The US Securities and Exchange Commission (SEC) recently charged and settled with hedge fund Galois Capital Management LLC over a private fund managed by the firm that primarily invested in crypto. The charges were related to Galois Capital allegedly failing to comply with client asset safeguarding requirements, particularly crypto assets that were labeled as securities by the regulator. As part of the settlement, Galois Capital agreed to pay a $225,000 civil penalty to be distributed to harmed investors.
The SEC found that Galois Capital violated the Investment Advisers Act’s Custody Rule by not securing its assets with a qualified custodian. Instead, the firm held digital assets in online trading accounts on platforms like FTX, which were not qualified custodians. This lack of compliance resulted in approximately half of the fund’s assets under management being lost when FTX collapsed in November 2022.
In addition to the custody rule violations, the SEC’s order revealed that Galois Capital misrepresented redemption notice periods to investors. Despite claiming a five-business-day notice requirement, the firm allowed some investors to redeem with shorter notice. This misconduct exposed investors to risks of losing, misusing, or misappropriating their assets. Galois Capital consented to cease further violations, accept censure, and pay the imposed civil penalty without admitting or denying the findings.
As a result of the FTX collapse and misconduct, co-founder Kevin Zho disclosed that roughly $40 million in funds were locked up in FTX after the exchange froze customers’ withdrawals. Following these events, Galois Capital decided to shut down its operations and sell its claims on FTX at a significantly reduced value. The fund also announced a payment plan to reimburse clients, with up to 90% of the funds being returned initially while the remaining 10% would be held until the auditing process is completed.
The SEC’s charges against Galois Capital Management highlight the importance of compliance with investor protection regulations in the crypto investment space. Failure to adhere to rules such as the Custody Rule can have severe consequences for both the firm and its clients, as evidenced by the loss of assets and subsequent shutdown of operations. It serves as a cautionary tale for other hedge funds and investment advisers to ensure proper safeguarding of client assets and transparent communication with investors.