May 13 (Bloomberg) -- KeyCorp, Ohio’s second-largest bank, is liquidating an investment fund and returning clients’ assets after losses tied to Bernard Madoff’s $65 billion Ponzi scheme.

The bank decided to “curtail” operations at its Austin Capital Management unit after investors suffered as much as $186 million in losses, KeyCorp said May 11 in its quarterly report to regulators. Austin is liquidating its Safe Harbor Fund and returning clients’ money, KeyCorp spokeswoman Laura Mimura said in an e-mailed statement.

Madoff, 71, pleaded guilty to 11 felony counts and faces a prison sentence of as many as 150 years. Before his Dec. 11 arrest, Madoff told his thousands of clients that they had about $65 billion, prosecutors said.

KeyCorp client losses “stem from investments that Austin made in certain Madoff-advised ‘hedge’ funds,” the Cleveland- based bank said in its quarterly filing. The lender said three “purported class actions and one arbitration proceeding” were filed against Austin in the first quarter and that KeyCorp had insurance to cover costs.

KeyCorp’s Victory Capital Management business bought Austin in 2006. Austin, founded in 1993, had about $900 million in assets under management, the bank said in a statement in January of 2006 announcing the agreement. Pensions & Investments reported previously that Austin had notified clients about the liquidation plans.

In a Ponzi scheme, early investors are typically paid returns from money contributed by later participants. The scams inevitably collapse when operators can no longer attract enough money to make payments.

To contact the reporter on this story: Linda Shen in New York at lshen21@bloomberg.net

Last Updated: May 13, 2009 09:14 EDT