Recently, the US Securities and Exchange Commission (SEC) charged and settled with hedge fund Galois Capital Management LLC over a private fund managed by the firm that primarily invested in crypto. The SEC found that Galois Capital violated the Investment Advisers Act’s Custody Rule by not securing its assets with a qualified custodian. The firm held the digital assets in online trading accounts on platforms like FTX, which were not qualified custodians. This led to approximately half of the fund’s assets under management being lost when FTX collapsed in November 2022.
Consequences and Penalties
As a result of these violations, the SEC has charged Galois Capital a $225,000 civil penalty to settle the charges. This penalty will be distributed to harmed investors. Corey Schuster, Co-Chief of the SEC Enforcement Division’s Asset Management Unit, emphasized that failing to comply with Custody Rule provisions exposes investors to risks that fund assets, including crypto assets, could be lost, misused, or misappropriated. He further mentioned that the regulator will continue to hold advisers accountable for violating their core investor protection obligations.
The SEC’s order also revealed that Galois Capital misrepresented redemption notice periods, claiming a five-business-day notice requirement while allowing some investors to redeem with shorter notice. Galois Capital consented to cease further Advisers Act violations, accept the censure, and pay the imposed civil penalty without admitting or denying the findings. Furthermore, Galois Capital co-founder Kevin Zho disclosed that roughly $40 million in funds were locked up in FTX after the exchange froze customers’ withdrawals.
Following the revelation of the locked funds on FTX, Galois Capital shut down its operations and sold its claims on FTX for roughly 16 cents on the dollar. The hedge fund gained notoriety in 2022 for predicting the collapse of the Terra ecosystem. After shutting down, Galois Capital revealed a payment plan consisting of paying clients up to 90% of the funds not retained on FTX, while withholding the remaining 10% until the completion of the hedge fund’s auditing process.
The settlement between the SEC and Galois Capital Management LLC sheds light on the importance of regulatory compliance and investor protection in the crypto investment space. The consequences of failing to adhere to SEC regulations can result in significant financial losses for investors and reputational damage for firms involved in the mismanagement of digital assets. It serves as a cautionary tale for all financial advisers to prioritize compliance with regulatory requirements to ensure the safeguarding of client assets.
