Galois Capital Management LLC, a hedge fund that primarily invested in crypto, has recently settled with the US Securities and Exchange Commission (SEC) over charges related to client asset safeguarding requirements. The SEC accused Galois Capital of failing to comply with these requirements, particularly with crypto assets that were considered securities. As a result, the firm has agreed to pay a $225,000 civil penalty, which will be distributed to harmed investors.
The SEC found that starting in July 2022, Galois Capital violated the Investment Advisers Act’s Custody Rule by failing to secure 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 decision ultimately led to approximately half of the fund’s assets under management being lost when FTX collapsed in November 2022.
In addition to failing to comply with the Custody Rule, the SEC’s order also revealed that Galois Capital misrepresented redemption notice periods to investors. The firm claimed a five-business-day notice requirement while allowing some investors to redeem with shorter notice. This misleading practice further exposed investors to risks and added to the SEC’s findings against Galois Capital.
As a result of the charges brought by the SEC, Galois Capital has consented to cease further violations of the Advisers Act, accept censure, and pay the imposed civil penalty. The firm’s co-founder, Kevin Zho, disclosed that approximately $40 million in funds were locked up in FTX after the exchange froze customer withdrawals. Despite gaining notoriety for predicting the collapse of the Terra ecosystem, Galois Capital eventually shut down its operations and sold its claims on FTX for a fraction of their original value.
The downfall of Galois Capital Management serves as a cautionary tale for hedge funds and investment advisers operating in the crypto space. Compliance with regulations, especially those related to safeguarding client assets, is crucial for maintaining trust and credibility in the industry. By failing to adhere to the Custody Rule and engaging in misleading practices, Galois Capital not only faced regulatory consequences but also lost a significant portion of its assets.
Overall, the case of Galois Capital highlights the importance of transparency, accountability, and proper risk management in the rapidly evolving crypto market. As regulatory scrutiny increases, firms must prioritize compliance to protect investors and avoid costly penalties. The downfall of Galois Capital should serve as a wake-up call for all players in the industry to prioritize regulatory compliance and investor protection above all else.
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