The US Securities and Exchange Commission (SEC) recently brought charges against hedge fund Galois Capital Management LLC for its mishandling of a private fund that predominantly invested in cryptocurrency assets. The SEC alleged that Galois Capital failed to adhere to client asset safeguarding regulations, especially regarding cryptocurrencies classified as securities. As a result, Galois Capital has agreed to pay a $225,000 civil penalty to resolve the charges, with the funds being allocated to affected investors.
Custody Rule Violations
One of the SEC’s findings was that Galois Capital violated the Custody Rule of the Investment Advisers Act starting in July 2022. The firm did not store its assets with a qualified custodian, instead relying on online trading platforms like FTX to hold digital assets. This decision proved costly when FTX experienced a collapse in November 2022, resulting in approximately half of the fund’s assets under management being lost.
Additionally, the SEC’s order disclosed that Galois Capital misled investors regarding redemption notice periods. While stating a five-business-day notice requirement, the hedge fund allowed certain investors to redeem their investments with shorter notice periods. This discrepancy put investors at risk and demonstrated a lack of transparency in Galois Capital’s operations.
Following the revelation that around $40 million was frozen on FTX, Galois Capital ultimately decided to wind down its operations. The hedge fund sold its claims on FTX at a substantial loss, further impacting investors who entrusted their assets to the firm. Galois Capital outlined a payment plan to return up to 90% of the funds held on FTX to clients, withholding the remaining 10% until the completion of the auditing process.
The SEC’s actions against Galois Capital Management highlight the importance of compliance with regulatory requirements and the protection of investor assets. The mishandling of cryptocurrency investments and misrepresentations regarding fund management can have severe consequences for both the investment firm and its clients. Moving forward, it is essential for all financial advisers to prioritize transparency, adherence to regulations, and safeguarding client assets to maintain trust and integrity in the industry.