
war or other hostilities could disrupt US12OF’s trading activity and materially
affect US12OF’s profitability.
The
operations of US12OF, the exchanges, brokers and counterparties with which
US12OF does business, and the markets in which US12OF does business could
be
severely disrupted in the event of a major terrorist attack or the outbreak,
continuation or expansion of war or other hostilities. The terrorist attacks
of
September 11, 2001 and the war in Iraq, global anti-terrorism initiatives
and
political unrest in the Middle East and Southeast Asia continue to fuel
this
concern.