SEC Charges Galois Capital Over Misleading Investors and Custody Failures

Highlights:

• The SEC charged Galois Capital for failing to safeguard crypto assets, leading to a $225,000 penalty.
• Galois Capital misled investors about redemption periods, allowing some to redeem earlier than others.
• The firm lost half of its assets in the FTX collapse, highlighting significant custody failures.

The U.S. Securities and Exchange Commission (SEC) has charged and settled with Galois Capital Management LLC, a Florida-based crypto-focused investment advisory firm, over custody failures and misleading redemption practices. The charges stem from violations related to safeguarding client assets, particularly crypto assets offered and sold as securities.

The U.S. SEC announced a $225,000 civil penalty against Galois Capital Management LLC, a crypto asset investment advisory firm, for failing to comply with customer asset protection regulations and misleading investors about redemption notice periods. Galois deposited some of its…

— Wu Blockchain (@WuBlockchain) September 3, 2024

Galois Capital, known for its investment in crypto assets, failed to ensure that client assets were maintained with a qualified custodian, as required by the Investment Advisers Act’s Custody Rule. Instead, the firm held certain assets in online trading accounts on platforms like FTX Trading Ltd., which were not qualified custodians. This failure exposed investors to significant risks, including the loss, misuse, or misappropriation of funds.

Misleading Investors and SEC Settlement

The SEC’s investigation revealed that Galois Capital misled investors regarding the notice period required for redemptions. The firm informed some investors that redemptions required at least five business days’ notice before month-end but allowed others to redeem with fewer days’ notice. This inconsistency in redemption practices further eroded investor trust.

Beginning in July 2022, Galois Capital’s custody failures became evident, and the situation worsened when FTX collapsed in November 2022. Galois Capital lost approximately half of its assets under management, amounting to significant financial damage. This loss highlighted the firm’s inadequate custody practices and its failure to protect investor assets.

In response to the SEC’s charges, Galois Capital agreed to a settlement without admitting or denying the findings. The firm will pay a civil penalty of $225,000, which will be distributed to harmed investors. The SEC’s order also requires Galois Capital to cease further violations of the Advisers Act and censures the firm.

Galois Capital’s case serves as a cautionary tale for other investment advisory firms in the crypto sector. Corey Schuster, Co-Chief of the SEC Enforcement Division’s Asset Management Unit, emphasized the risks posed by custody failures

Schuster stated:

By failing to comply with Custody Rule provisions, Galois Capital exposed investors to risks that fund assets, including crypto assets, could be lost, misused, or misappropriated

SEC Criticized Over FTX Crypto Repayment Restrictions

Recently, the US Securities and Exchange Commission raised concerns about the exchange’s strategy to repay creditors using crypto assets. This recent intervention adds another layer of complexity to an already convoluted recovery process for the victims of the collapsed crypto exchange.

The U.S. #SEC has warned that it might challenge the repayment plan of the defunct #crypto exchange #FTX, particularly if the repayments are made using #stablecoins.

While the SEC acknowledged that such payments may not be illegal, it reserves the right to contest transactions… pic.twitter.com/mlFHrV63Ar

— TOBTC (@_TOBTC) September 2, 2024

Coinbase’s Chief Legal Officer, Paul Grewal, has vocally criticized the SEC’s recent actions, describing them as hindering regulatory clarity in the cryptocurrency sector. “Investors, consumers, and markets deserve better,” Grewal commented, highlighting the need for clearer guidelines rather than constraints.

According to the filing, SEC lawyers cautioned FTX against its plans to use stablecoins for creditor repayments. While not outright illegal, such transactions could face challenges from the agency, particularly concerning US-dollar-pegged cryptocurrencies. The filing pointedly did not approve the plan’s legality, reserving the SEC’s right to object to the proposed repayment methods.

Moreover, the SEC and the US Trustee overseeing the bankruptcy oppose a provision in FTX’s plan to shield the company’s debtors from future legal actions. The regulatory body insists that the court deny confirmation of the plan unless revised to exclude any discharge protections for FTX’s debtors.