Where Ezra Merkin lost his way

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Where Ezra Merkin Lost His Way
By JASON ZWEIG

Last fall, the celebrated money manager J. Ezra Merkin told a room full of value investors that he was "in the business of buying broken promises." Now, some clients are accusing him of selling broken promises.

Mr. Merkin, who runs Gabriel Capital Group in New York, is sometimes called "Ezra the Wise" after the Biblical prophet. He has been revered for his ability to ferret out value in the bombed-out stocks and distressed bonds that only a follower of the great Benjamin Graham could love. He contributed an insightful chapter on bankruptcy investing to the new edition of Mr. Graham and David Dodd's classic 1940 book, "Security Analysis."


So value investors were stunned when Mr. Merkin revealed a month ago that he had lost $2.4 billion in the alleged Ponzi scheme run by Bernard L. Madoff. "How the h- an incredibly intelligent guy like Ezra got hornswoggled into this is utterly beyond me," says Bruce Greenwald, a professor at Columbia Business School.

"In retrospect," says Mr. Merkin's attorney, Andrew Levander, "Madoff brazenly fooled Mr. Merkin and many others. The experience has been a source of terrible consternation and sadness for Mr. Merkin, and obviously for his investors, too."

At a panel sponsored by Columbia last fall, Mr. Merkin expounded on the value in complex mortgage securities, the ups and downs of auto loans, and the pitfalls of commercial real estate and credit-card securities. "Since we've had the mother of all parties," he joked, "we might have the mother of all cleanups." Mr. Merkin sounded like someone who still spent every waking hour ransacking the markets for bargains.

Indeed, the offering document for Mr. Merkin's Ascot Partners LP states that he "intends...to adopt a selective approach in evaluating potential investment situations, generally concentrating on relatively fewer transactions that he can follow more closely. [Mr. Merkin] is expected to engage in hedging and short sales." That sounds like just what a great value investor should do: Scour the markets for reward and avoid risk.

Instead, it seems, Mr. Merkin was earning a lot of money for doing very little. According to a letter he sent clients on Dec. 11, Mr. Merkin delegated "substantially all" of Ascot's $1.8 billion to Bernie Madoff. Roughly 25% of the assets in Mr. Merkin's Ariel Fund Ltd. and Gabriel Capital LP were also meted out to Madoff. (Ariel Fund Ltd. has no connection to the Ariel mutual funds of Chicago.)

How did Mr. Merkin end up in this mess? Some think that as an honest person himself, Mr. Merkin simply believed that Bernie Madoff was equally trustworthy. Paul Isaac of Cadogan Management, a hedge-fund research firm, cites "Hotel California risk" -- the danger that years of profits can trap a manager in a position even if he wants out. Or Mr. Merkin's success may have gone to his head, dulling his eye for detail.

Or, perhaps, the money itself went to Mr. Merkin's head. After all, Mr. Merkin still collected full fees on the assets he had given to Bernie Madoff. In Ascot alone, Mr. Merkin's deferred fees (which he is now unlikely to receive) exceeded $320 million by the end of 2007.

Mr. Merkin also charged full freight as a philanthropist.

The UJA/Federation of New York had put $10.5 million of its endowment in Mr. Merkin's Ariel fund before he joined the UJA investment committee in 1999. After the committee waived a conflict-of-interest rule, the money stayed in Ariel (earning fees for Mr. Merkin) until 2005, when UJA revisited the rule and sold the fund.

As chairman of the investment committee at Yeshiva University, Mr. Merkin put about $15 million of the school's endowment into Ascot. He thus captured a 1.5% annual fee for himself, even though Yeshiva could have given its money directly to Bernie Madoff -- who was later treasurer of the university's board -- for nothing. Although Mr. Merkin was also a donor to Yeshiva, the arrangement strikes many as highly unusual.

"What was in his mind to charge that fee?" asks a financier familiar with the Yeshiva investment. " How in the world could he justify that?"

Now, sadly, Mr. Merkin seems to have become the latest testament to the emotional struggle even the greatest investors must undertake to resist temptation. Of all the seductions that can lead a value investor to stray from the true path, perhaps the worst is simply making too much money.