Recent news from the US Securities and Exchange Commission (SEC) sheds light on the importance of complying with investor protection regulations in the crypto industry. The SEC charged and settled with hedge fund Galois Capital Management LLC over a private fund managed by the firm that primarily invested in crypto assets. The charges stemmed from Galois Capital’s alleged failure to comply with client asset safeguarding requirements, particularly with regards to crypto assets that the regulator deemed were offered as securities. As a result, the hedge fund agreed to pay a $225,000 civil penalty to settle the charges, which will be distributed to harmed investors.
Corey Schuster, Co-Chief of the SEC Enforcement Division’s Asset Management Unit, emphasized the severity of the situation by stating that, “By failing to comply with Custody Rule provisions, Galois Capital exposed investors to risks that fund assets, including crypto assets, could be lost, misused, or misappropriated.” This violation underscores the critical importance of adhering to investor protection obligations in the financial services industry. The regulator made it clear that advisers will be held accountable for any lapses in meeting these core obligations to protect investors’ interests.
The findings by the SEC revealed that Galois Capital violated the Investment Advisers Act’s Custody Rule by neglecting to secure its assets with a qualified custodian. The firm held digital assets in online trading accounts on platforms like FTX, which were not qualified custodians. This lapse in compliance led to approximately half of the fund’s assets under management being lost when FTX collapsed in November 2022. Furthermore, the SEC’s order disclosed that Galois Capital misrepresented redemption notice periods, indicating a five-business-day notice requirement while allowing some investors to redeem with shorter notice.
Galois Capital co-founder Kevin Zho disclosed in November 2022 that around $40 million in funds were locked up in FTX after the exchange froze customers’ withdrawals. The hedge fund, known for predicting the collapse of the Terra ecosystem, subsequently ceased operations and sold its claims on FTX for a fraction of their original value. In an attempt to rectify the situation, Galois Capital revealed a payment plan to pay clients up to 90% of the funds not retained on FTX, with the remaining 10% being withheld pending the completion of the auditing process. The financial impact and operational closure of Galois Capital serve as a cautionary tale for financial firms operating in the crypto industry.
The recent settlement between Galois Capital and the SEC demonstrates the significant repercussions of failing to comply with investor protection regulations in the crypto industry. Firms operating in this space must prioritize safeguarding client assets and meeting core investor protection obligations to avoid similar pitfalls and maintain the trust and confidence of their investors.
