November 5, 2019

Madoff Suit Tossed Against Hedge Fund Feeder

Madoff Suit Tossed against hedge fund feeder

The Lipstick Building, the former office of Bernard L. Madoff Securities

A district judge had a Madoff suit tossed against hedge fund feeder firms for Bernard L. Madoff Securities. In a ruling this week, Federal Judge Deborah Batts, dismissed suits against J. Ezra Merkin, the hedge fund manager who funneled investments to Bernie Madoff. Investors in Merkin’s hedge funds, Ascot Partners LP, Gabriel Partners LP and Ariel Fund Ltd. brought the suits claiming Merkin was either a conspiracy in the Ponzi scheme or was negligent in his fiduciary duties to them. Alison Frankel reported in Reuters:

In an August 2010 motion to dismiss, Dechert focused on the “explicit disclosures” in the fund offering materials, which, according to Dechert, specifically granted Merkin the right to delegate investment decisions to outside money managers. “The offering memoranda disclosed not only the fact that investment discretion would be delegated to other money managers, but also the heightened risks associated with delegating assets,” the brief said. The funds weren’t required to disclose that the outside money manager was Madoff, the brief said, but the Ascot documentation did just that, twice identifying Madoff as the prime broker and custodian of the fund. Moreover, Merkin’s own enormous losses in Madoff’s Ponzi scheme were proof that he wasn’t acting with the requisite intent to deceive his investors.

Judge Deborah Batts, who’s overseeing the federal class action, agreed. In a 40-page ruling disclosed Monday, the judge concluded that the plaintiffs had plucked particular statements out of offering documents while ignoring the overall context of the hedge funds’ investment disclosures. “Plaintiffs cannot be permitted to ‘cherry pick’ language from the offering memoranda, and then ignore explicit cautionary language, which warned plaintiffs that third-party managers would have custody over the funds’ assets,” she wrote.

Nor was there evidence that Merkin knew or should have known Madoff was a Ponzi schemer, the judge found; unlike the Fairfield Greenwich defendants in a ruling by her Manhattan federal court colleague Victor Marrero, Judge Batts said, Merkin didn’t evidence serious doubts about Madoff until it was too late.

In what may turn out to be the most controversial parts of Batts’s ruling, the judge dismissed the investors’ state and common law claims, finding that they’re precluded by the federal law pre-empting suits involving financial instruments covered by the Securities Act of 1933 and the Exchange Act of 1934 and New York State’s Martin Act, which reserves state-law fraud cases for the AG.

Ezra Merkin made between 1 and 5% on the funds he channeled to Madoff. He invested almost if not all of his clients’ money with the man. He made hundreds of millions of dollars running his hedge funds. I will give him the benefit of the doubt in that he did not know of the fraud. As the prospectus said, potential investors were responsible for their own due diligence before investing the $5 million minimum. They are at fault for not looking into where their money was going – or knowingly allowing 100% to go to Madoff.

What Merkin did wrong was the same thing his investors did – he didn’t perform adequate due diligence and he didn’t follow a simple rule of investing – diversification. Even though Judge Batts had the Madoff suit tossed against hedge fund feeder, Merkin, he still bears responsibility for the unfortunate outcome. Investors must perform their utmost due diligence on their hedge fund no matter the manager’s reputation or returns.

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