On September 3, 2024, the U.S. Securities and Exchange Commission (the “SEC”) announced settled charges against Galois Capital Management LLC (“Galois”), a Florida-based former registered investment adviser, for failing to ensure that certain crypto-assets held by the private fund it advised (the “Fund”) were maintained with a qualified custodian, as required by Rule 206(4)-2 (the “Custody Rule”) under the Investment Advisers Act of 1940 (the “Advisers Act”). Galois maintained client assets in online crypto trading platforms, including FTX Trading Ltd. (“FTX”). In November of 2022, the Fund lost approximately half of its assets in connection with the collapse of FTX.
Additionally, the SEC alleged that Galois misled certain investors about its redemption practices for the Fund, requiring 30 days’ written notice for redemptions in the Fund’s Limited Partnership Agreement (“LPA”) but communicating a different informal practice to certain investors. Lastly, the SEC found that during the time Galois was registered as an investment adviser with the SEC, it failed to adopt or implement written compliance policies and procedures reasonably designed to prevent violations of the Advisers Act. To settle charges with the SEC, Galois agreed to pay a civil monetary penalty of $225,000, to be distributed to the Fund’s harmed investors.
Violations Relating to the Custody Rule
The SEC order found that Galois violated the Custody Rule by failing to maintain certain crypto-assets of the Fund with a qualified custodian. The Custody Rule requires SEC registered investment advisers who have custody of client funds, designed to prevent loss, theft, misuse or misappropriation of those assets and to safeguard client funds and securities. According to the SEC order, between at least July 8, 2022, and December 22, 2022, the Fund held certain crypto-assets that were offered and sold as securities. Galois held those assets in online trading accounts on crypto-asset trading platforms, including FTX. As disclosed on Galois’ Form ADV, Galois also utilized Fireblocks, a digital asset company providing its clients with a secure platform for the custody, transfer and settlement of digital assets, to secure client assets as a form of “self-custody” of client funds. Neither the crypto-asset trading platforms such as FTX nor Fireblocks met the definition of a qualified custodian as defined under the Advisers Act. The SEC stated that the crypto-assets held by the Fund were considered securities, and as such, Galois was subject to the requirements relating to the safeguarding of client assets with respect to such crypto-assets, including that such assets be maintained with a qualified custodian. In failing to do so, Galois violated the Custody Rule of the Advisers Act.
Violations Relating to Fund Redemptions
The SEC also found that Galois mislead investors about the redemption policy of the Fund. The Fund’s LPA provided that investors may redeem assets from the Fund as of the last day of any calendar month with 30 days’ written notice, unless the general partner of the Fund approved a shorter notice period. However, Galois communicated an informal practice to certain investors that it would permit redemptions with less than 30 days’ notice if investors provided at least five days’ written notice. Such informal policy was not communicated to all investors in the Fund, and in certain cases, Galois approved redemptions made by investors, including affiliated investors, with less than five days’ notice. The SEC found that Galois’ practice of permitting redemptions with less than five days’ notice for certain investors, while disclosing different redemptions policies and procedures to other investors, was misleading.
Penalty
Without admitting or denying the SEC’s findings, Galois agreed to a cease-and-desist order, a censure, and to a civil monetary penalty in the amount of $225,000, to be distributed to the Fund’s harmed investors.
Conclusion
The Galois order provides insights on how the SEC and its staff interpret the Custody Rule as it pertains to crypto-assets that are offered and sold as securities. Moreover, the SEC’s conclusions regarding the Fund’s redemption policies should serve as a reminder for private fund advisers to review their redemption practices in light of the disclosure of these policies in the private fund’s offering documents, marketing materials and/or Form ADV.
