UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 [No Fee Required] For the year ended December 31, 1999 or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 [No Fee Required] For the transition period from ___________to_______________ Commission File Number 0-17446 DEAN WITTER DIVERSIFIED FUTURES FUND II L.P. (Exact name of registrant as specified in its Limited Partnership Agreement) DELAWARE 13- 3490286 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) c/o Demeter Management Corporation Two World Trade Center, -62nd Fl., New York, N.Y. 10048 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (212) 392-5454 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class on which registered None None Securities registered pursuant to Section 12(g) of the Act: Units of Limited Partnership Interest (Title of Class) Indicate by check-mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check-mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K. [X] State the aggregate market value of the Units of Limited Partnership Interest held by non-affiliates of the registrant. The aggregate market value shall be computed by reference to the price at which units were sold, as of a specified date within 60 days prior to the date of filing: $7,718,657 at January 31, 2000. DOCUMENTS INCORPORATED BY REFERENCE (See Page 1) DEAN WITTER DIVERSIFIED FUTURES FUND II L.P. INDEX TO ANNUAL REPORT ON FORM 10-K DECEMBER 31, 1999 Page No. DOCUMENTS INCORPORATED BY REFERENCE. . . . . . . . . . . . . . . . . . . . 1 Part I . Item 1. Business. . . . . . . . . . . . . . . . . . . . . . . . . 2-4 Item 2. Properties. . . . . . . . . . . . . . . . . . . . . . . . 4 Item 3. Legal Proceedings. . . . . . . . . . . . . . . . . . . . . 4-6 Item 4. Submission of Matters to a Vote of Security Holders . . . 6 Part II. Item 5. Market for the Registrant's Partnership Units and Related Security Holder Matters . . . . . . . . . . . . 7 Item 6. Selected Financial Data . . . . . . . . . . . . . . . . . 8 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. . . . . . . . . . . 9-21 Item 7A.Quantitative and Qualitative Disclosures About Market Risk . . . . . . . . . . . . . . . . . . . . . . 21-33 Item 8. Financial Statements and Supplementary Data . . . . . . .33- 34 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. . . . . . . . . . 34 Part III. Item10. Directors and Executive Officers of the Registrant . . 35-39 Item11. Executive Compensation . . . . . . . . . . . . . . . . 39 Item12. Security Ownership of Certain Beneficial Owners and Management . . . . . . . . . . . . . . . . . . . . . 39 Item13. Certain Relationships and Related Transactions . . . . 39-40 Part IV. Item14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K . . . . . . . . . . . . . . . . . . 41 DOCUMENTS INCORPORATED BY REFERENCE Portions of the following documents are incorporated by reference as follows: Documents Incorporated Part of Form 10-K Partnership's Prospectus dated October 28, 1988 I Annual Report to Dean Witter Diversified Futures Fund II L.P. Limited Partners for the year ended December 31, 1999 II, III and IV PART I Item 1. BUSINESS (a) General Development of Business. Dean Witter Diversified Futures Fund II L.P. (the "Partnership") is a Delaware limited partnership organized to engage primarily in the speculative trading of commodity futures and forward contracts, physical commodities, and other commodity interests (collectively, "futures interests"). The general partner for the Partnership is Demeter Management Corporation ("Demeter"). The non-clearing commodity broker is Dean Witter Reynolds Inc. ("DWR") and an unaffiliated clearing commodity broker, Carr Futures Inc. ("Carr"), provides clearing and execution services. The trading manager is Dean Witter Futures & Currency Management Inc. ("DWFCM" or the "Trading Manager"). Demeter, DWR and DWFCM are wholly-owned subsidiaries of Morgan Stanley Dean Witter & Co. ("MSDW"). The Partnership's Net Asset Value per unit of limited partnership interest ("Unit(s)") as of December 31, 1999, was $2,556.25 representing a loss of 9.5 percent from the Net Asset Value per Unit of $2,824.45 at December 31, 1998. For a more detailed description of the Partnership's business, see subparagraph (c). (b) Financial Information about Industry Segments. For financial information reporting purposes, the Partnership is deemed to engage in one industry segment, the speculative trading of futures interests. The relevant financial information is presented in Items 6 and 8. (c) Narrative Description of Business. The Partnership is in the business of speculative trading of futures interests, pursuant to trading instructions provided by the Trading Manager. For a detailed description of the different facets of the Partnership's business, see those portions of the Partnership's Prospectus ("Prospectus"), dated October 28, 1988 incorporated by reference in this Form 10-K, set forth below: Facets of Business 1. Summary 1. "Summary of the Prospectus" (Pages 2-7). 2. Commodity Markets 2. "The Commodities Markets" (Pages 57-67). 3. Partnership's Trading 3. "Trading Policies" (Pages Arrangements and 28-29). "The Trading Policies Manager" (Pages 29- 38). 4. Management of the Part- 4. "The Management Agreement" nership (Pages 39-41). "The General Partner" (Pages 41-56) and "The Commodity Broker"(Pages 56-57). "The Limited Partnership Agreement" (Pages 68- 73). 5. Taxation of the Partner- 5. "Federal Income Tax ship's Limited Partners Aspects" and "State and Local Income Tax Aspects" (Pages 75- 83). (d) Financial Information About Foreign and Domestic Operations and Export Sales. The Partnership has not engaged in any operations in foreign countries; however, the Partnership (through the commodity brokers) enters into forward contract transactions where foreign banks are the contracting party and trades in futures interests on foreign exchanges. Item 2. PROPERTIES The executive and administrative offices are located within the offices of DWR. The DWR offices utilized by the Partnership are located at Two World Trade Center, 62nd Floor, New York, NY 10048. Item 3. LEGAL PROCEEDINGS The class actions first filed in 1996 in California and in New York State courts were each dismissed in 1999. However, in the New York State class action, plaintiffs appealed the trial court's dismissal of their case on March 3, 2000. On September 6, 10, and 20, 1996, and on March 13, 1997, purported class actions were filed in the Superior Court of the State of California, County of Los Angeles, on behalf of all purchasers of interests in limited partnership commodity pools sold by DWR. Named defendants include DWR, Demeter, DWFCM, MSDW, the Partnership, certain limited partnership commodity pools of which Demeter is the general partner (all such parties referred to hereafter as the "Morgan Stanley Dean Witter Parties") and certain trading advisors to those pools. On June 16, 1997, the plaintiffs in the above actions filed a consolidated amended complaint, alleging, among other things, that the defendants committed fraud, deceit, negligent misrepresentation, various violations of the California Corporations Code, intentional and negligent breach of fiduciary duty, fraudulent and unfair business practices, unjust enrichment, and conversion in the sale and operation of the various limited partnership commodity pools. The complaints seek unspecified amounts of compensatory and punitive damages and other relief. The court entered an order denying class certification on August 24, 1999. On September 24, 1999, the court entered an order dismissing the case without prejudice on consent. Similar purported class actions were also filed on September 18 and 20, 1996, in the Supreme Court of the State of New York, New York County, and on November 14, 1996 in the Superior Court of the State of Delaware, New Castle County, against the Morgan Stanley Dean Witter Parties and certain trading advisors on behalf of all purchasers of interests in various limited partnership commodity pools, including the Partnership, sold by DWR. A consolidated and amended complaint in the action pending in the Supreme Court of the State of New York was filed on August 13, 1997, alleging that the defendants committed fraud, breach of fiduciary duty, and negligent misrepresentation in the sale and operation of the various limited partnership commodity pools. The compalints seek unspecified amounts of compensatory and punitive damages and other relief. The New York Supreme Court dismissed the New York action in November 1998, but granted plaintiffs leave to file an amended complaint, which they did in early December 1998. The defendants filed a motion to dismiss the amended complaint with prejudice on February 1, 1999. By decision dated December 21, 1999, the New York Supreme Court dismissed the case with prejudice. In addition, on December 16, 1997, upon motion of the plaintiffs, the action pending in the Superior Court of the State of Delaware was voluntarily dismissed without prejudice. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. PART II Item 5. MARKET FOR THE REGISTRANT'S PARTNERSHIP UNITS AND RELATED SECURITY HOLDER MATTERS (a) Market Information There is no established public trading market for Units of the Partnership. (b) Holders The number of holders of Units at December 31, 1999 was approximately 473. (c) Distributions No distributions have been made by the Partnership since it commenced trading operations on January 18, 1989. Demeter has sole discretion to decide what distributions, if any, shall be made to investors in the Partnership. Demeter currently does not intend to make any distribution of Partnership profits. Item 6. SELECTED FINANCIAL DATA (in dollars) For the Years Ended December 31, 1999 1998 1997 1996 1995 Total Revenues (including interest) (65,754) 1,559,1102,490,979 643,498 1,556,726 Net Income (Loss) (948,607) 543,0881,247,087 (824,517) (410,574) Net Income (Loss) Per Unit (Limited & General Partners) (268.20) 140.02272.02 (122.41) (75.58) Total Assets 8,365,734 10,845,65411,801,172 12,617,666 15,550,215 Total Limited Partners' Capital 7,787,964 10,281,22311,209,045 12,019,867 14,341,357 Net Asset Value Per Unit 2,556.25 2,824.452,684.43 2,41 2.41 2,534.82 Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Liquidity. The Partnership deposits its assets with DWR as non- clearing broker and Carr as clearing broker in separate futures trading accounts established for the Trading Manager, which assets are used as margin to engage in trading. The assets are held in either non-interest-bearing bank accounts or in securities and instruments permitted by the Commodity Futures Trading Commission ("CFTC") for investment of customer segregated or secured funds. The Partnership's assets held by the commodity brokers may be used as margin solely for the Partnership's trading. Since the Partnership's sole purpose is to trade in futures and forwards, it is expected that the Partnership will continue to own such liquid assets for margin purposes. The Partnership's investment in futures, and forwards may, from time to time, be illiquid. Most U.S. futures exchanges limit fluctuations in prices during a single day by regulations referred to as "daily price fluctuations limits" or "daily limits". Trades may not be executed at prices beyond the daily limit. If the price for a particular futures contract has increased or decreased by an amount equal to the daily limit, positions in that futures contract can neither be taken nor liquidated unless traders are willing to effect trades at or within the limit. Futures prices have occasionally moved the daily limit for several consecutive days with little or no trading. These market conditions could prevent the Partnership from promptly liquidating its futures contracts and result in restrictions on redemptions. There is no limitation on daily price moves in trading forward contracts on foreign currency. The markets for some world currencies have low trading volume and are illiquid, which may prevent the Partnership from trading in potentially profitable markets or prevent the Partnership from promptly liquidating unfavorable positions in such markets and subjecting it to substantial losses. Either of these market conditions could result in restrictions on redemptions. The Partnership has never had illiquidity affect a material portion of its assets. Capital Resources. The Partnership does not have, or expect to have, any capital assets. Redemptions of Units in the future will affect the amount of funds available for investments in futures interests in subsequent periods. It is not possible to estimate the amount and therefore, the impact of future redemptions of Units. Results of Operations. General. The Partnership's results depend on its Trading Manager and the ability of the Trading Manager's trading programs to take advantage of price movements or other profit opportunities in the futures, forwards, and options markets. The following presents a summary of the Partnership's operations for the three years ended December 31, 1999 and a general discussion of its trading activities during each period. It is important to note, however, that the Trading Manager trades in various markets at different times and that prior activity in a particular market does not mean that such market will be actively traded by the Trading Manager or will be profitable in the future. Consequently, the results of operations of the Partnership are difficult to discuss other than in the context of its Trading Manager's trading activities on behalf of the Partnership as a whole and how the Partnership has performed in the past. At December 31, 1999, the Partnership's total capital was $8,053,814, a decrease of $2,521,152 from the Partnership's total capital of $10,574,966 at December 31, 1998. For the year ended December 31, 1999, the Partnership generated a net loss of $948,607, and total redemptions aggregated $1,572,545. For the year ended December 31, 1999, the Partnership recorded total trading losses, net of interest income, of $65,754 and posted a decrease in Net Asset Value per Unit. The Partnership experienced losses in the global interest rate futures markets, approximately 8.92%, primarily from short Australian interest rate futures positions as prices increased during July and August on the temporary strength in U.S. bonds and weaker-than-expected business spending data out of Australia. Additional losses were recorded from short Japanese bond futures positions as prices increased during the first quarter and third quarters. In the currency markets, losses of approximately 7.08% were recorded primarily from Australian dollar positions. Throughout a majority of the first quarter, losses were experienced from long Australian dollar positions as its value dropped significantly relative to the U.S. dollar on speculation regarding potential currency devaluations in the Asian region. Early in the third quarter, additional losses were recorded from long positions in this currency due to depressed commodities prices, emerging market concerns and on-going talks that China may eventually devalue its currency. Newly established short positions in the Australian dollar resulted in losses during September as its value strengthened relative to the U.S. dollar following the rally in gold prices. Offsetting currency gains of 3.76% were recorded from Japanese yen positions, primarily long positions. During the third quarter, gains were recorded from long positions in the Japanese yen as the value of the yen climbed to a 44-month high versus the U.S. dollar due to continued optimism over Japan's economic recovery. The energy markets produced gains of approximately 7.39%. During March, gains were recorded from long positions in oil futures as prices moved significantly higher on news that both OPEC and non-OPEC countries had reached an agreement to cut total output beginning April 1st. Gains were also recorded in this market complex during the third quarter after OPEC ministers confirmed that they would uphold their global cutbacks until April of next year. Total expenses for the year were $882,853, resulting in a net loss of $948,607. The value of a Unit decreased from $2,824.45 at December 31, 1998 to $2,556.25 at December 31, 1999. At December 31, 1998, the Partnership's total capital was $10,574,966, a decrease of $913,260 from the Partnership's total capital of $11,488,226 at December 31, 1997. For the year ended December 31, 1998, the Partnership generated net income of $543,088, and total redemptions aggregated $1,456,348. For the year ended December 31, 1998, the Partnership recorded total trading revenues, including interest income, of $1,559,110 and posted an increase in Net Asset Value per Unit. Gains of approximately 13.65% were recorded in the global interest rate futures markets from bond futures in most major world countries throughout the year. The most significant gains were recorded in German, by approximately 5.66%, U.S., by approximately 4.06% and Japanese bond futures, by approximately 2.99% from primarily long positions during August and September as investors sought the safety of fixed income investments from notable volatility in the global financial markets. Additional profits were recorded from short Japanese government bond futures positions during December as prices declined amid a surge in Japanese bond yields, which was attributed to news that Japan's Ministry of Finance will end outright purchases of government debt. Total expenses for the year were $1,016,022, resulting in net income of $543,088. The value of a Unit increased from $2,684.43 at December 31, 1997 to $2,824.45 at December 31, 1998. At December 31, 1997, the Partnership's total capital was $11,488,226, a decrease of $782,531 from the Partnership's total capital of $12,270,757, at December 31, 1996. For the year ended December 31, 1997, the Partnership generated net income of $1,247,087 and total redemptions aggregated $2,029,618. For the year ended December 31, 1997, the Partnership recorded total trading revenues, including interest income, of $2,490,979 and posted an increase in Net Asset Value per Unit. 1997 was a profitable year for the Partnership. Gains of approximately 19.13% were recorded in the currency markets primarily from sustained price movements during January and February and then again in November and December from short Japanese yen positions as the value of the U.S. dollar increased versus the yen. A portion of the Partnership's overall gains was offset by losses of approximately 5.00% recorded in the global interest rate futures markets primarily due to a sharp trend reversal in international interest rate futures prices during the fourth quarter and as a result of short-term volatility in domestic bond and stock index futures. Offsetting gains were recorded from long global interest rate futures positions during June and July. Although, many of the profitable periods with long price trends were followed by trend reversals and short-term volatile price movement, DWFCM's intermediate to long-term trend following trading methodology was able to retain profits. Total expenses for the year were $1,243,892, resulting in net income of $1,247,087. The value of a Unit increased from $2,412.41 at December 31, 1996 to $2,684.43 at December 31, 1997. The Partnership's overall performance record represents varied results of trading in different futures interests markets. For a further description of 1999, trading results, refer to the letter to the Limited Partners in the accompanying Annual Report to Limited Partners for the year ended December 31, 1999, which is incorporated by reference to Exhibit 13.01 of this Form 10-K. The Partnership's gains and losses are allocated among its partners for income tax purposes. Credit Risk. Financial Instruments. The Partnership is a party to financial instruments with elements of off-balance sheet market and credit risk. The Partnership may trade futures, forwards, and options in a portfolio of agricultural commodities, energy products, foreign currencies, interest rates, precious and base metals, soft commodities, and stock indices. In entering into these contracts, the Partnership is subject to the market risk that such contracts may be significantly influenced by market conditions, such as interest rate volatility, resulting in such contracts being less valuable. If the markets should move against all of the positions held by the Partnership at the same time, and if the Trading Manager was unable to offset positions of the Partnership, the Partnership could lose all of its assets and investors would realize a 100% loss. In addition to the Trading Manager's internal controls, the Trading Manager must comply with the trading policies of the Partnership. These trading policies include standards for liquidity and leverage with which the Partnership must comply. The Trading Manager and Demeter monitor the Partnership's trading activities to ensure compliance with the trading policies. Demeter may require the Trading Manager to modify positions of the Partnership if Demeter believes they violate the Partnership's trading policies. In addition to market risk, in entering into futures, forwards, and options contracts there is a credit risk to the Partnership that the counterparty on a contract will not be able to meet its obligations to the Partnership. The ultimate counterparty or guarantor of the Partnership for futures contracts traded in the United States and the foreign exchanges on which the Partnership trades is the clearinghouse associated with such exchange. In general, a clearinghouse is backed by the membership of the exchange and will act in the event of non-performance by one of its members or one of its member's customers, which should significantly reduce this credit risk. For example, a clearinghouse may cover a default by drawing upon a defaulting member's mandatory contributions and/or non- defaulting members' contributions to a clearinghouse guarantee fund, established lines or letters of credit with banks, and/or the clearinghouse's surplus capital and other available assets of the exchange and clearinghouse, or assessing its members. In cases where the Partnership trades off-exchange forward contracts with a counterparty, the sole recourse of the Partnership will be the forward contracts counterparty. There is no assurance that a clearinghouse or exchange will meet its obligations to the Partnership, and Demeter and the commodity brokers will not indemnify the Partnership against a default by such parties. Further, the law is unclear as to whether a commodity broker has any obligation to protect its customers from loss in the event of an exchange or clearinghouse defaulting on trades effected for the broker's customers. Any such obligation on the part of a broker appears even less clear where the default occurs in a non-U.S. jurisdiction. Demeter deals with these credit risks of the Partnership in several ways. First, it monitors the Partnership's credit exposure to each exchange on a daily basis, calculating not only the amount of margin required for it but also the amount of its unrealized gains at each exchange, if any. The commodity brokers inform the Partnership, as with all their customers, of its net margin requirements for all its existing open positions, but do not break that net figure down, exchange by exchange. Demeter, however, has installed a system which permits it to monitor the Partnership's potential margin liability, exchange by exchange. As a result, Demeter is able to monitor the Partnership's potential net credit exposure to each exchange by adding the unrealized trading gains on that exchange, if any, to the Partnership's margin liability thereon. Second, the Partnership's trading policies limit the amount of its Net Assets that can be committed at any given time to futures contracts and require, in addition, a minimum amount of diversification in the Partnership's trading, usually over several different products. One of the aims of such trading policies has been to reduce the credit exposure of the Partnership to a single exchange and, historically, the Partnership's exposure has typically amounted to only a small percentage of its total Net Assets. On those relatively few occasions where the Partnership's credit exposure may climb above that level, Demeter deals with the situation on a case by case basis, carefully weighing whether the increased level of credit exposure remains appropriate. Material changes to the trading policies may be made only with the prior written approval of the limited partners owning more than 50% of Units then outstanding. Third, Demeter has secured, with respect to Carr acting as the clearing broker for the Partnership, a guarantee by Credit Agricole Indosuez, Carr's parent, of the payment of the "net liquidating value" of the transactions (futures and forward contracts) in the Partnership's account. With respect to forward contract trading, the Partnership trades with only those counterparties which Demeter, together with DWR, have determined to be creditworthy. At the date of this filing, the Partnership deals only with Carr as its counterparty on forward contracts. The guarantee by Carr's parent, discussed above, covers these forward contracts. See "Financial Instruments" under Notes to Financial Statements in the Partnership's Annual Report to Limited Partners for the year ended December 31, 1999, which is incorporated by reference to Exhibit 13.01 of this Form 10-K. Year 2000. Commodity pools, like financial and business organizations and individuals around the world, depend on the smooth functioning of computer systems. The Year 2000 issue arose since many of the world's computer systems (including those in non-information technology systems) traditionally recorded years in a two-digit format. If not addressed, such computer systems may have been unable to properly interpret dates beyond the year 1999, which may have led to business disruptions in the U.S. and internationally. Such disruptions could have adversely affected the handling or determination of futures trades and prices and other services for the Partnership. Accordingly, Demeter has fully participated in a firmwide initiative established by MSDW to address issues associated with the Year 2000. As part of this initiative, MSDW reviewed its global software and hardware infrastructure for mainframe, server and desktop computing environments and engaged in extensive remediation and testing. The Year 2000 initiative also encompassed the review of agencies, vendors and facilities for Year 2000 compliance. Since 1995, MSDW prepared actively for the Year 2000 issue to ensure that it would have the ability to respond to any critical business process failure, to prevent the loss of workspace and technology, and to mitigate any potential financial loss or damage to its global franchise. Where necessary, contingency plans were expanded or developed to address specific Year 2000 risk scenarios, supplementing existing business policies and practices. In conjunction with MSDW's Year 2000 preparations, Demeter monitored the progress of Carr and the Trading Manager throughout 1999 in their Year 2000 compliance and, where applicable, tested its external interfaces, with Carr and the Trading Manager. In addition, Demeter, the commodity brokers, the Trading Manager and all U.S. futures exchanges were subjected to monitoring by the CFTC of their Year 2000 preparedness, and the major foreign futures exchanges engaged in market-wide testing of their Year 2000 compliance during 1999. MSDW and Demeter consider the transition into the Year 2000 successful from the perspective of their internal systems and global external interactions. Over the millennial changeover period, no material issues were encountered, and MSDW, Demeter and the Partnership conducted business as usual. Risks Associated With the Euro. On January 1, 1999, eleven countries in the European Union established fixed conversion rates on their existing sovereign currencies and converted to a common single currency (the euro). During a three-year transition period, the sovereign currencies will continue to exist but only as a fixed denomination of the euro. Conversion to the euro prevents the Trading Manager from trading those sovereign currencies and thereby limits its ability to take advantage of potential market opportunities that might otherwise have existed had separate currencies been available to trade. This could adversely affect the performance results of the Partnership. Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Introduction The Partnership is a commodity pool involved in the speculative trading of futures interests. The market-sensitive instruments held by the Partnership are acquired for speculative trading purposes only and, as a result, all or substantially all of the Partnership's assets are at risk of trading loss. Unlike an operating company, the risk of market-sensitive instruments is central, not incidental, to the Partnership's main business activities. The futures interests traded by the Partnership involve varying degrees of market risk. Market risk is often dependent upon changes in the level or volatility of interest rates, exchange rates, and prices of financial instruments and commodities. Fluctuations in market risk based upon these factors result in frequent changes in the fair value of the Partnership's open positions, and, consequently, in its earnings and cash flow. The Partnership's total market risk is influenced by a wide variety of factors, including the diversification among the Partnership's open positions, the volatility present within the markets, and the liquidity of the markets. At different times, each of these factors may act to increase or decrease the market risk associated with the Partnership. The Partnership's past performance is not necessarily indicative of its future results. Any attempt to numerically quantify the Partnership's market risk is limited by the uncertainty of its speculative trading. The Partnership's speculative trading may cause future losses and volatility (i.e. "risk of ruin") that far exceed the Partnership's experiences to date or any reasonable expectations based upon historical changes in market value. Quantifying the Partnership's Trading Value at Risk The following quantitative disclosures regarding the Partnership's market risk exposures contain "forward-looking statements" within the meaning of the safe harbor from civil liability provided for such statements by the Private Securities Litigation Reform Act of 1995 (set forth in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934). All quantitative disclosures in this section are deemed to be forward-looking statements for purposes of the safe harbor, except for statements of historical fact. The Partnership accounts for open positions using mark-to-market accounting principles. Any loss in the market value of the Partnership's open positions is directly reflected in the Partnership's earnings, whether realized or unrealized, and its cash flow. Profits and losses on open positions of exchange- traded futures interests are settled daily through variation margin. The Partnership's risk exposure in the market sectors traded by the Trading Manager is estimated below in terms of Value at Risk ("VaR"). The VaR model used by the Partnership includes many variables that could change the market value of the Partnership's trading portfolio. The Partnership estimates VaR using a model based upon historical simulation with a confidence level of 99%. Historical simulation involves constructing a distribution of hypothetical daily changes in the value of a trading portfolio. The VaR model takes into account linear exposures to price and interest rate risk. Market risks that are incorporated in the VaR model include equity and commodity prices, interest rates, foreign exchange rates, and correlation among these variables. The hypothetical changes in portfolio value are based on daily percentage changes observed in key market indices or other market factors ("market risk factors") to which the portfolio is sensitive. The historical observation period of the Partnership's VaR is approximately four years. The one-day 99% confidence level of the Partnership's VaR corresponds to the negative change in portfolio value that, based on observed market risk factors, would have been exceeded once in 100 trading days. VaR models, including the Partnership's, are continuously evolving as trading portfolios become more diverse and modeling techniques and systems capabilities improve. Please note that the VaR model is used to numerically quantify market risk for historic reporting purposes only and is not utilized by either Demeter or the Trading Manager in their daily risk management activities. The Partnership's Value at Risk in Different Market Sectors The following tables indicates the VaR associated with the Partnership's open positions as a percentage of total Net Assets by primary market risk category as of December 31, 1999 and 1998. As of December 31, 1999 and 1998, the Partnership's total capitalization was approximately $8 million and $11 million, respectively. Primary Market December 31, 1999 December 31, 1998 Risk Category Value at Risk Value at Risk Interest Rate (.22)% (.47)% Currency (.79) (.96) Commodity (.80) (1.04) Equity (.16) (.18) Aggregate Value at Risk (1.24)% (1.37)% Aggregate Value at Risk represents the aggregate VaR of all the Partnership's open positions and not the sum of the VaR of the individual Market Categories listed above. Aggregate VaR will be lower as it takes into account correlation among different positions and categories. The table above represents the VaR of the Partnership's open positions at December 31, 1999 and 1998 only and is not necessarily representative of either the historic or future risk of an investment in the Partnership. Because the Partnership's only business is the speculative trading of futures interests, the composition of its trading portfolio can change significantly over any given time period, or even within a single trading day. Any changes in open positions could positively or negatively materially impact market risk as measured by VaR. The table below supplements the year end VaR by presenting the Partnership's high, low and average VaR, as a percentage of total Net Assets for the four quarterly reporting periods from January 1, 1999 through December 31, 1999. Primary Market Risk Category High Low Average Interest Rate (1.93)% (.22)% (.96)% Currency (1.94) (.79) (1.60) Commodity (1.42) (.80) (1.07) Equity (.74) (.16) (.39) Aggregate Value at Risk (3.12)% (1.24)% (2.28)% Limitations on Value at Risk as an Assessment of Market Risk The face value of the market sector instruments held by the Partnership is typically many times the applicable margin requirements. Margin requirements generally range between 2% and 15% of contract face value. Additionally, the use of leverage causes the face value of the market sector instruments held by the Partnership to typically be many times the total capitalization of the Partnership. The value of the Partnership's open positions thus creates a "risk of ruin" not typically found in other investments. The relative size of the positions held may cause the Partnership to incur losses greatly in excess of VaR within a short period of time, given the effects of the leverage employed and market volatility. The VaR tables above, as well as the past performance of the Partnership, gives no indication of such "risk of ruin". In addition, VaR risk measures should be viewed in light of the methodology's limitations, which include the following: past changes in market risk factors will not always result in accurate predictions of the distributions and correlations of future market movements; changes in portfolio value in response to market movements may differ from those of the VaR model; VaR results reflect past trading positions while future risk depends on future positions; VaR using a one-day time horizon does not fully capture the market risk of positions that cannot be liquidated or hedged within one day; and the historical market risk factor data used for VaR estimation may provide only limited insight into losses that could be incurred under certain unusual market movements. The VaR tables above present the results of the Partnership's VaR for each of the Partnership's market risk exposures and on an aggregate basis at December 31, 1999 and for the end of the four quarterly reporting periods during calendar year 1999. Since VaR is based on historical data, VaR should not be viewed as predictive of the Partnership's future financial performance or its ability to manage or monitor risk. There can be no assurance that the Partnership's actual losses on a particular day will not exceed the VaR amounts indicated above or that such losses will not occur more than 1 in 100 trading days. Non-Trading Risk The Partnership has non-trading market risk on its foreign cash balances not needed for margin. These balances and any market risk they may represent are immaterial. The Partnership also maintains a substantial portion (approximately 91%) of its available assets in cash at DWR. A decline in short-term interest rates will result in a decline in the Partnership's cash management income. This cash flow risk is not considered material. Materiality, as used throughout this section, is based on an assessment of reasonably possible market movements and any associated potential losses, taking into account the leverage, optionality and multiplier features of the Partnership's market sensitive instruments. Qualitative Disclosures Regarding Primary Trading Risk Exposures The following qualitative disclosures regarding the Partnership's market risk exposures - except for (A) those disclosures that are statements of historical fact and (B) the descriptions of how the Partnership manages its primary market risk exposures - constitute forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act. The Partnership's primary market risk exposures as well as the strategies used and to be used by Demeter and the Trading Manager for managing such exposures are subject to numerous uncertainties, contingencies and risks, any one of which could cause the actual results of the Partnership's risk controls to differ materially from the objectives of such strategies. Government interventions, defaults and expropriations, illiquid markets, the emergence of dominant fundamental factors, political upheavals, changes in historical price relationships, an influx of new market participants, increased regulation and many other factors could result in material losses as well as in material changes to the risk exposures and the risk management strategies of the Partnership. Investors must be prepared to lose all or substantially all of their investment in the Partnership. The following were the primary trading risk exposures of the Partnership as of December 31, 1999, by market sector. It may be anticipated however, that these market exposures will vary materially over time. Interest Rate. The largest exposure in the fourth quarter was in the interest rate sector. Exposure was spread across the U.S., Swiss, Australian, and Japanese interest rate sectors. Interest rate movements directly affect the price of the sovereign bond positions held by the Partnership and indirectly affect the value of its stock index and currency positions. Interest rate movements in one country as well as relative interest rate movements between countries materially impact the Partnership's profitability. The Partnership's primary interest rate exposure is generally to interest rate fluctuations in the G-7 countries and Australia. The G-7 countries consist of France, U.S., Britain, Germany, Japan, Italy and Canada. Demeter anticipates that G-7 and Australian interest rates will remain the primary interest rate exposure of the Partnership for the foreseeable future. The changes in interest rates, which have the most effect on the Partnership, are changes in long-term and medium- term instruments. Consequently, even a material change in short- term rates would have little effect on the Partnership, were the medium to long term rates to remain steady. Currency. The next most significant exposure in the Partnership is in the currency complex. The Partnership's currency exposure is to exchange rate fluctuations, primarily fluctuations that disrupt the historical pricing relationships between different currencies and currency pairs. Interest rate changes as well as political and general economic conditions influence these fluctuations. The Partnership trades in a large number of currencies, including cross-rates i.e., positions between two currencies other than the U.S. Dollar. For the fourth quarter of 1999, the Partnership's foreign currency exposure was in the euro currency crosses and outright U.S. dollar positions (outright positions consist of the U.S. dollar vs. other currencies). The currency trading VaR figure includes foreign margin amounts converted into U.S. dollars with an incremental adjustment to reflect the exchange rate risk inherent to the dollar-based Partnership in expressing VaR in a functional currency other than dollars. Commodity. Metals. The next noteworthy exposure was in the base and precious metals markets. The Partnership's metals market exposure in the fourth quarter of 1999 was to fluctuations in the prices of base metals, as well as exposure in the gold and silver markets. A significant amount of exposure was evident in the base metals as the Partnership held sizeable positions due to a period of low volatility prior to the upward price breakout. The Partnership aims to equally weigh market exposure in the metals as much as possible, however base metals, during periods of volatility, will affect performance more dramatically than the precious metals markets. Demeter anticipates that base metals will remain the primary metals market exposure of the Partnership. Energy. On December 31, 1999, the Partnership's energy exposure was in futures contracts in the New York and Brent crude oil markets. Price movements in these markets result from political developments in the Middle East, weather patterns, and other economic fundamentals. As oil prices have increased over 100% this year, and, given that the agreement by OPEC to cut production is closing in on expiring in March of 2000, it is possible that volatility will remain on the high end. Significant profits and losses have been and are expected to continue to be experienced in these markets. Soft Commodities. On December 31, 1999, the Partnership had moderate exposure in the markets that comprise these sectors. Most of the exposure however was in the cotton and sugar markets. Supply and demand inequalities, severe weather disruptions and market expectations affect price movements in these markets. Equity. The Partnership's equity exposure on December 31, 1999 to price risk in the S&P 500 futures index was noteworthy. The stock index futures traded by the Partnership are by law limited to futures on broadly based indices. Demeter anticipates little, if any, trading in non G-7 stock indices. The Partnership is primarily exposed to the risk of adverse price trends or static markets in the U.S. and Japanese indices. (Static markets would not cause major market changes but would make it difficult for the Partnership to avoid being "whipsawed" into numerous small losses.) Qualitative Disclosures Regarding Non-Trading Risk Exposure The following was the only non-trading risk exposures of the Partnership as of December 31, 1999: Foreign Currency Balances. The Partnership's foreign currency balances are in Japanese yen, British pounds, euros, Swiss francs and Australian dollars. The Fund controls the non-trading risk of these balances by regularly converting these balances back into dollars upon liquidation of the respective position. Qualitative Disclosures Regarding Means of Managing Risk Exposure The Partnership and the Trading Manager, separately, attempt to manage the risk of the Partnership's open positions in essentially the same manner in all market categories traded. Demeter attempts to manage market exposure by diversifying the Partnership's assets among different market sectors and trading approaches, and monitoring the performance of the Trading Manager daily. In addition, the Trading Manager establishes diversification guidelines, often set in terms of the maximum margin to be committed to positions in any one market sector or market sensitive instrument. Demeter monitors and controls the risk of the Partnership's non- trading instrument, cash, which is the only Partnership investment directed by Demeter, rather than the Trading Manager. Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Financial Statements are incorporated by reference to the Partnership's Annual Report, which is filed as Exhibit 13.01 hereto. Supplementary data specified by Item 302 of Regulation S-K (selected quarterly financial data) is not applicable. Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT There are no directors or executive officers of the Partnership. The Partnership is managed by Demeter. Directors and Officers of the General Partner The directors and officers of Demeter are as follows: Robert E. Murray, age 39, is Chairman of the Board, President and a Director of Demeter. Mr. Murray is also Chairman of the Board, President and a Director of DWFCM. Effective as of the close of business on January 31, 2000, Mr. Murray replaced Mr. Hawley as Chairman of the Board of Demeter and DWFCM. Mr. Murray is currently a Senior Vice President of DWR's Managed Futures Department. Mr. Murray began his career at DWR in 1984 and is currently the Director of the Managed Futures Department. In this capacity, Mr. Murray is responsible for overseeing all aspects of the firm's Managed Futures Department. Mr. Murray currently serves as Vice Chairman and a Director of the Managed Funds Association, an industry association for investment professionals in futures, hedge funds and other alternative investments. Mr. Murray graduated from Geneseo State University in May 1983 with a B.A. degree in Finance. Mitchell M. Merin, age 46, is a Director of Demeter. Mr. Merin is also a Director of DWFCM. Mr. Merin was appointed the Chief Operating Officer of Individual Asset Management for MSDW in December 1998 and the President and Chief Executive Officer of Morgan Stanley Dean Witter Advisors in February 1998. He has been an Executive Vice President of DWR since 1990, during which time he has been director of DWR's Taxable Fixed Income and Futures divisions, Managing Director in Corporate Finance and Corporate Treasurer. Mr. Merin received his Bachelor's degree from Trinity College in Connecticut and his M.B.A. degree in finance and accounting from the Kellogg Graduate School of Management of Northwestern University in 1977. Joseph G. Siniscalchi, age 54, is a Director of Demeter. Mr. Siniscalchi joined DWR in July 1984 as a First Vice President, Director of General Accounting and served as a Senior Vice President and Controller for DWR's Securities Division through 1997. He is currently Executive Vice President and Director of the Operations Division of DWR. From February 1980 to July 1984, Mr. Siniscalchi was Director of Internal Audit at Lehman Brothers Kuhn Loeb, Inc. Edward C. Oelsner, III, age 57, is a Director of Demeter. Mr. Oelsner is currently an Executive Vice President and head of the Product Development Group at Morgan Stanley Dean Witter Advisors, an affiliate of DWR. Mr. Oelsner joined DWR in 1981 as a Managing Director in DWR's Investment Banking Department specializing in coverage of regulated industries and, subsequently, served as head of the DWR Retail Products Group. Prior to joining DWR, Mr. Oelsner held positions at The First Boston Corporation as a member of the Research and Investment Banking Departments from 1967 to 1981. Mr. Oelsner received his M.B.A. in Finance from the Columbia University Graduate School of Business in 1966 and an A.B. in Politics from Princeton University in 1964. Lewis A. Raibley, III, age 37, is Vice President, Chief Financial Officer, and a Director of Demeter. Mr. Raibley is also a Director of DWFCM. Mr. Raibley is currently Senior Vice President and Controller in the Individual Asset Management Group of MSDW. From July 1997 to May 1998, Mr. Raibley served as Senior Vice President and Director in the Internal Reporting Department of MSDW and prior to that, from 1992 to 1997, he served as Senior Vice President and Director in the Financial Reporting and Policy Division of Dean Witter Discover & Co. He has been with MSDW and its affiliates since June 1986. Richard A. Beech, age 48, is a Director of Demeter. Mr. Beech has been associated with the futures industry for over 23 years. He has been at DWR since August 1984 where he is presently Senior Vice President and head of Branch Futures. Mr. Beech began his career at the Chicago Mercantile Exchange, where he became the Chief Agricultural Economist doing market analysis, marketing and compliance. Prior to joining DWR, Mr. Beech also had worked at two investment banking firms in operations, research, managed futures and sales management. Ray Harris, age 43, is a Director of Demeter. Mr. Harris is currently Executive Vice President, Planning and Administration for Morgan Stanley Dean Witter Asset Management and has worked at DWR or its affiliates since July 1982, serving in both financial and administrative capacities. From August 1994 to January 1999, he worked in two separate DWR affiliates, Discover Financial Services and Novus Financial Corp., culminating as Senior Vice President. Mr. Harris received his B.A. degree from Boston College and his M.B.A. in finance from the University of Chicago. Mark J. Hawley, age 56, served as Chairman of the Board and a Director of Demeter and DWFCM throughout 1999. Mr. Hawley joined DWR in February 1989 as Senior Vice President and served as Executive Vice President and Director of DWR's Product Management for Individual Asset Management throughout 1999. In this capacity, Mr. Hawley was responsible for directing the activities of the firm's Managed Futures, Insurance, and Unit Investment Trust Business. From 1978 to 1989, Mr. Hawley was a member of the senior management team at Heinold Asset Management, Inc., a commodity pool operator, and was responsible for a variety of projects in public futures funds. From 1972 to 1978, Mr. Hawley was a Vice President in charge of institutional block trading for the Mid-West at Kuhn Loeb & Company. Mr. Hawley resigned effective January 31, 2000. All of the foregoing directors have indefinite terms. Item 11. EXECUTIVE COMPENSATION The Partnership has no directors and executive officers. As a limited partnership, the business of the Partnership is managed by Demeter, which is responsible for the administration of the business affairs of the Partnership but receives no compensation for such services. Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (a) Security Ownership of Certain Beneficial Owners - As of December 31, 1999, there were no persons known to be beneficial owners of more than 5 percent of the Units. (b) Security Ownership of Management - At December 31, 1999, Demeter owned 104 Units of General Partnership Interest representing a 3.30 percent interest in the Partnership. (c) Changes in Control - None Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Refer to Note 2 - "Related Party Transactions" of "Notes to Financial Statements", in the accompanying Annual Report to Limited Partners for the year ended December 31, 1999, which is incorporated by reference to Exhibit 13.01 of this Form 10-K. In its capacity as the Partnership's retail commodity broker, DWR received commodity brokerage commissions (paid and accrued by the Partnership) of $568,131 for the year ended December 31, 1999. In its capacity as the Partnership's trading manager, DWFCM received management fees of $278,026 for the year ended December 31, 1999. PART IV Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) 1. Listing of Financial Statements The following financial statements and report of independent public auditors, all appearing in the accompanying Annual Report to Limited Partners for the year ended December 31, 1999, are incorporated by reference to Exhibit 13.01 of this Form 10-K: - - Report of Deloitte & Touche LLP, independent auditors, for the years ended December 31, 1999, 1998 and 1997. - Statements of Financial Condition as of December 31, 1999 and 1998. - - Statements of Operations, Changes in Partners' Capital, and Cash Flows for the years ended December 31, 1999, 1998 and 1997. - Notes to Financial Statements. With exception of the aforementioned information and the information incorporated in Items 7, 8, and 13, the Annual Report to Limited Partners for the year ended December 31, 1999 is not deemed to be filed with this report. 2. Listing of Financial Statement Schedules No financial statement schedules are required to be filed with this report. (b) Reports on Form 8-K No reports on Form 8-K have been filed by the Partnership during the last quarter of the period covered by this report. (c) Exhibits Refer to Exhibit Index on Page E-1. SIGNATURES Pursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. DEAN WITTER DIVERSIFIED FUTURES FUND II L.P. (Registrant) BY: Demeter Management Corporation, General Partner March 30, 2000 BY: /s/ Robert E. Murray Robert E. Murray, Director, Chairman of the Board and President Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Demeter Management Corporation. BY: /s/ Robert E. Murray March 29, 2000 Robert E. Murray, Director, Chairman of the Board and President /s/ Joseph G. Siniscalchi __ March 29, 2000 Joseph G. Siniscalchi, Director /s/ Edward C. Oelsner III __ March 29, 2000 Edward C. Oelsner III, Director /s/ Mitchell M. Merin____________ March 29, 2000 Mitchell M. Merin, Director /s/ Richard A. Beech ____________ March 29, 2000 Richard A. Beech, Director /s/ Ray Harris ___ March 29, 2000 Ray Harris, Director /s/ Lewis A. Raibley, III __ March 29, 2000 Lewis A. Raibley, III, Director, Chief Financial Officer and Principal Accounting Officer EXHIBIT INDEX ITEM METHOD OF FILING 3.01 Limited Partnership Agreement of the Partnership, dated as of October 28, 1988. (1) 10.01 Management Agreement among the Partnership, Demeter Management Corporation and Dean Witter Futures (2) & Currency Management Inc. dated as of October 28, 1988. 13.01 Annual Report to Limited Partners for the year ended December 31, 1999. (3) (1) Incorporated by reference to Exhibit 3.01 and Exhibit 3.02 of the Partnership's Registration Statement on Form S-1. (File No. 24662) (2) Incorporated by reference to Exhibit 10.02 of the Partnership's Registration Statement on Form S-1. (File No. 24462) (3) Filed herewith. Diversified Futures Fund II December 31, 1999 Annual Report MORGAN STANLEY DEAN WITTER Demeter Management Corporation Two World Trade Center 62nd Floor New York, NY 10048 Telephone (212) 392-8899 Dean Witter Diversified Futures Fund II L.P. Annual Report 1999 Dear Limited Partner: This marks the eleventh annual report for the Dean Witter Diversified Futures Fund II L.P. (the "Fund"). The Fund began the year at a Net Asset Value per Unit of $2,824.45 and decreased by 9.5% to $2,556.25 on December 31, 1999. The Fund has increased by 155.6% since it began trading in 1989 (a compound annualized return of 9.0%). Overall, the Fund experienced difficulty in the global interest rate futures markets primarily from short Australian interest rate futures positions as prices increased during July and August on the temporary strength in U.S. bonds and weaker-than-expected business spending data out of Australia. Additional losses were recorded from short Japanese bond futures positions as prices in- creased during the first quarter and the third quarter. In the currency mar- kets, losses were recorded throughout the majority of the first quarter from long Australian dollar positions as its value dropped significantly relative to the U.S. dollar on speculation regarding potential currency devaluations in the Asian region. Early in the third quarter, losses were recorded from long posi- tions in this currency due to depressed commodities prices, emerging market concerns and on-going talks that China may eventually devalue its currency. Newly established short positions in the Australian dollar resulted in addi- tional losses during September as its value strengthened relative to the U.S. dollar following the rally in gold prices. Offsetting currency gains were re- corded during the third quarter from long positions in the Japanese yen as the value of the yen climbed to a 44-month high versus the U.S. dollar due to con- tinued optimism over Japan's economic recovery. The energy markets were profitable during March from long positions in oil futures as prices moved significantly higher on news that both OPEC and non-OPEC countries had reached an agreement to cut total output beginning April 1st. Gains were also recorded in this market during the third quarter after OPEC ministers confirmed that they would uphold their global cut- backs until April of 2000. While we are disappointed that the Fund had a difficult year in 1999, we remind investors that managed futures funds such as Diversified Futures Fund II are designed to provide diversification and non-correlation, that is, the ability to perform independently, of global equities and bonds. Managed futures have historically performed independently of traditional investments, such as stocks and bonds. This is referred to as non-correlation, or the potential for managed futures to perform when traditional markets such as stocks and bonds may expe- rience difficulty performing. Of course, managed futures funds will not auto- matically be profitable during unfavorable periods for these traditional in- vestments and vice versa. The degree of non-correlation of any given managed futures fund will vary, particularly as a result of market conditions, and some funds will have significantly lesser degrees of non-correlation (i.e., greater correlation) with stocks and bonds than others. Managed futures have histori- cally performed independently of traditional investments, such as stocks and bonds. 1999 proved to be another strong year for equities, due in large part to continued growth and stability in most major world economies accompanied by low inflation. This environment, while strong for equities, provided few major sus- tained price trends in the world's futures and currency markets, and as such, proved to be a difficult trading environment for the money manager in this Fund, whose trading strategy relies on the existence of longer-term price trends for trading opportunities. Nevertheless, we remain confident in the role that managed futures investments play in the overall investment portfolio, and we believe this confidence is well-founded based on the longer-term diversified non- correlated returns of this alternative investment. Demeter Management Corpora- tion, as General Partner to the Fund, has been and continues to be an active investor with more than $18 million invested among the 24 managed futures funds to which we act as General Partner. Should you have any questions concerning this report, please feel free to con- tact Demeter Management Corporation at Two World Trade Center, 62nd Floor, New York, NY 10048, or your Morgan Stanley Dean Witter Financial Advisor. I hereby affirm, that to the best of my knowledge and belief, the information contained in this report is accurate and complete. Past performance is not a guarantee of future results. Sincerely, /s/ Robert E. Murray Robert E. Murray Chairman Demeter Management Corporation General Partner Dean Witter Diversified Futures Fund II L.P. Independent Auditors' Report The Limited Partners and the General Partner: We have audited the accompanying statements of financial condition of Dean Wit- ter Diversified Futures Fund II L.P. (the "Partnership") as of December 31, 1999 and 1998 and the related statements of operations, changes in partners' capital, and cash flows for each of the three years in the period ended Decem- ber 31, 1999. These financial statements are the responsibility of the Partner- ship's management. Our responsibility is to express an opinion on these finan- cial statements based on our audits. We conducted our audits in accordance with generally accepted auditing stan- dards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of mate- rial misstatement. An audit includes examining, on a test basis, evidence sup- porting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement pre- sentation. We believe that our audits provide a reasonable basis for our opin- ion. In our opinion, such financial statements present fairly, in all material re- spects, the financial position of Dean Witter Diversified Futures Fund II L.P. at December 31, 1999 and 1998 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1999 in con- formity with generally accepted accounting principles. /s/ Deloitte & Touche LLP February 14, 2000 (March 3, 2000 as to Note 5) New York, New York Dean Witter Diversified Futures Fund II L.P. Statements of Financial Condition December 31, -------------------- 1999 1998 --------- ---------- $ $ ASSETS Equity in futures interests trading accounts: Cash 8,042,490 10,606,680 Net unrealized gain on open contracts 293,674 206,564 --------- ---------- Total Trading Equity 8,336,164 10,813,244 Interest receivable (DWR) 29,570 32,410 --------- ---------- Total Assets 8,365,734 10,845,654 ========= ========== LIABILITIES AND PARTNERS' CAPITAL LIABILITIES Redemptions payable 291,006 239,703 Accrued management fee (DWFCM) 20,914 27,114 Accrued incentive fee (DWFCM) -- 3,871 --------- ---------- Total Liabilities 311,920 270,688 --------- ---------- PARTNERS' CAPITAL Limited Partners (3,046.638 and 3,640.082 Units, respectively) 7,787,964 10,281,223 General Partner (104 Units) 265,850 293,743 --------- ---------- Total Partners' Capital 8,053,814 10,574,966 --------- ---------- Total Liabilities and Partners' Capital 8,365,734 10,845,654 ========= ========== NET ASSET VALUE PER UNIT 2,556.25 2,824.45 ========= ========== The accompanying notes are an integral part of these financial statements. Dean Witter Diversified Futures Fund II L.P. Statements of Operations For the Years Ended December 31, ------------------------------- 1999 1998 1997 -------- ---------- --------- $ $ $ REVENUES Trading profit (loss): Realized (497,690) 2,694,659 427,530 Net change in unrealized 87,110 (1,542,785) 1,589,156 -------- ---------- --------- Total Trading Results (410,580) 1,151,874 2,016,686 Interest income (DWR) 344,826 407,236 474,293 -------- ---------- --------- Total Revenues (65,754) 1,559,110 2,490,979 -------- ---------- --------- EXPENSES Brokerage commissions (DWR) 568,131 633,726 814,111 Management fee (DWFCM) 278,026 327,157 360,670 Transaction fees and costs 40,412 48,099 69,111 Incentive fee (DWFCM) (3,716) 7,040 -- -------- ---------- --------- Total Expenses 882,853 1,016,022 1,243,892 -------- ---------- --------- NET INCOME (LOSS) (948,607) 543,088 1,247,087 ======== ========== ========= Net Income (Loss) Allocation: Limited Partners (920,714) 528,526 1,218,796 General Partner (27,893) 14,562 28,291 Net Income (Loss) per Unit: Limited Partners (268.20) 140.02 272.02 General Partner (268.20) 140.02 272.02 Statements of Changes in Partners' Capital For the Years Ended December 31, 1999, 1998 and 1997 Units of Partnership Limited General Interest Partners Partner Total ----------- ---------- ------- ---------- $ $ $ Partners' Capital, December 31, 1996 5,086.521 12,019,867 250,890 12,270,757 Net income -- 1,218,796 28,291 1,247,087 Redemptions (806.941) (2,029,618) -- (2,029,618) --------- ---------- ------- ---------- Partners' Capital, December 31, 1997 4,279.580 11,209,045 279,181 11,488,226 Net income -- 528,526 14,562 543,088 Redemptions (535.498) (1,456,348) -- (1,456,348) --------- ---------- ------- ---------- Partners' Capital, December 31, 1998 3,744.082 10,281,223 293,743 10,574,966 Net loss -- (920,714) (27,893) (948,607) Redemptions (593.444) (1,572,545) -- (1,572,545) --------- ---------- ------- ---------- Partners' Capital, December 31, 1999 3,150.638 7,787,964 265,850 8,053,814 ========= ========== ======= ========== The accompanying notes are an integral part of these financial statements. Dean Witter Diversified Futures Fund II L.P. Statements of Cash Flows For the Years Ended December 31, -------------------------------------- 1999 1998 1997 ------------ ---------- ---------- $ $ $ CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) (948,607) 543,088 1,247,087 Noncash item included in net income (loss): Net change in unrealized (87,110) 1,542,785 (1,589,156) Decrease in operating assets: Interest receivable (DWR) 2,840 4,262 5,371 Increase (decrease) in operating liabilities: Accrued management fee (DWFCM) (6,200) (2,389) (2,035) Accrued incentive fee (DWFCM) (3,871) 3,871 -- Accrued brokerage commissions (DWR) -- -- (15,137) Accrued transaction fees and costs -- -- (2,330) ------------ ---------- ---------- Net cash provided by (used for) operating activities (1,042,948) 2,091,617 (356,200) ------------ ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES Increase (decrease) in redemptions payable 51,303 (43,740) (14,461) Redemptions of Units (1,572,545) (1,456,348) (2,029,618) ------------ ---------- ---------- Net cash used for financing activities (1,521,242) (1,500,088) (2,044,079) ------------ ---------- ---------- Net increase (decrease) in cash (2,564,190) 591,529 (2,400,279) Balance at beginning of period 10,606,680 10,015,151 12,415,430 ------------ ---------- ---------- Balance at end of period 8,042,490 10,606,680 10,015,151 ============ ========== ========== The accompanying notes are an integral part of these financial statements. Dean Witter Diversified Futures Fund II L.P. Notes to Financial Statements 1. Summary of Significant Accounting Policies Organization--Dean Witter Diversified Futures Fund II L.P. (the "Partnership") is a limited partnership organized to engage primarily in the speculative trad- ing of commodity futures and forward contracts, physical commodities, and other commodity interests (collectively, "futures interests"). The general partner for the Partnership is Demeter Management Corporation ("De- meter"). The non-clearing commodity broker is Dean Witter Reynolds Inc. ("DWR") and an unaffiliated clearing commodity broker, Carr Futures Inc. ("Carr"), pro- vides clearing and execution services. The trading manager is Dean Witter Futures & Currency Management Inc. ("DWFCM" or the "Trading Manager"). Demeter, DWR and DWFCM are wholly-owned subsidiaries of Morgan Stanley Dean Witter & Co. ("MSDW"). On May 31, 1997, Morgan Stanley Group Inc. was merged with and into Dean Wit- ter, Discover & Co. ("DWD"). At that time DWD changed its corporate name to Morgan Stanley, Dean Witter, Discover & Co. ("MSDWD"). Effective February 19, 1998, MSDWD changed its corporate name to Morgan Stanley Dean Witter & Co. Demeter is required to maintain a 1% minimum interest in the equity of the Partnership and income (losses) are shared by Demeter and the Limited Partners based upon their proportional ownership interests. Use of Estimates--The financial statements are prepared in accordance with gen- erally accepted accounting principles, which require management to make esti- mates and assumptions that affect the reported amounts in the financial state- ments and related disclosures. Management believes that the estimates utilized in the preparation of the financial statements are prudent and reasonable. Ac- tual results could differ from those estimates. Revenue Recognition--Futures interests are open commitments until settlement date. They are valued at market on a daily basis and the resulting net change in unrealized gains and losses is reflected in the change in unrealized profit (loss) on open contracts from one period to the next in the statements of oper- ations. Monthly, DWR pays the Partnership interest income based upon 80% of its average daily Net Assets for the month at a rate equal to the average yield on 13-week U.S. Treasury bills. For purposes of such interest payments, Net Assets do not include monies due the Partnership on futures interests, but not actu- ally received. Net Income (Loss) per Unit--Net income (loss) per unit of limited partnership interest ("Unit(s)") is com- Dean Witter Diversified Futures Fund II L.P. Notes to Financial Statements--(Continued) puted using the weighted average number of Units outstanding during the period. Equity in Futures Interests Trading Accounts--The Partnership's asset "Equity in futures interests trading accounts," reflected in the statements of finan- cial condition, consists of (A) cash on deposit with DWR and Carr to be used as margin for trading and (B) net unrealized gains or losses on open contracts, which are valued at market, and calculated as the difference between original contract value and market value. The Partnership, in the normal course of business, enters into various con- tracts with Carr acting as its commodity broker. Pursuant to brokerage agree- ments with Carr, to the extent that such trading results in unrealized gains or losses, the amounts are offset and reported on a net basis in the Partnership's statements of financial condition. The Partnership has offset the fair value amounts recognized for forward con- tracts executed with the same counterparty as allowable under terms of the mas- ter netting agreement with Carr, the sole counterparty on such contracts. The Partnership has consistently applied its right to offset. Brokerage Commissions and Related Transaction Fees and Costs--Brokerage commis- sions are accrued at 80% of DWR's published non-member rates on a half-turn ba- sis. Transaction fees and costs are accrued on a half-turn basis. Brokerage commissions and transaction fees combined are capped at 13/20 of 1% per month (a maximum 7.8% annual rate) of the Partnership's Net Assets as of the last day of each month. Operating Expenses--The Partnership incurs a monthly management fee and may in- cur an incentive fee. Demeter and/or DWR bear all other operating expenses. Income Taxes--No provision for income taxes has been made in the accompanying financial statements, as partners are individually responsible for reporting income or loss based upon their respective share of the Partnership's revenues and expenses for income tax purposes. Distributions--Distributions, other than redemptions of Units, are made on a pro-rata basis at the sole discretion of Demeter. No distributions have been made to date. Redemptions--Limited Partners may redeem some or all of their Units at 100% of the Net Asset Value per Unit as of the end of the last day of any calendar quarter, upon five business days advance notice by redemption form to Demeter. Dissolution of the Partnership--The Partnership will terminate on December 31, 2025 or at an earlier date if certain conditions set forth in the Limited Part- nership Agreement occur. Dean Witter Diversified Futures Fund II L.P. Notes to Financial Statements--(Continued) 2. Related Party Transactions The Partnership pays brokerage commissions to DWR as described in Note 1. The Partnership's cash is on deposit with DWR and Carr in futures interests trading accounts to meet margin requirements as needed. DWR pays interest on these funds as described in Note 1. Demeter, on behalf of the Partnership and itself, has entered into a Management Agreement with DWFCM to make all trading decisions for the Partnership. Compensation to DWFCM by the Partnership consists of a management fee and an incentive fee as follows: Management Fee--The monthly management fee is accrued daily at the rate of 1/4 of 1% (a 3% annual rate), of adjusted Net Assets, as defined in the Management Agreement, at each month-end. Incentive Fee--The Partnership pays an annual incentive fee to DWFCM equal to 15% of the trading profits earned by the Partnership as of the end of each an- nual incentive period ending January 31. Trading profits represent the amount by which profits from futures and forwards trading exceed losses after broker- age commissions, management fee and transaction fees and costs are deducted. Such incentive fee is accrued in each month in which trading profits occur. In those months in which trading profits are negative, previous accruals, if any, during the incentive period are reduced. 3. Financial Instruments The Partnership trades commodity futures and forward contracts, physical com- modities, and other commodity interests. Futures and forwards represent con- tracts for delayed delivery of an instrument at a specified date and price. Risk arises from changes in the value of these contracts and the potential in- ability of counterparties to perform under the terms of the contracts. There are numerous factors which may significantly influence the market value of these contracts, including interest rate volatility. In June 1998, the Financial Accounting Standards Board ("FASB") issued State- ment of Financial Accounting Standard ("SFAS") No. 133, "Accounting for Deriva- tive Instruments and Hedging Activities" effective for fiscal years beginning after June 15, 1999. In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities--Deferral of the Effective Date of SFAS No. 133," which defers the required implementation of SFAS No. 133 until fiscal years beginning after June 15, 2000. However, the Partnership had previously elected to adopt the provisions of SFAS No. 133 beginning with the fiscal year ended December 31, 1998. SFAS No. 133 supercedes SFAS No. 119 and Dean Witter Diversified Futures Fund II L.P. Notes to Financial Statements--(Continued) No. 105, which required the disclosure of average aggregate fair values and contract/notional values, respectively, of derivative financial instruments for an entity which carries its assets at fair value. The application of SFAS No. 133 does not have a significant effect on the Partnership's financial statements. The net unrealized gains on open contracts are reported as a component of "Eq- uity in futures interests trading accounts" on the statements of financial con- dition and totaled $293,674 and $206,564 at December 31, 1999 and 1998, respec- tively. Of the $293,674 net unrealized gain on open contracts at December 31, 1999, $262,869 related to exchange-traded futures contracts and $30,805 related to off-exchange-traded forward currency contracts. Of the $206,564 net unrealized gain on open contracts at December 31, 1998, $596,320 related to exchange-traded futures contracts and $(389,756) related to off-exchange-traded forward currency contracts. Exchange-traded futures contracts held by the Partnership at December 31, 1999 and 1998 mature through September 2000 and June 1999, respectively. Off-ex- change-traded forward currency contracts held by the Partnership at December 31, 1999 and 1998 mature through March 2000 and April 1999, respectively. The Partnership has credit risk associated with counterparty nonperformance. The credit risk associated with the instruments in which the Partnership is in- volved is limited to the amounts reflected in the Partnership's statements of financial condition. The Partnership also has credit risk because DWR and Carr act as the futures commission merchants or the counterparties, with respect to most of the Part- nership's assets. Exchange-traded futures contracts are marked to market on a daily basis, with variations in value settled on a daily basis. Each of DWR and Carr, as a futures commission merchant for the Partnership's exchange-traded futures contracts, are required, pursuant to regulations of the Commodity Futures Trading Commission to segregate from their own assets, and for the sole benefit of their commodity customers, all funds held by them with respect to exchange-traded futures contracts including an amount equal to the net unrealized gain on all open futures contracts, which funds totaled $8,305,359 and $11,203,000 at December 31, 1999 and 1998, respectively. With respect to the Partnership's off-exchange-traded forward currency contracts, there are no daily settlements of variations in value nor is there any requirement that an amount equal to the net unrealized gain on open forward contracts be segregat- ed. With respect to those Dean Witter Diversified Futures Fund II L.P. Notes to Financial Statements--(Continued) off-exchange-traded forward currency contracts, the Partnership is at risk to the ability of Carr, the sole counterparty on all of such contracts, to per- form. The Partnership has a netting agreement with Carr. This agreement, which seeks to reduce both the Partnership's and Carr's exposure on off-exchange- traded forward currency contracts, should materially decrease the Partnership's credit risk in the event of Carr's bankruptcy or insolvency. Carr's parent, Credit Agricole Indosuez, has guaranteed to the Partnership payment of the net liquidating value of the transactions in the Partnership's account with Carr (including foreign currency contracts). 4. Legal Matters The class actions first filed in 1996 in California and in New York State courts were each dismissed in 1999. On September 6, 10, and 20, 1996, and on March 13, 1997, purported class actions were filed in the Superior Court of the State of California, County of Los Angeles, on behalf of all purchasers of in- terests in limited partnership commodity pools sold by DWR. Named defendants include DWR, Demeter, DWFCM, MSDW, the Partnership, certain limited partnership commodity pools of which Demeter is the general partner (all such parties re- ferred to hereafter as the "Morgan Stanley Dean Witter Parties") and certain trading advisors to those pools. On June 16, 1997, the plaintiffs in the above actions filed a consolidated amended complaint, alleging, among other things, that the defendants committed fraud, deceit, negligent misrepresentation, vari- ous violations of the California Corporations Code, intentional and negligent breach of fiduciary duty, fraudulent and unfair business practices, unjust en- richment, and conversion in the sale and operation of the various limited part- nership commodity pools. The complaints seek unspecified amounts of compensa- tory and punitive damages and other relief. The court entered an order denying class certification on August 24, 1999. On September 24, 1999, the court en- tered an order dismissing the case without prejudice on consent. Similar pur- ported class actions were also filed on September 18 and 20, 1996 in the Su- preme Court of the State of New York, New York County and on November 14, 1996 in the Superior Court of the State of Delaware, New Castle County, against the Morgan Stanley Dean Witter Parties and certain trading advisors on behalf of all purchasers of interests in various limited partnership commodity pools, in- cluding the Partnership, sold by DWR. A consolidated and amended complaint in the action pending in the Supreme Court of the State of New York was filed on August 13, 1997, alleging that the defendants committed fraud, breach of fidu- ciary duty, and negligent misrepresentation in the sale and operation of the various limited partnership commodity pools. The complaints seek unspecified amounts of compensa- Dean Witter Diversified Futures Fund II L.P. Notes to Financial Statements--(Concluded) tory and punitive damages and other relief. The New York Supreme Court dis- missed the New York action in November 1998, but granted plaintiffs leave to file an amended complaint, which they did in early December 1998. The defen- dants filed a motion to dismiss the amended complaint with prejudice on Febru- ary 1, 1999. By decision dated December 21, 1999, the New York Supreme Court dismissed the case with prejudice. In addition, on December 16, 1997, upon motion of the plaintiffs, the action pending in the Superior Court of the State of Delaware was voluntarily dis- missed without prejudice. 5. Subsequent Event On March 3, 2000, the plaintiffs in the New York action referred to in Note 4 filed an appeal of the order dismissing the consolidated complaint. MORGAN STANLEY DEAN WITTER & CO. Two World Trade Center 62nd Floor New York, NY 10048 Presorted First Class Mail U.S. Postage Paid Brooklyn, NY Permit No. 148