Andrew Cuomo (New York’s attorney general) and son of Mario Cuomo (former NY governor who is now on the Willkie Farr & Gallagher payroll) filed a complaint today charging J. Ezra Merkin (a Harvard Law School graduate) and his Gabriel Capital Corporation (the Ascot, Gabriel and Ariel funds) with civil fraud charges alleging, in part, that:

1) Merkin concealed his links to Madoff
2) Lied about where investor’s money was actually going
3) Used company’s funds for personal purchases (including approximately $91 million of artwork for his apartment at the famous 740 Park Avenue, New York, NY)
4) Collected more than $470 million in management and incentive fees
5) Was responsible for investor losses of approximately $2.4 billion

The statement from Cuomo’s office can be read here and the full complaint can be read here.

The complaint’s more interesting quote highlights include:

1) “J. Ezra Merkin betrayed hundreds of investors who entrusted him with their savings by recklessly feeding their funds into the largest Ponzi scheme in history,…”
2) “Merkin was just a ‘glorified mailbox.‘”
3) “Merkin admitted that his ‘monitoring’ of Ascot consisted of, at best, general conversations with Madoff approximately once per month”
4) “Merkin was ‘at best a charlatan.‘”

Mr. Merkin’s lawyer (Dechert’s Andrew Levander) claims that the suit is “hasty” and “without merit.”  Mr. Levander further elaborated that:
1) clients knew that money was going to Madoff
2) some of them even met with Madoff personally
3) Merkin analyzed Madoff’s strategy before investing
4) “Contrary to Mr. Zuckerman’s allegations, Mr. Merkin performed extensive due diligence on Madoff and his trading strategy,” Levander said. “Unfortunately, Mr. Merkin’s due diligence, just like the detailed investigations performed by countless others, including regulators, was thwarted by the intricate, fraudulent scheme perpetrated by Madoff.”

Schulte Roth & Zabel represents the Ascot Partners fund.

Merkin reportedly lost millions of his own money in the Madoff fraud.

Adding to Mr. Merkin’s woes was another suit filed by Mort Zukerman. Mr. Zukerman is the chairman of chairman of Boston Properties Inc. and publisher of the New York Daily News.

According to Bloomberg the case is CRT Investments Ltd. v. J. Ezra Merkin, 601052/2009, filed in New York State Supreme Court (Manhattan).

The Cuomo complaint raises a number of operational due diligence red flags:

1) Misstatements regarding the roles of Madoff:

Merkin misstated Madoff’s role in offering memorandum for the Ascot funds. The offering memorandum suggested that Madoff was one of many prime brokers utilized when quite the opposite was in place.

In 2006, for example, approximately 98% of Ascot’s transactions were both effected and cleared by Madoff, and Madoff had custody of over 99% of Ascot’s purported securities holdings.

The role, diversity and independent oversight of third-parties is an essential element to proper operational due diligence. All of which were apparently missing in this case.

2) Lack of reporting transparency:
Ascot’s quarterly statements to investors disclosed only the value of each investor’s account and the purported appreciation during the prior quarter.

3) A smoke screen was created regarding the roles of traders:

If investors asked who carried out Ascot’s trading activity, Merkin would sometimes deceive them by explicitly indicating that he and his employees at the 450 Park Avenue office did so.

Merkin’s traders however, were involved only in managing Ariel’s and Gabriel’s assets, not Ascot’s, and Ascot’s trading was almost entirely carried out by Madoff.

4) Unclear investment strategy:

Merkin at times concealed the fact that Ascot engaged in the “split strike conversion” strategy by misrepresenting Ascot’s investment strategy as well as its management.

5) Counterparty risk:
Merkin made false and misleading statements to investors to foster the impression that Ascot’s funds were held with a sound, creditworthy broker (Morgan Stanley) when in fact the majority of assets were held with Madoff.

6) Misstatements about the role of BDO (the Ascot fund’s auditor):
The complaint alleges that Merkin told an investor that he required Ascot’s auditor, BDO Seidman LP, to visit Madoff’s offices two or three times a year to perform standard operational due diligence. This representation was false. BDO did not perform standard operational due diligence, or any other kind of examination, on Madoff’s operation, and Merkin had no reason to believe otherwise.

Interestingly, the complaint also claims that Mr. Merkin himself “failed to conduct adequate due diligence in the face of clear warning signals for fraud.”

• I am curious how many investors picked up the phone and called Morgan Stanley, BDO or anyone else to check on the nature of Merkin’s claims?

• Or a better question could be what kind of due diligence was being conducted by the financial advisors of the hundred of investors who most likely funneled their client’s money to Merkin?

• With all of these red flags seemingly overlooked, how did so many get it so wrong?

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