Hedge fund founder Ezra Merkin "knew or should have known" that Bernard Madoff was a fraud, the trustee liquidating the firm said on Thursday in a lawsuit seeking $500 million from Merkin and his funds

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UPDATE 2-Madoff trustee sues Merkin, funds for $500 mln
Thu May 7, 2009 7:53pm BST

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[-] Text [+] * Merkin sued for $500 mln by Madoff firm trustee

* Says Merkin 'knew or should have known' about fraud (Adds quotes, bank subpoena)

By Grant McCool

NEW YORK, May 7 (Reuters) - Hedge fund founder Ezra Merkin "knew or should have known" that Bernard Madoff was a fraud, the trustee liquidating the firm said on Thursday in a lawsuit seeking $500 million from Merkin and his funds.

The lawsuit in U.S. Bankruptcy Court in New York, the second against a major Madoff "feeder" investment manager, said that Merkin and his Gabriel Capital Corp received tens of millions of dollars in fees from dealings with Madoff. A similar action against Stanley Chais of California was filed last Friday. [ID:nN01350662].

Madoff pleaded guilty in March to running the biggest investment fraud in Wall Street history that took in about $65 billion worldwide over two decades. Madoff, 71, is in jail while he awaits sentencing in June and is likely to spend the rest of his life in prison.

Merkin's lawyer Andrew Levander said in a statement that he would vigorously defend the lawsuit.

"The Trustee's lawsuit does not establish any basis for a clawback against the funds or Mr. Merkin," Levander said. "To the contrary, the complaint acknowledges that the funds were net investors in, not redeemers from, Madoff.

"Nor does it offer any support for the contention that Mr. Merkin should have detected Madoff's fraud."
Merkin, who ran Gabriel Capital LP, Ariel Fund Ltd, Ascot Partners LP and Gabriel Capital Corp, has also been sued by New York State Attorney General Andrew Cuomo and private and institutional investors.

New York lawyer Irving Picard is the court-appointed trustee seeking to recover the Madoff billions and other assets to distribute to customers defrauded by Bernard L. Madoff Investment Securities LLC (BLMIS).

The court document said Merkin or Gabriel withdrew "more than $500 million of nonexistent principal" between 1995 and 2008 from the Madoff firm.

"In connection with these investments, Merkin, individually or through Gabriel Capital Corporation, 'earned' tens of millions of dollars in management and performance fees, even though he knew or should have known that BLMIS was engaged in fraud," the lawsuit said.

The lawsuit said Merkin was told by a colleague and an accountant working for his funds that the Madoff firm's returns were too consistent or appeared to be a fraud.

It said that between 1995 through 2008, the funds received "unrealistically high and consistent" annual returns of between 11 percent and 16 percent.

The lawsuit described Merkin "as a sophisticated investment manager who was a close business and social associate of Madoff."

Picard and his team of lawyers said they have managed to recover about $1 billion for former customers under the Securities Investor Protection Act. As part of their effort to identify and seize money and assets, lawyers around the world have issued subpoenas to an array of firms and banks, including UBS (UBSN.VX: Quote, Profile, Research) (UBS.N: Quote, Profile, Research).

"We have received a third-party subpoena, and we are complying with it," a UBS spokeswoman said on Thursday
The trustee's lawyers said in a statement last week that they planned to sue "entities that either acted as insiders" with Madoff and his firm or benefited from the scheme "to the severe detriment" of other Madoff investors.

The cases are Irving H. Picard v J. Ezra Merkin, Gabriel Capital, L.P., Ariel Fund Ltd., Ascot Partners, L.P., Gabriel Capital Corporation 09-01182 and Securities Investor Protection Corp v Bernard L. Madoff Investment Securities 08-01789 in U.S. Bankruptcy Court for the Southern District of New York (Manhattan) (Reporting by Grand McCool; Additional reporting by Lisa Jucca in Zurich; Editing by Andre Grenon)