On September 3, the U.S. Securities and Exchange Commission (SEC) announced charges against Galois Capital Management for failing to adhere to proper asset custody protocols, specifically in relation to holding client funds with the now-bankrupt cryptocurrency exchange FTX. This enforcement action highlights the SEC’s ongoing scrutiny of investment advisers’ compliance with custody rules, particularly in the volatile crypto market.
Violations of Custody Regulations
The SEC’s charges stem from allegations that Galois Capital did not comply with the custody rule, which requires investment advisers to keep client funds with a qualified custodian, such as a registered broker-dealer or bank. Instead, Galois reportedly held crypto assets in online trading accounts across various exchanges, notably including FTX. The collapse of FTX in November 2022 resulted in the fund losing about half of its assets, underscoring the risks associated with non-compliance.
Corey Schuster, co-chief of the SEC Enforcement Division’s Asset Management Unit, emphasized the consequences of such oversight, stating, “Failing to comply with custody rule provisions exposed investors to risks that fund assets, including crypto assets, could be lost, misused, or misappropriated. We will continue to hold accountable advisers who violate their core investor protection obligations.”
FTX, once a prominent player in the cryptocurrency exchange market, filed for bankruptcy in November 2022 following a severe liquidity crisis exacerbated by allegations of mismanagement and fraud. This event significantly impacted various stakeholders, including investors who found their funds suddenly inaccessible, highlighting the importance of rigorous compliance with custodial standards.
Galois Capital’s Misrepresentations
In addition to the custody rule violations, the SEC alleges that Galois Capital misled investors regarding the notice period required for redemptions. According to the agency, Galois represented to some investors that redemptions required at least five business days’ notice prior to month-end, while permitting others to redeem with fewer days’ notice. This discrepancy in policy enforcement further illustrates the lack of transparency and fairness in managing client investments.
As part of the resolution with the SEC, Galois Capital has agreed to pay a civil penalty of $225,000. This amount is designated for distribution to the fund’s harmed investors, aiming to partially mitigate the financial losses incurred due to the firm’s non-compliance with SEC regulations.
Since 2021, the U.S. has seen an increase in the number of qualified custodians for digital assets, which include institutions like Anchorage Digital Bank, Fireblocks Trust Company, Coinbase Custody Trust, and Fidelity Digital Asset Services. These entities are recognized for their compliance with stringent custodial standards, providing a safer environment for holding digital assets. The incident with FTX, which was not a qualified custodian, serves as a cautionary tale for both investors and fund managers about the critical importance of due diligence and regulatory adherence.
| Date | Event | Impact |
|---|---|---|
| Nov 2022 | FTX files for bankruptcy | Triggering loss of assets for Galois Capital |
| Sept 2023 | SEC announces charges against Galois Capital | Due to improper asset custody and misleading practices |
| Post-Settlement | Galois agrees to $225,000 penalty | Funds to be distributed to harmed investors |
The SEC’s action against Galois Capital underscores the importance of compliance with financial custody rules, especially in the burgeoning field of cryptocurrency. This case highlights the potential risks associated with the custody of digital assets and the necessity for investment advisers to adhere to established legal frameworks to protect investor interests.
As the digital asset landscape continues to evolve, this case will likely serve as a critical reference point for regulatory compliance and operational integrity within the financial advisory sector.
