The MF Global saga could soon become a legal battle between hedge funds and the futures brokerage's shortchanged customers, with more than a billion dollars at stake.

As the investigation into the collapse of the Jon Corzine-led brokerage moves into more of a regulatory whodunnit than a criminal case, the guessing game centers on who the two court-appointed trustees overseeing MF Global's liquidation will sue to recoup money owed to customers of MF's broker-dealer unit and creditors of its parent.

Those decisions are not easy ones, legal experts say, and they could end up pitting hedge funds like David Tepper's Appaloosa Management and Paul Singer's Elliott Management - who own MF Global bonds - against brokerage customers trying to recover an estimated $1.6 billion shortfall in their accounts.

It's likely that James Giddens, the trustee in charge of recovering customer funds, and Louis Freeh, the trustee in charge of recovering money for parent creditors, will dispute the ownership of certain assets, said attorney Chris Ward, vice chair of Polsinelli Shughart's bankruptcy practice, who is not involved in the case.

A more complex battle could arise from the fact that both customers and bondholders claim priority for payouts from MF Global's general estate.

Customer groups have said that if efforts to recoup customer cash do not make them whole, they have a right under Commodity Futures Trading Commission regulations to demand payment from the parent company.

Customers are going to claim they should be satisfied in entirety first before one penny goes to MF Holdings' bond holders and other creditors, said Fred Grede, an attorney who served as trustee for fallen cash-management firm Sentinel Management Group.

But distressed debt investors like Elliott and Appaloosa, who scooped-up MF Global's bonds after the firm filed for bankruptcy on October 31, say bankruptcy laws paint a different picture, one giving them priority over customers for general estate payouts.

I will not be surprised at all if sometime in the near future you find Freeh and Giddens as adversaries, said attorney Chris Dickerson, who is not involved in MF Global but represented defunct financial services firm Refco in its 2005 bankruptcy.

A spokeswoman for MF Global Holdings said Freeh will not know exactly how much creditors of the parent company are owed until claims are filed. The company has $650 million in senior debt and another $850 million in subordinated debt, the spokeswoman said.

PICKING A TARGET

Before any decision can be made on the order of payouts, Giddens and Freeh, the former FBI director, must think strategically about which deep-pocketed institutions to pursue.

Some of the likely litigation targets are MF Global's main trading partners, its primary banker JPMorganChase, and clearinghouses that processed last minute trades for MF Global as it spiraled towards bankruptcy. Another possibility is MF Global's own United Kingdom affiliate, where about $700 million in customer money is tied up.

But recovering any funds won't be easy.

In terms of resources, the worst counterparty in the world to go up against in court is the government, said one bankruptcy lawyer, who asked not to be named due to relationships with firms that have a stake in the outcome of potential litigation. The next is JP Morgan.

A spokeswoman for JPMorgan declined to comment on whether either of the trustees have indicated that litigation may be in the offing.

We lost money too from MF Global's collapse, JPMorgan spokeswoman Mary Sedarat said on Thursday. We're doing everything we can to assist in the investigations.

Connecticut-based broker-dealer CRT Capital Group told investors in November, and again earlier this month, that if they were looking at buying MF Global securities, they should expect at least a two-to-three-year battle to reclaim funds.

You may see go after low-hanging fruit first, said Ward. Pursue cases that are easy, get money back into the estate, and give them a war chest to go after bigger claims later.

JPMorgan is likely to make a strong argument, at least on the customer side, that its financial dealings were not improper because it did not have a responsibility to analyze the legality of the transactions it was clearing, Ward said.

UK FACE-OFF

One source close to Freeh said claims against MF Global's UK entity may be the first to be dealt with, noting that much of the money that changed hands in the company's last days wound up at the UK unit.

The source, who asked for anonymity because Freeh is still formulating his litigation strategies, said the UK unit will also have its own claims against various counterparties, adding another layer of complexity to recovery efforts.

One particular dispute likely to wind up in court is the battle over the ownership of about $700 million being held in the UK subsidiary. The money is associated with the accounts of US customers who traded on UK exchanges, and US and UK laws are inconsistent on who has a right to those funds.

A Giddens spokesman acknowledged the likelihood of a court battle, saying We are hoping we can reach an accommodation with the UK administrators, but it looks very tough.

Giddens has hired a U.K. law firm to advise it on that issue.

Giddens and Freeh may also target individual executives, including Corzine, who resigned on November 4, Dickerson said. Hedge funds that own MF Global bonds also include potential litigation against executives on their laundry list of avenues that could bring money back to creditors.

Reuters has previously reported that investigators are having trouble finding an element of criminal intent in MF Global's downfall.[ID:nL2E8D9IKR] But they can still bring cases for civil infractions like breach of fiduciary duty, Dickerson said, and, because most executives are covered by insurance policies, there may be plenty of money to be recouped from those lawsuits.

MF Global's bankruptcy is In re MF Global Holdings Ltd, U.S. Bankruptcy Court, Southern District of New York, No. 11-15059.

The broker-dealer liquidation case is In re MF Global Inc, U.S. Bankruptcy Court, Southern District of New York, No. 11-2790.

(Reporting by Katya Wachtel and Nick Brown; Editing by Matt Goldstein and Edward Tobin)