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Judge cuts back Madoff trustee lawsuit

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

Mr. 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.

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

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

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

Andrew Levander, a lawyer for Mr. 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 Mr. Picard, said the trustee is reviewing the decision and "prepared to move forward to trial" on the remaining claims.

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

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

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

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

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

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

Mr. Picard has recovered $9.83 billion for Madoff customers who lost roughly $17.5 billion of principal. Mr. 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.

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