On September 3, the U.S. Securities and Exchange Commission (SEC) announced charges against Galois Capital Management for failing to properly custody client assets, particularly involving funds held with the now-defunct cryptocurrency exchange FTX.Digital asset custodians often seek a New York trust charter. Source: NYDFSViolations of the SEC Custody RuleThe SEC alleges that Galois Capital violated the agency's custody rule, which mandates that investment advisers must hold client funds with a "qualified custodian," such as a registered bank or broker-dealer. Instead, Galois reportedly held crypto assets on multiple cryptocurrency exchanges, including FTX Trading Ltd., which collapsed in November 2022.The collapse of FTX led to Galois losing approximately half of its assets, exposing investors to substantial risks. According to Corey Schuster, co-chief of the SEC enforcement division’s asset management unit, the firm's actions failed to protect investor funds. He stated, “We will continue to hold accountable advisers who violate their core investor protection obligations.”Custody of Digital AssetsSince 2021, several firms, including Anchorage Digital Bank, Fireblocks Trust Company, Coinbase Custody Trust, and Fidelity Digital Asset Services, have emerged as qualified digital asset custodians. However, FTX was never among them. Its collapse resulted in billions of dollars in customer funds becoming inaccessible due to mismanagement and alleged fraud.Misleading Redemption PracticesThe SEC further alleged that Galois Capital misled its investors regarding the notice period required for redemptions. The firm reportedly told some investors that redemptions required at least five business days’ notice while allowing other investors to redeem with fewer days’ notice.Penalties and Investor CompensationIn response to the charges, Galois Capital has agreed to pay a civil penalty of $225,000, which will be distributed to investors harmed by the fund's mismanagement.This case serves as a reminder of the importance of proper custody of assets and investor protections, particularly in the rapidly evolving cryptocurrency market.