Alison Frankel

There’s a very good chance that former Securities and Exchange Commission general counsel David Becker owes absolutely nothing to the folks who lost money in Bernard Madoff’s Ponzi scheme. Nevertheless, on Monday, Becker and his two brothers agreed to turn over every penny of the proceeds they received from their mother’s long-ago Madoff investment account, a total of $556,017. Becker, a partner at Cleary Gottlieb Steen & Hamilton, didn’t return my call seeking comment. But he is doubtless hoping that the $556,017 settlement with Madoff bankruptcy trustee Irving Picard of Baker & Hostetler puts an end to the ugliest chapter in his career.

For a brief while last year, you’ll recall, Becker was the favorite whipping boy of Madoff victims and their congressional champions. Becker and his two brothers were what’s known as net winners in the Madoff pyramid. After their mother’s death in 2004 they transferred the approximately $2 million in her Madoff investment account to a Smith Barney probate account. By September 2006, the will was probated and the account was liquidated. But in December 2010, Picard sued Becker and his brothers, demanding the return of $1.5 million in allegedly fraudulent profits from their mother’s estate.

At the time, Becker was the SEC’s general counsel. And though he informed the agency’s ethics office of his inheritance (and SEC Chairman Mary Schapiro was aware of Becker’s Madoff proceeds), the GC was not asked to step out of SEC deliberations — and did not recuse himself from the debate — on the appropriate method for compensating investors. When word got out of Becker’s Madoff money, Schapiro took a beating in Congress.

Becker faced even more potentially serious consequences. An exhaustive September 2011 report by then-SEC Inspector General David Kotz concluded with the finding that Becker’s actions merited a referral to the Justice Department’s Office of Public Integrity for a criminal investigation. Becker, who had resigned from the SEC in February 2011 to return to his partnership at Cleary, defended himself before a congressional committee buzzing about Kotz’s allegations; in November, the Justice Department told Becker’s counsel, William Baker of Latham & Watkins, that it was not opening a criminal investigation of the former SEC GC.

Meanwhile, U.S. Senior District Judge Jed Rakoff issued a ruling in Picard’s case against the owners of the New York Mets that could have wiped out any Picard claims against Becker and his brothers. Rakoff determined that Picard could not attempt to claw back allegedly fictitious profits dating back more than two years before Madoff’s firm collapsed. By any measurement, the Beckers’ ties to Madoff ended more than two years before December 2008, when the Madoff fraud was exposed. If Rakoff’s reasoning is upheld on appeal, Becker and his brothers would be off the hook entirely.

Instead, they chose to give back every penny they received from their mother’s Madoff investment. (The difference between Picard’s clawback claim and the $556,017 settlement is the fees and taxes the Beckers paid on their inheritance.)

A Picard spokesperson said the settlement “represents the recovery of an amount equal to 100 percent of the subsequent transfers received by the sons,” noting that to recover more than that, Picard would have had to reopen the probate proceeding, “a time-consuming, expensive and difficult undertaking under Massachusetts law.”

Becker’s lawyers at Latham & Watkins issued a statement pointing out that the Becker brothers are “returning 100 percent of the fictitious profits distributed to them,” which is entirely consistent with David Becker’s previous statements on his Madoff inheritance. “He always expected that he would return any fictitious profits that he unknowingly received,” the statement said. “Mr. Becker has done everything possible, both at the SEC and in his private affairs, to assist the victims of the Madoff fraud.”

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Over the last six months, U.S. Senior District Judge Jed Rakoff has made Irving Picard of Baker & Hostetler look more like Don Quixote than a white knight riding to the rescue of investors who lost billions in Bernard Madoff’s Ponzi scheme.

Rakoff has already squelched the Madoff trustee’s fraud claims against the banks that allegedly aided and abetted Madoff’s scheme, as well as cutting off Picard clawback claims that date back more than two years. On Tuesday, in Rakoff’s biggest-dollar ruling in the Madoff case, the judge said Picard does not have standing to pursue a $60 billion racketeering suit against UniCredit and two other foreign banks that allegedly participated in a scheme to funnel $9.1 billion to Madoff in exchange for kickbacks to a woman named Sonja Kohn. (Picard had claimed $20 billion in damages, which can be tripled under the Racketeer Influenced and Corrupt Organizations Act.)

Interestingly, Rakoff did not use the same analysis to dismiss the RICO claims as he did in tossing fraud claims against UniCredit and the other banks. In a quick dismissal of the fraud counts, the judge reiterated his July 2011 holding that Picard can’t stand in the shoes of Madoff investors to assert fraud against the financial institutions that allegedly abetted Madoff’s Ponzi scheme. He could have simply said the same is true in the trustee’s racketeering case (which is what I assumed he would do when I wrote about the fraud dismissal in July). Instead, Rakoff seemed to accept, for the purposes of considering the banks’ motion to dismiss, Picard’s argument that Sonja Kohn’s alleged racketeering scheme was, at least to some extent, distinct from Madoff’s scam.

That was, however, Picard’s only success. Rakoff, who is the co-editor of a leading guide to RICO litigation, found that Picard’s RICO suit against the foreign banks failed under at least three defense theories. First, Rakoff said, Picard couldn’t show a link between the banks’ alleged participation in Kohn’s kickback scheme and any injury to Madoff investors. The trustee tried to rely on a 1992 ruling by the U.S. Supreme Court in Holmes v. SIPC, which acknowledged the difficulty of proving indirect injuries under RICO. But Rakoff said Picard was misreading Holmes. According to the judge, the Supreme Court’s ruling requires RICO plaintiffs to establish a direct connection to the defendant’s conduct.

The judge also rejected Picard’s extremely nuanced argument for why his RICO claims against UniCredit and the other banks are not barred by the Private Securities Litigation Reform Act. According to Rakoff, the 2nd Circuit Court of Appeals has held, in a case called MLSMK v. JPMorgan Chase, that under the PSLRA, securities claims cannot serve as predicate acts in a civil RICO suit. (A related 3rd Circuit ruling specifically said that the bar applies to RICO claims related to a Ponzi scheme.) Picard tried a tricky argument, asserting that because Madoff investors can’t bring a securities case against UniCredit and the other banks under Morrison v. National Australia Bank, the PSLRA bar shouldn’t apply to their RICO suit. Rakoff rejected Picard’s reasoning, noting that RICO has its own limits under Morrison, according to the 2nd Circuit’s holding last month in Cedeno v. Castillo.

“[Picard's argument] is too clever by half and would in many cases allow artful pleading to eviscerate either the territorial reach of the Securities Exchange Act or the purpose of the RICO Amendment to the PSLRA,” the judge wrote.

Finally, and most fundamentally, Rakoff said that Picard hadn’t alleged sufficient facts to proceed to discovery under the heightened pleading standards the U.S. Supreme Court established in Ashcroft v. Iqbal. In a fairly cursory consideration of the trustee’s complaint, Rakoff derided Picard’s “paltry and otherwise unexceptional” allegations, writing that the trustee casts his assertions in a “sinister” light only by “invoking the specter” of a RICO scheme.

UniCredit counsel Susan Saltzstein of Skadden, Arps, Slate, Meagher & Flom said the bank is pleased with Rakoff’s ruling. A spokesperson for Picard sent me an email statement: “The SIPA Trustee and his counsel remain confident in his RICO and common law claims against [UniCredit and related defendants]. The SIPA Trustee will appeal to the United States Court of Appeals for the Second Circuit.”

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One of the most intriguing offshoots of the mess Bernard Madoff created is the underground market for claims against the estate of his bankrupt securities firm. Last June, when the Wall Street Journal ran a revelatory story on big banks’ trading in Madoff claims, suits by Madoff trustee Irving Picard of Baker Hostetler seemed so promising that claims were trading at 75 cents on the dollar. But according to fascinating new litigation between Deutsche Bank and two Madoff feeder funds, the value of claims has been dropping ever since, and was down to 60 cents on the dollar last month. The billion-dollar declaratory judgment complaint by Kingate Global and Kingate Euro against Deutsche Bank doesn’t offer an explanation for the declining value of Madoff claims. But it’s not much of a leap of inference to guess that U.S. District Judges Jed Rakoff and Colleen McMahon of Manhattan federal district court have more than a little to do with it.

Some background: The British Virgin Islands-based Kingate funds channeled billions of dollars to Madoff before his Ponzi scheme was exposed in December 2008. When Madoff’s securities business collapsed, Kingate investors were out $3.5 billion, according to the funds’ complaint against Deutsche Bank. The funds asserted that they were net losers in Madoff’s scheme, meaning that their losses exceeded their withdrawals from Madoff accounts. They claimed more than $1.6 billion against the Madoff estate.

Picard had rather a different view of the Kingate funds, which he said ignored warning signs of Madoff’s fraud. He sued Kingate Global and Kingate Euro to claw back $1 billion in withdrawals the funds made in the run-up to Madoff’s collapse, as well as allegedly excessive compensation the funds paid top executives.

In April 2011 the Kingate funds solicited bids on their $1.6 billion in Madoff claims, according to a countersuit Deutsche Bank filed Wednesday. Deutsche Bank wasn’t Kingate’s first choice, but in July, after talks with another (unidentified) bidder fell through, Kingate and Deutsche Bank began negotiating a deal under which Deutsche Bank would pay 66 cents on the dollar for the Kingate funds’ claims, or about $1 billion. Interestingly, Rakoff’s enormously consequential ruling on Picard’s standing to sue the banks that allegedly abetted Madoff’s fraud came just as Kingate and Deutsche Bank talks heated up.

Deutsche Bank and Kingate both acknowledge that the bank had big concerns about two things: Picard’s claims against Kingate and Kingate’s ability to recover from a Justice Department forfeiture fund as well as from the Madoff estate. (The forfeiture fund controls about 20 percent of the recovery Picard has obtained for Madoff investors.) Kingate’s complaint, filed by Richard Werder Jr. of Quinn Emanuel Urquhart & Sullivan, asserted that the funds took the extreme step of bringing Picard – who, in addition to being the bankruptcy trustee, is special master of the forfeiture fund — into the talks in order to satisfy Deutsche Bank’s demands. The funds claim that the bank ultimately signed an agreement to buy their Madoff claims for about $1 billion.

But the bank said it signed a document that only guaranteed the Kingate funds would sell the claims, not that Deutsche Bank would buy them. Its lawyers, led by Thomas Arena of Milbank, Tweed, Hadley & McCloy, argued that Kingate failed to satisfy the bank’s conditions despite talks that continued through November.

Kingate said that’s a pretext. “There is no mystery why, in fact, Deutsche Bank is refusing to close on its obligations under the confirmation letter,” the Kingate complaint said. “The confirmation letter provides that Deutsche Bank will pay the Kingate funds 66 percent of the designated claim amounts in exchange for those claims. On information and belief, similar claims are now selling at a price below 66 percent, perhaps as low as 60 percent (or lower).” That represents a $90 million drop in the value of the Kingate claims, the complaint said.

Deutsche Bank’s countersuit, which rejected Kingate’s “pretext” assertion, attributed the decline in Madoff claim value to Rakoff’s September ruling limiting Picard’s reach on clawbacks to withdrawals made within two years of Madoff’s bankruptcy. The bank doesn’t mention Rakoff’s July decision on standing, nor McMahon’s parallel conclusion in November. That’s curious, because the Kingate funds potentially benefit, as defendants, from all three of those rulings, even as the value of their claims against the estate declined in the overall market for Madoff claims. The web between Madoff and his former feeder funds is tangled indeed.

Neither Kingate counsel Werder nor Deutsche Bank counsel Arena returned my calls for comment.

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Irving Picard has given the bankruptcy laws one hell of a workout. As trustee in the Chapter 7 bankruptcy of Bernard Madoff’s securities firm, Picard, a partner at Baker & Hostetler, has been more aggressive and creative than any bankruptcy trustee in history in his search for defendants to blame for Madoff’s epic Ponzi scheme. His most ambitious gambit, as everyone knows, was a series of megabillion-dollar suits against the international financial institutions that Picard’s team of lawyers at Baker & Hostetler accused of willfully ignoring warnings of Madoff’s fraud.

The trustee’s suits were provocative headline-grabbers — and on Tuesday, a second Manhattan federal judge concluded that they’re fatally flawed. U.S. District Court Judge Colleen McMahon dismissed Picard’s common law tort claims against JPMorgan Chase and UBS (and related defendants), finding that Picard does not have standing. Her ruling expands and reinforces a previous decision on the same issue by her Manhattan federal court colleague Judge Jed Rakoff, who in July dismissed Picard’s common law claims against HSBC and UniCredit. Tuesday’s decision wipes out about $20 billion in alleged damages, leaving Picard with about $450 million in traditional bankruptcy court clawback claims against JPMorgan and about $80 million against UBS. It’s a huge win for JPMorgan’s lawyers at Wachtell, Lipton, Rosen & Katz — who were actually the first lawyers to ask a federal district court judge to hear one of Picard’s cases — and for UBS’s lawyers at Gibson, Dunn & Crutcher.

But now the question is whether Picard’s allegations that these global banks helped Madoff perpetuate his scheme are dead. The answer is not quite. The trustee’s spokesperson has already announced that Picard’s team from Baker & Hostetler intends to appeal McMahon’s ruling to the 2nd U.S. Circuit Court of Appeals; the trustee has already filed a notice of appeal of Rakoff’s decision. Moreover, as both McMahon and Rakoff discussed in their opinions, Madoff’s customers have the standing Picard lacks. Some enterprising plaintiffs lawyer could certainly capitalize on Picard’s spade work and file a class action against the banks on behalf of Madoff victims.

But I don’t think the odds are good for either the 2nd Circuit appeal or a class action.

Let’s first consider the problems a class action would face. If Madoff victims claimed the banks helped the Ponzi scheme break federal securities laws, they’d have to overcome U.S. Supreme Court rulings that limit the reach of securities laws to alleged aiders and abettors. To get to the banks, victims would have to show that their Madoff investments relied on the banks’ endorsement of him, an unlikely scenario given the banks’ indirect relationship with Madoff customers. To show securities fraud, customers would also have to show that the banks acted with fraudulent intent, another tough sell since aiding a Ponzi schemer isn’t a good long-term business plan. And if customers tried to bring state or common-law fraud claims, they’d face Securities Litigation Uniform Standards Act pre-emption. Add in forum non conveniens and Morrison v. National Australia Bank defenses for the foreign institutions, and potential statute of limitations defenses for all of the banks, and you have a very uncertain case. It’s probably not an oversight that no one has yet filed a class action against the banks for Madoff customers.

So what about Picard’s appeal to the 2nd Circuit? (As a preliminary matter, it’s not clear that Picard has an automatic right to appeal; he may have to ask Rakoff and McMahon to certify the issue of the trustee’s standing for 2nd Circuit consideration.) Both Rakoff and McMahon are well-respected judges, and both of their opinions concluded the standing issue isn’t even a close call. McMahon endorsed Rakoff’s reasoning for why Picard doesn’t have standing under the Bankruptcy Code or the Securities Investor Protection Act — a bankruptcy trustee is only empowered to bring the claims that belonged to the estate, not to its customers. And Madoff’s now-defunct firm, both judges found, can’t sue the banks for abetting its own fraud under the doctrine of in pari delicto.

McMahon also agreed with Rakoff that Picard’s contribution theory — in which Picard asserted he can bring tort claims against the banks because he, in turn, has an obligation to Madoff customers — doesn’t hold up; both judges said SIPA doesn’t give him that power, under a contribution, subrogation, or bailment theory. (If you want more details on these theories, I previously discussed them in a post about Rakoff’s ruling.)

Picard’s Baker lawyers added a new argument for the trustee’s standing in the case against JPMorgan and UBS after Rakoff’s ruling in July. Under a provision of the Bankruptcy Code, they asserted, the trustee has the rights of a “judgment creditor,” which is a lender to the estate at the time it files for bankruptcy. The Code, in the 10th Circuit’s description, “permits the trustee … to assume the guise of a creditor with a judgment against the debtor,” which means the trustee can turn to state law remedies to satisfy that judgment. Picard said the provision permitted him to step into the shoes of Madoff creditors — defrauded brokerage customers — to bring claims against UBS and JPMorgan. (The trustee didn’t make this argument before Rakoff, and, in fact, didn’t make the argument in opposing the banks’ move out of bankruptcy court and into federal district court.)

McMahon resoundingly rejected the new argument. “The problems with this theory are legion,” she wrote. “Foremost is that its conclusion — the trustee is empowered to pursue the pre-petition common-law claims of actual creditors — does not follow from its premise — that the trustee has the powers of a judgment creditor… The trustee does not argue that New York law allows a judgment creditor to seek recovery against a debtor by appropriating causes of action against third parties that belong not to the debtor but to the debtor’s other creditors. Nor could he; the result would be preposterous.” (This language is the strongest in McMahon’s otherwise very moderate opinion.)

Picard’s best hope for success at the 2nd Circuit probably lies with an old ruling by the very same court. In a 1978 case called Redington v. Touche Ross, a divided 2nd Circuit panel found that a liquidation trustee does have the right to bring claims on behalf of a brokerage’s customers. The U.S. Supreme Court subsequently overturned the Redington ruling on other grounds, so the 2nd Circuit’s finding on the trustee’s standing has been in a sort of weird judicial limbo. In his ruling in July on Picard’s standing, Rakoff cited a previous ruling by Manhattan federal judge Milton Pollack in holding that Redington is no longer good law. (He also said that even if it were, the ruling wouldn’t confer standing on Picard in the Madoff cases because the facts aren’t parallel.)

McMahon’s ruling Tuesday includes a more thorough analysis of why Redington is no longer 2nd Circuit precedent, as if the judge were anticipating Picard’s eventual appeal. (“Let me elaborate further on Judge Rakoff’s discussion,” she wrote.) The judge said that the threshold issue in the Redington case was not actually the trustee’s standing, but whether federal law provided a private right of action against Touche Ross under the Securities Act. The 2nd Circuit made a mistake, according the Supreme Court, in concluding there was a claim under federal law, McMahon reasoned. So the appeals court never should have gotten to the question of the trustee’s standing. “Once the Supreme Court told the 2nd Circuit that no private right of action existed under federal law, whatever the 2nd Circuit said about standing was rendered superfluous,” she wrote. “Its finding on standing should never have been made…. Whatever [the 2nd Circuit's] reasoning in the court of (erroneously) reaching the standing question surely cannot bind a lower court.”

If the 2nd Circuit decides to reinstate Picard’s claims, in other words, it will have to repudiate very thoughtful analysis by two smart, careful trial judges. But the Madoff litigation is groundbreaking, and Picard’s team is endlessly resourceful. I can’t wait to see their next move.

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Helen Chaitman of Becker & Poliakoff represents more than 300 investors who had accounts with Bernard Madoff. For more than two years she’s hammered away at one particular argument in federal bankruptcy court, in Congress, even on YouTube: Madoff bankruptcy trustee Irving Picard of Baker & Hostetler shouldn’t be allowed to demand the return of profits that Madoff investors pulled out of their accounts as long ago as 2002, six years before the Ponzi scheme imploded in December 2008. On Tuesday night, Chaitman finally found vindication, even though it wasn’t in any of her cases. Manhattan federal judge Jed Rakoff, ruling in Picard’s fraud case against the owners of the New York Mets, concluded that a section of the federal bankruptcy code precludes Picard from attempting to claw back money Madoff investors pulled out of the Ponzi scheme before 2006.

“This is something I’ve been saying from the beginning,” Chaitman told me. “Anyone who didn’t withdraw their money in the last two years [of Madoff's scheme] is out completely.” Jonathan Landers of Milberg, who represents 30 clawback clients, agreed: “This is a very, very significant ruling.”

That’s putting it mildly. Judge Rakoff’s 18-page ruling could completely upend the Madoff bankruptcy. Among the big-name Madoff investors who would be off Picard’s hook completely if Rakoff’s ruling stands is former Securities and Exchange Commission general counsel David Becker, who’s in hot water for allegedly failing to alert SEC commissioners of a potential conflict of interest stemming from his parents’ long-closed Madoff account. Picard had filed a clawback suit against Becker, who inherited money after his parents’ account was liquidated in 2002; Rakoff’s ruling would wipe out Picard’s suit.

Other big winners from Rakoff’s ruling could be Madoff’s surviving children, who would still face a $58.7 million clawback claim for their two-year withdrawals but not claims on another $83.3 million they withdrew between 2002 and 2006, according to Picard’s 2009 complaint. Bank Medici founder Sonja Kohn’s clawback exposure would be reduced from $38.8 million to $11.2 million. Madoff’s early alleged enablers Frank Avellino and Michael Bienes would be looking at $17.2 million in clawback claims, not $56 million. Hard luck Madoff investor Melvyn Weiss, the onetime securities class action kingpin who was convicted for paying kickbacks to name plaintiffs, won’t see much relief from Rakoff’s ruling. His two-year exposure is $17.5 million, only $2 million less than Picard’s six-year claim.

Under Rakoff’s ruling, Madoff mentor Jeffrey Picower’s clawback liability would have been slashed from $2.4 billion to a fraction of that amount. But according to Picower counsel William Zabel of Schulte Roth & Zabel, the reduction in Picower’s case is “irrelevant,” since his widow decided to return $7.2 billion to the Madoff estate to remove any taint from her foundation.

Picard has asserted a total of about $8 billion in clawback claims, seeking the return of fictitious profits withdrawn from Madoff Securities accounts. That total includes claims against the financial institutions, such as UBS, UniCredit, and HSBC that allegedly abetted Madoff’s fraud. If Judge Rakoff’s ruling stands, about $5 billion of those clawbacks would be disallowed because the money was withdrawn before 2006.

The decision is obviously a boon to the Mets owners and their lawyers at Davis Polk & Wardwell. The judge left standing only one of Picard’s fraud counts against the Mets, limiting the Madoff trustee’s potential recovery to no more than $386 million, rather than the nearly $1 billion in principal and profits Picard wanted. Moreover, for Picard to get his hands on any of the Mets owners’ principal, he will have to prove they were “willfully blind,” a prospect Judge Rakoff doesn’t seem to consider very likely. He said Picard’s evidence that the Mets owners deliberately ignored warnings of Madoff’s fraud was sufficient to get past the Mets’ motion to dismiss but still “less than overwhelming.”

That’s only the beginning of this ruling’s story, though. Judge Rakoff has offered an interpretation of the intersection of bankruptcy and securities laws that could extend well beyond the Madoff bankruptcy. Bankruptcy lawyers are just beginning to parse the decision, but there’s no doubt that if it stands, it could have profound implications for bankruptcy trustees trying to recover money for defrauded investors.

Rakoff’s ruling is based on a provision of the federal bankruptcy code that offers a so-called “safe harbor” in cases involving stock brokerages and securities contracts. The provision restricts a bankruptcy trustee’s ability to undo securities transactions except in cases of actual fraud. The intent of the provision was to quell market chaos, putting a two-year time limit on a trustee’s attempts to go after counterparties in stock deals. The safe harbor cuts out fraudulent conveyance claims based on state laws, which often have longer time frames. (New York, for instance, has a six-year statute of limitations on fraud, which is the source of Picard’s assertion that he can recover fictitious profits dating back six years.)

In the Madoff Chapter 11, Manhattan bankruptcy court judge Burton Lifland ruled that the safe harbor provision doesn’t apply in the Madoff case. Federal appeals courts have found that the provision does not apply to Ponzi schemes, and Manhattan federal court senior judge Kimba Wood recently ruled, albeit indirectly, that the safe harbor doesn’t come into play in the Madoff case.

Judge Rakoff, however, found it does. He concluded that under a June 2011 ruling by the U.S. Court of Appeals for the Second Circuit, in a case involving a trustee’s attempt to recover money from a redemption of Enron debt, he must look at the plain language of the safe harbor provision. And under a strict reading of the law, he said, Madoff investors are shielded from fraudulent conveyance claims except in instances of actual fraud. “Because Madoff Securities was a registered stock brokerage firm,” the judge wrote. “The liabilities of customers like [the Mets owners] are subject to the ‘safe harbor’ provision.” Madoff’s contracts with his customers, Judge Rakoff wrote, fell under the provision’s definition of a securities contract; and his customers’ withdrawals from their accounts constituted “settlement payments” or transfers “in connection with a securities contract” under the language of the law.

Rakoff expressly rejected arguments by Picard’s Baker & Hostetler lawyers that Congress did not intend the safe harbor to protect investors who cashed out fictitious profits, because seeking the return of their ill-gotten withdrawals would have no effect on the broader market. They also argued that Congress meant the law to protect only brokers, not investors. Judge Rakoff said that didn’t matter. “Resort to legislative history is inappropriate where, as here, the language of the statute is plain and controlling on its face,” he wrote.

Landers of Milberg said Rakoff’s interpretation was compelled by the Second Circuit’s Enron decision, which holds that “there’s no squirreling around with [the provision]-if it applies, it applies.”

Picard has no automatic right to appeal Judge Rakoff’s ruling, but must petition the judge to grant leave for an appeal. Spokeswoman Amanda Remus declined comment on the trustee’s plans.

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You had to be a sophisticated investor if you wanted to give J. Ezra Merkin your money. The hedge fund director made that clear in the offering documents for three of his funds: investors had to entrust considerable assets to him (at least $5 million for individuals and $25 million for businesses); had to conduct their own due diligence before deciding to invest; and had to accept the risk that Merkin’s funds might lose their money. Unsaid, but well-understood by many of the investors in Merkin’s Ascot fund (at least according to Merkin lawyer Andrew Levander of Dechert), was that Merkin would be feeding investors’ money to Bernard Madoff.

Merkin earned between 1 and 5 percent fees on the hundreds of millions of dollars he funneled to Madoff beginning in the early 1990s. At the same time, his own Madoff investment blossomed to more than $100 million. When Madoff’s Ponzi scheme was exposed in December 2008, Merkin was as stunned as his hedge fund clients, according to his lawyers. Merkin also claimed that he and his family were among Madoff’s biggest victims, with nine-figure paper losses.

Many doubted that depictions of events, including the New York attorney general, who filed a state-law fraud action against Merkin; real estate developer and Merkin investor Morton Zuckerman, who brought in Susman Godfrey for a New York state supreme court suit; and investors in Merkin’s Ascot, Gabriel, and Arial funds, whose cases were consolidated in June 2009 in a Manhattan federal court securities class action. The hedge fund investors, represented by lead counsel from Abbey Spanier Rodd Abrams & Paradis and Wolf Haldenstein Adler Freeman & Herz, alleged that Merkin had misrepresented the operation of his funds in offering documents that implied Merkin himself — and not Bernie Madoff — would be making investment decisions. They also asserted that Merkin ignored warning signs.

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.

That holding, according to Morton Zuckerman’s lead counsel, rules directly contrary to prior rulings by state supreme court judge Richard Lowe III in the Zuckerman and state AG cases against Merkin. In fact, said Harry Susman of Susman Godfrey, Judge Batts’s dismissal is “crazy. She’s a federal judge and I don’t want to second-guess her, but all you can do is shake your head.” In Zuckerman’s case, Susman said, Judge Lowe recently re-instated state law securities fraud claims after a state appellate court found they’re not precluded by the Martin Act. (Susman did concede that unlike investors in the federal class action, Zuckerman was able to point to specific assurances he received from Merkin about how his investment would be handled.)

Presumably, the investors in the dismissed federal class action could still see some recovery from the AG’s suit against Merkin, which is headed for a summary judgment ruling on liability. Lawyers at Abbey Spanier and Wolf Haldenstein declined my requests for comment.

But Merkin counsel Andy Levander of Dechert said Judge Batts’s opinion is vindication for Merkin. “It’s what we’ve said all along,” Levander told me. “The facts show the Mr. Merkin was not a crook, not a fraudster. He did a good job but he missed this.” Levander declined to comment on whether Judge Batts’s opinion will have sway in the AG case, but said, “It’s a good first step.”

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The damages claims in Irving Picard’s pursuit of the banks that allegedly helped Ponzi schemer Bernard Madoff are so outsized that even a simple two-page letter from a federal judge can lead to a $2 billion kerfuffle. On Tuesday, Manhattan federal district court judge Colleen McMahon sent a letter to lawyers for Picard, the bankruptcy trustee for Bernard L. Madoff Investment Securities, and to lawyers for UBS, which is a defendant in two of Picard’s suits. UBS’s counsel at Gibson, Dunn & Crutcher had moved in June to transfer two Picard suits naming the bank as a defendant out of bankruptcy court and into federal court; Judge McMahon, who is overseeing Picard’s case against JPMorgan Chase, agreed to take the cases on July 7 and began requesting information, by letter, from Picard counsel at Baker & Hostetler and UBS counsel at Gibson Dunn.

To understand Judge McMahon’s July 19 letter — and how it was misinterpreted — it’s important to know that in the two actions naming UBS defendants, Picard is asserting different causes of action and seeking different amounts of money. In the case known as Luxalpha, Picard and Baker & Hostetler claim that UBS breached its fiduciary duty and aided and abetted fraud. That suit demands $2 billion from UBS and other defendants. The other case, known as LIF, is a clawback action demanding the return of all the money the bank and other defendants redeemed from Madoff or earned in fees, a total of $550 million, according to Picard. Though the press release announcing the LIF suit refers to “alleged financial fraud” by UBS, the suit actually claims only unjust enrichment and another common-law cause of action as an alternative to the clawback theory.

In a July 14 letter, Judge McMahon told Baker & Hostetler and Gibson Dunn that she needed more explanation of how the LIF and Luxalpha cases intersected and overlapped, and warned the lawyers that she wasn’t going to slow down the JPMorgan case to address complications in the UBS suit. In response, the Picard lawyers decided to simplify matters, reasoning that if they dropped the alternative-theory common law claims in the $550 million LIF case, there would be no reason for the case to stay in federal court. Picard could simply go after the $550 million in a bankruptcy court clawback action.

Baker & Hostetler’s letter explaining its decision to drop LIF claims to Judge McMahon isn’t in the docket. But the judge entered into the record her July 19 letter, in which she notes (rather cryptically unless you know the background) that Picard “has withdrawn his non-bankruptcy claims.”

On Wednesday morning, Bloomberg put out a hot story, reporting that Picard “may drop $2 billion in claims against UBS AG,” and quoting a bankruptcy lawyer who’s not involved in the Madoff litigation saying that Picard may have made a tactical decision to retreat from bigger claims. Bloggers who picked up the story reported that Picard was only going to pursue clawback claims against UBS. (See here and here.) Bloomberg updated its story to indicate that UBS’s shares were up in both Switzerland and the United States “after the withdrawal of Picard’s claims was reported.”

But according to Picard’s lawyers, he hasn’t given up a penny of his demands against UBS. Oren Warshavsky of Baker & Hostetler told OTC Wednesday that the common-law claims Picard dropped from the $550 million LIF suit “were alternative theories of recovery,” to the bankruptcy-court clawback theory. “By dismissing the two common-law causes of action, our goal is to streamline the case and effect judicial economy. We did not diminish the amount sought in any way,” he said.

Moreover, Picard hasn’t dropped any claims in the $2 billion Luxalpha fraud case against UBS, in which both sides will now presumably brief the very serious questions of standing and pre-emption that Judge McMahon is considering in Picard’s JPMorgan case.

I contacted the editor of the Bloomberg story, asking for comment on my reporting that Picard hadn’t, in fact, dropped any valuable claims. “Our story is based on Judge McMahon’s letter to counsel filed in the district court docket yesterday,” he replied in an e-mail. Bloomberg updated its story Wednesday afternoon to include a comment from Picard’s spokesperson stating that the dropped claims don’t impact the damages sought against UBS. Bloomberg also reports that the bankruptcy lawyer quoted in early versions of the story had reviewed “Picard’s original suit against UBS” (it doesn’t say which one) and concluded, “The trustee ‘will get large sums of money using garden bankruptcy law, but he is giving up at least $2 billion based on common and state law claims.’”

UBS’s lawyers at Gibson Dunn didn’t respond to requests for comment.

There’s going to be big news coming soon in Picard’s cases against the banks. Judge Jed Rakoff has promised to rule by the end of this month on the threshold question of whether the trustee has standing to sue the banks that allegedly abetted Madoff’s fraud. If Rakoff agrees with the banks, that’s a titanic defeat for Picard.

But the trustee dropping duplicative claims to keep his case in the friendlier confines of bankruptcy court? Not so much.

(Reporting by Alison Frankel)