SEC Takes Action Against Galois Capital Over FTX Crypto Custody Breach

The United States Securities and Exchange Commission (SEC) has taken decisive action against Galois Capital Management, accusing the hedge fund adviser of mishandling client funds, including placing investor assets on the now-defunct cryptocurrency exchange, FTX Crypto Custody. According to an official announcement dated September 3, the SEC charges center on allegations that Galois Capital failed to comply with the agency’s strict regulations concerning the custody of crypto assets, a move that has placed investor assets at considerable risk.

Details of the Charges

The SEC’s charges against Galois Capital are primarily based on the alleged violation of the agency’s custody rule. This regulation mandates that investment advisers who manage client assets must place those funds with a “qualified custodian.” Such custodians are typically registered broker-dealers, banks, or entities deemed secure by regulatory standards. However, Galois Capital allegedly failed to adhere to these provisions by holding client funds on multiple cryptocurrency trading platforms, including FTX Crypto Custody, which collapsed in November 2022.

Galois Capital, a crypto-focused hedge fund, reportedly lost about half of its assets during the FTX fallout, an event that sent shockwaves through the cryptocurrency industry. The SEC claims that Galois’s decision to custody funds on FTX exposed investors to substantial risks, including the potential for assets to be lost, misused, or misappropriated due to FTX’s notorious collapse.

FTX Collapse and Its Impact on Custody Rules

The collapse of FTX in November 2022 was a major turning point for the crypto industry, underscoring the risks associated with unregulated or poorly regulated exchanges. FTX Crypto Custody’s downfall was precipitated by a severe liquidity crisis, compounded by allegations of mismanagement and fraud. As a result, billions of dollars in customer funds became inaccessible, with the exchange filing for bankruptcy shortly thereafter.

Galois Capital’s involvement with FTX has brought the issue of “FTX crypto custody” into sharp focus. According to the SEC, the use of FTX as a custodian for client assets was highly improper, as FTX was never considered a “qualified custodian.” Corey Schuster, co-chief of the SEC’s Enforcement Division’s Asset Management Unit, emphasized the importance of compliance with custody rules, stating, “Failing to comply with custody rule provisions exposed investors to risks that fund assets, including crypto assets, could be lost, misused, or misappropriated.”

SEC’s Stance on Investor Protection

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The SEC’s action against Galois Capital comes as part of its broader efforts to enforce investor protection in the rapidly evolving cryptocurrency market. Schuster added, “We will continue to hold accountable advisers who violate their core investor protection obligations.” This strong stance reflects the SEC’s ongoing commitment to ensuring that digital asset investment advisers adhere strictly to rules designed to protect investor interests.

The SEC has also noted that since 2021, there has been a significant increase in the number of qualified digital asset custodians in the U.S., such as Anchorage Digital Bank, Fireblocks Trust Company, Coinbase Custody Trust, and Fidelity Digital Asset Services. These custodians are subject to rigorous regulatory oversight to ensure the safety of client funds. In contrast, FTX, a Bahamian crypto exchange, was never recognized as a qualified custodian due to its offshore status and lack of compliance with U.S. regulations.

Allegations of Misleading Investors

In addition to the violations concerning FTX crypto custody, the SEC also alleges that Galois Capital misled investors about the notice period required for redemptions. Reports indicate that the fund adviser falsely represented to certain investors that redemptions required a minimum five-day notice period, a claim that the SEC argues was inaccurate and deceptive.

By providing misleading information about redemption policies, Galois Capital allegedly exacerbated the risks faced by its clients, many of whom were already facing substantial losses due to the FTX collapse. The SEC’s actions are aimed at protecting investors and maintaining the integrity of the financial markets, especially as digital assets become more integrated into mainstream finance.

FTX Crypto Custody and Broader Regulatory Implications

The case against Galois Capital illustrates the growing importance of FTX crypto custody and related issues within the regulatory landscape. With the collapse of FTX still fresh in the minds of investors, regulators are increasingly scrutinizing how investment firms handle digital assets and the level of due diligence exercised when selecting custodians. The SEC’s actions underscore the need for stricter compliance measures to protect investors from the volatility and risks inherent in the crypto market.

In the aftermath of the FTX collapse, many firms are re-evaluating their custody practices to ensure compliance with SEC guidelines. The focus on FTX crypto custody highlights the critical need for transparent, secure, and compliant methods of holding digital assets. Investment advisers and fund managers are now under pressure to review their custodial arrangements and adopt best practices to safeguard client assets.

Conclusion

The SEC’s charges against Galois Capital represent a significant move in its efforts to enforce regulatory compliance and protect investor interests in the complex world of cryptocurrency. As the case unfolds, the crypto industry will be watching closely to see how regulatory bodies continue to address the risks associated with digital asset custody. This case highlights the need for rigorous oversight of how crypto firms handle FTX Crypto Custody and other digital asset management practices. For more updates and in-depth analysis on this story and other cryptocurrency news, stay tuned to The BIT Journal.