Recently, the US Securities and Exchange Commission (SEC) charged and settled with Galois Capital Management LLC, a hedge fund that managed a private fund primarily investing in crypto assets. The charges stemmed from Galois Capital’s failure to comply with client asset safeguarding requirements, particularly concerning crypto assets labeled as securities by the SEC. As a result, Galois Capital agreed to pay a $225,000 civil penalty to settle the charges, with the funds being distributed to harmed investors.
The SEC discovered that starting in July 2022, 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 deemed qualified custodians. Unfortunately, approximately half of the fund’s assets under management were lost when FTX collapsed in November 2022. Additionally, Galois Capital misrepresented redemption notice periods, claiming a five-business-day notice requirement while allowing some investors to redeem with shorter notice.
In light of the charges brought forth by the SEC, Galois Capital agreed to cease further violations of the Advisers Act, accepted censure, and paid the imposed civil penalty without admitting or denying the findings. This settlement highlighted the importance of adhering to investor protection obligations and safeguarding client assets, especially in the crypto industry where risks of loss, misuse, or misappropriation are prevalent.
Following the SEC’s investigation and subsequent settlement, Galois Capital faced significant repercussions. Co-founder Kevin Zho disclosed that roughly $40 million in funds were trapped in FTX after the exchange froze customer withdrawals. Despite gaining notoriety for predicting the collapse of the Terra ecosystem, Galois Capital made the decision to shut down its operations and sell its claims on FTX at a fraction of their original value. The hedge fund outlined a payment plan for clients, aiming to reimburse up to 90% of the funds not retained on FTX, with the remaining 10% being held until the completion of the auditing process.
The case of Galois Capital serves as a cautionary tale for hedge funds and investment firms operating in the crypto space. Neglecting client asset safeguarding requirements and violating regulatory guidelines can have severe consequences, including financial penalties, loss of investor trust, and ultimately, the forced liquidation of assets. As the crypto industry continues to evolve, adherence to compliance standards and investor protection measures remains critical for maintaining a sustainable and ethical investment ecosystem.
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