A federal judge blocked the trustee seeking money for Bernard Madoff's victims from interfering with New York state's $410 million settlement with Ezra Merkin, a Wall Street hedge fund manager accused of steering client money to the swindler.
Irving Picard, the trustee, had said the settlement with New York Attorney General Eric Schneiderman interfered with his exclusive right to recover money for people who invested with Madoff, by reducing the sums available for him to pursue.
The trustee, "having for more than three years issued empty threats to seek a halt to the attorney general's suit, has lost his right to complain," Rakoff wrote on Monday. "The trustee unreasonably and inexcusably slept on his rights."
Amanda Remus, a spokeswoman for Picard, said the trustee considers the decision "incorrect and contrary to law," and plans to appeal immediately.
The decision is a setback for Picard, a partner at Baker & Hostetler, who has largely been successful in stopping Madoff-related litigation that he believes interferes with his own.
According to his website, Picard has recovered $9.32 billion for victims of Madoff's fraud, a little more than half of the $17.3 billion of principal he has said was lost. The trustee has been seeking more than $500 million from Merkin and his funds.
Schneiderman, in a statement, called Rakoff's decision "a victory for justice and accountability" that should speed the return of money to individuals, charities and other institutions that lost money with Merkin.
The settlement calls for Merkin to pay $405 million to investors over three years, and $5 million to New York State to cover fees and costs.
Andrew Levander, a partner at the Dechert law firm representing Merkin, said he was pleased with Rakoff's decision.
Madoff, 74, pleaded guilty in March 2009 and is serving a 150-year sentence in a North Carolina federal prison.
The settlement with Schneiderman was announced last June, and remains one of the largest settlements with any individual over activities linked to Madoff and his firm, Bernard L. Madoff Investment Securities LLC.
Schneiderman had accused Merkin of violating state law by "recklessly" feeding $2.4 billion from his investors to Madoff, while falsely claiming he had been actively managing the money.
Merkin was originally sued by Schneiderman's predecessor and current New York governor, Andrew Cuomo, in April 2009, four months after Madoff's Ponzi scheme was uncovered.
Picard sought to block the Merkin settlement last Aug. 1, claiming that it violated federal bankruptcy law and interfered with his own recovery efforts.
That lawsuit also named as defendants Merkin, his firm Gabriel Capital Corp, and receivers for his four private funds that invested with Madoff: Ariel Fund Ltd, Ascot Fund Ltd, Ascot Partners LP and Gabriel Capital LP.
Rakoff, however, said the trustee was "in no way" justified in letting the state case proceed despite claiming a right at the outset to stop it, even while "bombastically threatening" to stop activities by the attorney general and the receivers.
"The prejudice to the defendants here, to the investors in the Merkin funds, and even to the New York (State) Supreme Court that managed (the) case for three years, cannot be overstated," he said.
Bart Schwartz, the receiver for the Ariel and Gabriel funds, said: "This is a just and fair result for the victim investors in Ariel, Gabriel and Ascot."
Daniel Glosband, a partner at Goodwin Procter representing Ascot receiver David Pitofsky, said he was pleased with the decision.
The case is Picard v. Schneiderman et al, U.S. District Court, Southern District of New York, No. 12-06733.