The US Securities and Exchange Commission (SEC) recently charged and settled with hedge fund Galois Capital Management LLC over a private fund that was primarily investing in cryptocurrencies. The charges were related to Galois Capital’s alleged failure to comply with client asset safeguarding requirements, particularly with regards to crypto assets that were considered securities by the regulator. As a result, Galois Capital agreed to pay a civil penalty of $225,000 in order to settle the charges, with the funds being distributed to harmed investors.
The SEC found that starting from July 2022, Galois Capital had violated the Investment Advisers Act’s Custody Rule by not securing its assets with a qualified custodian. Instead, the firm had held digital assets in online trading accounts on platforms like FTX, which were not considered qualified custodians. This led to a significant loss of approximately half of the fund’s assets under management when FTX collapsed in November 2022. Additionally, Galois Capital was found to have misrepresented redemption notice periods to investors, claiming a five-business-day notice requirement while allowing some investors to redeem with shorter notice.
Corey Schuster, Co-Chief of the SEC Enforcement Division’s Asset Management Unit, emphasized the importance of compliance with Custody Rule provisions to protect investors from risks associated with fund mismanagement. Schuster stated that the SEC would continue to hold advisers like Galois Capital accountable for violating their core investor protection obligations. The SEC’s order required Galois Capital to cease further violations of the Advisers Act, accept censure, and pay the imposed civil penalty without admitting or denying the findings.
Galois Capital co-founder Kevin Zho disclosed that around $40 million in funds were locked up in FTX after the exchange froze customer withdrawals. Despite gaining notoriety in 2022 for predicting the collapse of the Terra ecosystem, Galois Capital faced challenges following the loss of assets on FTX. The hedge fund eventually decided to shut down its operations and sold its claims on FTX for a significantly reduced amount. In an effort to address the situation, Galois Capital proposed a payment plan to clients, offering to pay 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 Galois Capital Management and the SEC highlights the importance of compliance with regulatory requirements to protect investor interests and prevent potential risks associated with mismanagement of client assets. The case serves as a reminder for investment advisers to adhere to core investor protection obligations and uphold the necessary standards to safeguard assets under management.