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The U.S. Securities and Exchange Commission (SEC) has charged Galois Capital Management, a fund adviser, for alleged violations of its custody rule. According to a September 3 announcement, Galois is accused of mishandling client assets by holding investor funds with the now-defunct cryptocurrency exchange FTX.
The SEC’s custody rule mandates that investment advisers must place client funds with a qualified custodian, such as a registered broker-dealer or bank. The charges allege that Galois did not comply with this requirement, instead holding crypto assets in online trading accounts on various exchanges, including (FTX) Trading Ltd. The fund reportedly lost approximately half of its assets when FTX collapsed in November 2022.
The collapse of FTX, which was attributed to a severe liquidity crisis and allegations of mismanagement and fraud, left billions of dollars in customer funds inaccessible and led to the company’s bankruptcy. According to Corey Schuster, co-chief of the SEC enforcement division’s asset management unit, Galois's failure to follow proper custody protocols exposed investors to significant risks, including the loss, misuse, or misappropriation of assets.
In addition to the custody rule violations, the SEC alleges that Galois misled investors regarding redemption notices. The fund adviser is accused of misrepresenting the notice period required for redemptions, telling some investors that redemptions needed at least five business days' notice before month-end, while allowing others to redeem with less notice.
As part of the resolution, Galois has agreed to pay a civil penalty of $225,000. This penalty will be distributed to the investors affected by the fund's mismanagement. The case highlights ongoing regulatory scrutiny of investment advisers and their obligations to safeguard client assets, especially in the context of the volatile cryptocurrency market.
