Judge cuts back Madoff trustee lawsuit versus Merkin

NEW YORK (Reuters) - The trustee seeking money for Bernard Madoff's victims suffered his second loss in less than a week to Wall Street hedge fund manager J. Ezra Merkin, as a Manhattan bankruptcy judge dismissed most claims in a roughly $565 million lawsuit.

Judge Stuart Bernstein said the trustee Irving Picard failed to show that Merkin knew Madoff was running a giant Ponzi scheme while his "feeder funds" were sending money to the swindler's firm, Bernard L. Madoff Investment Securities LLC.

Picard's allegations "do not imply the level of certainty or absence of substantial doubt associated with actual knowledge," the judge wrote in a 66-page decision on Tuesday.

Bernstein dismissed claims alleging various fraudulent transfers among Merkin's funds, and said Picard cannot block the funds from trying to recoup money from the Madoff firm's estate.

He let Picard pursue a claim over roughly $315 million transferred to Merkin's funds from Madoff's firm in the two years prior to the firm's bankruptcy, on the ground that Merkin willfully blinded himself to the fraud and ignored red flags.

Picard may also pursue a claim that Merkin's funds should recover nothing from the estate until other customers and creditors get paid.

Andrew Levander, a lawyer for Merkin and his firm Gabriel Capital Corp, said he was pleased at the dismissal of the "vast majority of the trustee's baseless claims as a matter of law," and that the remaining claims are "factually without merit."

Amanda Remus, a spokeswoman for Picard, said the trustee is reviewing the decision and "prepared to move forward to trial" on the remaining claims.

JOKES, NOT ACKNOWLEDGMENTS

Bernstein ruled four days after a federal appeals court in New York rejected Picard's effort to void Merkin's $410 million settlement with New York Attorney General Eric Schneiderman to repay investors in the Gabriel Capital LP, Ariel Fund Ltd, Ascot Fund Ltd and Ascot Partners LP feeder funds.

Picard contended that the accord interfered with his ability to recoup money from Merkin to pay Madoff's own customers.

The trustee's case included comments Merkin allegedly made after fraud was uncovered in 2005 at Bayou Group LLC, whose principal Samuel Israel is serving a 22-year prison term.

Picard claimed Merkin mused to an investment adviser about renaming the "Ponzi scheme" the "Madoff scheme," and told Madoff himself that "as soon as there is a scam in the hedge fund industry, someone is going to call about Bernie."

Bernstein, however, said such quips "seem more like jokes than acknowledgments" about Madoff's activities.

But in allowing the willful blindness claim, the judge said Picard plausibly alleged that Merkin's "finer faculties were overcome by the fees" he earned by dealing with Madoff.

Picard has recovered $9.83 billion for Madoff customers who lost roughly $17.5 billion of principal. Madoff, 76, is serving a 150-year prison term.

The case is Picard v. Merkin et al, U.S. Bankruptcy Court, Southern District of New York, No. 09-ap-01182.

(Reporting by Jonathan Stempel in New York; Editing by Tom Brown)

By Jonathan Stempel