The US Securities and Exchange Commission (SEC) recently charged and settled with hedge fund Galois Capital Management LLC regarding a private fund primarily invested in crypto. The charges are related to Galois Capital’s failure to comply with client asset safeguarding requirements, specifically with crypto assets that were classified as securities. The firm agreed to pay a $225,000 civil penalty to settle the charges, which will go towards compensating harmed investors.
The SEC found that starting in July 2022, Galois Capital breached 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 qualified custodians. As a result, approximately half of the fund’s assets under management were lost when FTX collapsed in November 2022.
Deceptive Practices
In addition to violating the Custody Rule, the SEC’s order revealed that Galois Capital misrepresented redemption notice periods to investors. Although the firm claimed a five-business-day notice requirement, some investors were able to redeem their investments with much shorter notice. This deceptive practice put investors at further risk and showcased the firm’s lack of transparency.
Co-founder Kevin Zho disclosed that around $40 million in funds were stuck on FTX after the exchange froze withdrawals. Following this incident, Galois Capital gained attention for its prediction of the collapse of the Terra ecosystem. However, four months later, the hedge fund closed its operations and sold its claims on FTX for a fraction of their original value.
After shutting down, Galois Capital announced a payment plan for investors. The plan involved returning up to 90% of the funds not retained on FTX, with the remaining 10% being withheld until the completion of the auditing process. While this gesture may offer some relief to affected investors, it does not fully compensate for the losses incurred due to the mismanagement of the crypto fund.
Overall, the SEC’s charges against Galois Capital highlight the importance of following regulatory guidelines when managing investment funds, especially in emerging asset classes like crypto. It serves as a warning to other firms operating in the crypto space to prioritize investor protection and compliance with industry regulations to avoid similar repercussions.
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