Nov. 7 (Bloomberg) -- The liquidator for Bernard Madoff’s firm reduced by $279 million the amount of fake profit he wants returned from J. Ezra Merkin’s Ariel and Gabriel funds, which invested one-fourth of their money with the con man.

Trustee Irving Picard, who is suing Madoff’s biggest investors to help repay victims, on Nov. 2 dropped one of 12 claims against the hedge fund manager in U.S. Bankruptcy Court in New York, citing “further review of the law.”

In the abandoned claim, he had sought the return of “intra-fund” transfers of Madoff-linked money to Ariel and Gabriel from Merkin’s third fund, Ascot, which is also named in the lawsuit and invested all of its money with Madoff.

“We’ve determined that the facts don’t support a finding for the original fund being a conduit for the money,” Picard said yesterday in a phone interview. “The ultimate amount we are seeking in the lawsuit doesn’t change.”

The receiver still seeks a total of $564.6 million from the three funds, as well as from Merkin and his management company, Gabriel Capital Corp. With the claim dropped, Picard will have to try to get more money damages from Ascot, which lost almost all of its $1.7 billion in the fraud.

Ascot withdrew $527.6 million in fake profit from Madoff’s firm from 1995 to 2008, according to Picard’s complaint. Ariel and Gabriel, which managed a total of $2.6 billion, withdrew $40 million in fake profit from 2000 to 2008, Picard says.

Remaining Claims

Cayman Islands-based Ariel and New York-based Gabriel, among the biggest Madoff investors, are being liquidated by court-appointed receiver Bart M. Schwartz, who believes Picard’s remaining claims are meritless.

“We continue to press forward with our motion to dismiss those claims,” Schwartz said in a letter yesterday to the New York State Court, where the funds are being liquidated.

Ascot is being liquidated separately by the court-appointed receiver David Pitofsky of the firm Goodwin Procter LLP. In July, Picard won a freeze on Ascot’s remaining assets of about $10 million.

Lawyers for Ariel and Gabriel claim the funds’ managers didn’t know about Madoff’s fraud and withdrew only about 10 percent of their holdings in Bernard L. Madoff Investment Securities LLC.

Merkin, of New York, was closely associated with Madoff on a business and social level since at least the 1990s, according to the complaint. The men sat together on the board of trustees for Yeshiva University, Picard said.

New York Attorney General Andrew Cuomo sued Merkin and Gabriel Capital Corp. in April over claims he secretly placed client money with Madoff in exchange for $470 million in fees. Merkin has denied the claims and wants the lawsuit dismissed.

Madoff pleaded guilty in March to using his investment company as a Ponzi scheme. He is serving a 150-year sentence.

The case is Picard v. Merkin, 09-ap-01182, U.S. Bankruptcy Court, Southern District of New York (Manhattan).

To contact the reporter on this story: Erik Larson in New York at elarson4@bloomberg.net.

Last Updated: November 7, 2009 00:01 EST