Bear Stearns can challenge an order to pay out $125 million to investors who were left high-and-dry by the collapse of Bermuda-administered Manhattan Investment Fund in 2000.

The New York broker continued to accept $125 million in margin payments from the fund's Bank of Bermuda account during the final year leading up to the collapse of the fund in March 2000, which left investors with more than $400 million of losses.

It has been argued in court that Bear Stearns continued to extend margin to the boss of the fund Michael Berger, up to a year or more after it should have known he was acting in a fraudulent manner. Austrian-born Berger pleaded guilty to fraud in November 2000, some eight months after the fund collapsed.

In September this year Bear Stearns was ordered by a judge to pay $125.1 million for its "complicity" in the fraud to the estate of the defunct Manhattan Investment Fund, which was administered and audited in Bermuda but registered in the British Virgin Islands.

That money would be shared amongst investors who lost more than $400 million when the fund collapsed seven years ago after being exposed as a "Ponzi" scheme that cheated around 300 investors.

Companies involved in administering and auditing for the fund have already paid out tens of millions of dollars in liabilities.

Deloitte & Touche, the fund's Bermuda auditors agreed three years ago to pay $32 million in a settlement relating to its part in the collapse, while Fund Administration Services (Bermuda) Limited, an affiliate of Ernst & Young who administered the fund, paid out $40.8 million.

Then, three months ago, Bear Stearns was ordered to do likewise - to the sum of $125.1 million - by US bankruptcy court judge Burton Lifland. The judge said there was sufficient evidence that Bear Stearns, which was the prime broker for the fund, had been alerted in 1998 that not all was as it should be with the fund but had continued to provide margin for Berger.

In his view Bear Stearns had not thoroughly investigated what was going on and was therefore complicit to the resulting collapse of the fund and the fraud that had taken place.

Now a second judge, federal district judge Naomi Reice Buchwald, has reversed that judgement and cleared the way for Bear Stearns to have a trial where it can seek to prove it did enough due diligence to prove it was not at fault by knowingly allowing a fraud to continue.

In a written decision, the judge wrote: "Bear Stearns may prevail on its good faith defense (and so avoid liability) if its investigation of the Fund was diligent. We cannot say that no reasonable juror could find that Bear Stearns' actions were diligent."

Bear Stearns is now entitled to a jury trial as a predicate to any finding of liability.

The Manhattan Investment Fund fraud came to light when Deloitte & Touche withdrew approval for the fund's financial statements for 1996, 1997 and 1998.

The fund collapsed as Berger attempted to sell "short" overvalued technology stocks in a rising market.