The US Securities and Exchange Commission (SEC) recently charged and settled with hedge fund Galois Capital Management LLC over violations related to a private fund managed by the firm that primarily invested in cryptocurrency assets. The SEC alleges that Galois Capital failed to comply with client asset safeguarding requirements, especially in regards to crypto assets that were deemed as securities by the regulator.
Civil Penalty and Investor Compensation
As part of the settlement, Galois Capital has agreed to pay a $225,000 civil penalty to resolve the charges brought by the SEC. This penalty will be distributed to investors who were harmed by the firm’s actions. Corey Schuster, Co-Chief of the SEC Enforcement Division’s Asset Management Unit, emphasized the importance of complying with investor protection obligations and holding advisers accountable for any violations.
The SEC found that Galois Capital violated the Investment Advisers Act’s Custody Rule by failing to secure its assets with a qualified custodian. Instead, the firm kept the digital assets in online trading accounts on platforms like FTX, which were not considered qualified custodians. This negligence led to approximately half of the fund’s assets under management being lost when FTX collapsed in November 2022.
In addition to the custody rule violations, the SEC’s order also revealed that Galois Capital misrepresented redemption notice periods to investors. While claiming a five-business-day notice requirement, the firm allowed some investors to redeem their investments with shorter notice periods. This discrepancy raised further concerns about the firm’s adherence to regulatory requirements.
In response to the SEC’s findings, Galois Capital agreed to cease further violations of the Advisers Act, accept the censure, and pay the imposed civil penalty without admitting or denying the allegations. The firm’s co-founder, Kevin Zho, disclosed that around $40 million in funds were locked up in FTX after the exchange suspended customer withdrawals. Following these events, Galois Capital made the decision to shut down its operations and sell its claims on FTX at a significant loss.
Investor Compensation Plan
After closing its operations, Galois Capital outlined a payment plan for investors, promising to return up to 90% of the funds not retained on FTX. The remaining 10% would be withheld until the completion of the hedge fund’s auditing process. This plan aims to provide some level of compensation to affected investors and bring closure to the tumultuous events surrounding Galois Capital’s crypto fund.
The SEC’s enforcement action against Galois Capital highlights the importance of compliance with regulatory requirements in the cryptocurrency industry. By holding firms accountable for safeguarding client assets and upholding investor protection obligations, the SEC aims to maintain integrity and transparency in the asset management space.
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