Even though they are first in line to be paid back under broker liquidation rules, customers of bankrupt MF Global Holdings Ltd's brokerage may not get all their money back.

A federal statute designed to protect customers of failed brokerages may not be able to save MF Global's commodities customers if a court-appointed trustee cannot locate about $600 million in missing customer money.

A key reason: an insurance fund designed to help customers of failed brokerages generally does not apply to commodities customers, said Stephen Harbeck, the fund's chief executive.

Of the roughly 50,000 MF Global accounts totaling at least $5.45 billion, only about 400 are securities accounts and the rest are commodities accounts, said Kent Jarrell, a spokesman for the trustee now in control of MF Global.

MF Global was put under the control of the trustee, James Giddens, after its parent, MF Global Holdings, declared bankruptcy on October 31 after losing on euro zone debt bets.

Giddens' job is to pool the brokerage's customer property and pay it back to customers. He has also been awarded subpoena power to collect documents and interview MF Global employees as part of his own investigation into the source of the shortfall.

Customer recovery will really rise and fall with the success of the trustee, said Stephen Lubben, a professor at Seton Hall University School of Law in New Jersey.

The Securities Investor Protection Act, which went into effect in 1970 as a mechanism for liquidating brokerages, puts brokerage customers at the front of the payback line in bankruptcy.

That means brokerage customers' debts should be repaid in full before non-customer creditors, such as a company's lenders or bondholders, receive a dime. In cases where there are shortfalls in customer funds, other creditors may not get paid at all.

MF Global's brokerage could be one of those cases. The company last month reported a significant shortfall in customer money, fueling questions about whether the firm may have improperly commingled client funds with the firm's own money.

Recent estimates by the Commodity Futures Trading Commission peg the gap at about $600 million, and the FBI and other authorities are investigating the matter.

SHORTFALL = LOSSES

For MF Global customers, the large shortfall could translate into losses. What makes MF Global's case different from some other high-profile brokerage blowups is that the vast majority of its clients hold commodities accounts.

The Securities Investor Protection Corp, an insurance vehicle created by SIPA and funded by member brokers, has authority to use its own funds to pay back securities customers up to $500,000 per account when brokerages fail. But the insurance benefits do not extend to commodities accounts.

Commodities people really do not have the protection securities customers have, said Harbeck, SIPC's chief executive.

An explanation for the divide may be that commodities trading was not as common or as sophisticated when SIPA was enacted, Harbeck said. But it remains unprotected despite playing a larger role in today's market.

Many of my counterparts around the world protect both securities and futures, and if you're starting a new market, you protect all financial products, Harbeck said. I think it's for historical reasons that you still see the divide here.

The upshot: while MF Global's securities and commodities account holders will be equally entitled to their share of assets identified by the trustee for customer recovery, only securities customers have insurance, Jarrell said.

Once the distribution occurs, if a commodity account holder has a loss, that's their loss, he said.

And such a loss may be unavoidable for MF Global's commodities customers, Lubben said. Without a buyer for the company's brokerage business -- and none has emerged -- MF Global could have to liquidate.

The trustee then would be unlikely to find much value within the estate to pay back commodities customers, unless he can locate the missing cash, Lubben said.

THE LEGAL OPTION

Customers could have other options. If MF Global is found to have improperly commingled customer money, they could sue the parent company to try to recover more, said Chris Dickerson, a bankruptcy attorney at DLA Piper who is not involved in the case.

But such lawsuits would be difficult to pursue if a customer cannot trace his money and prove that it was improperly commingled, said Dickerson, who represented defunct financial services firm Refco in its 2005 bankruptcy.

Tracing money is one of the most arcane areas of law out there, Dickerson said. It's hard to predetermine what your likelihood of recovery is.

Customers may also try looking outside the MF Global business to pursue recovery, said Bill Brandt, chief executive of turnaround consultant Development Specialists Inc.

When the reality of this loss finally dawns on these investors, there is the likelihood ... that they wind up suing the banks and others, maybe directors and officers, claiming they were essentially defrauded, Brandt said.

Customers can bring such lawsuits. In litigation stemming from Bernard Madoff's Ponzi scheme, two judges have said the Madoff customers -- not a trustee -- can sue banks for recoveries over their alleged failure to heed warning signs.

The definition of a customer claim could also be a source of litigation as the trustee weighs how to treat the claims, said Martin Bienenstock, a bankruptcy attorney at Dewey & LeBoeuf.

From the company's point of view, they're going to want a narrow definition of a customer claim, whereas customers will want a broad definition, Bienenstock said.

Litigation is a fact of life in most brokerage liquidations. In addition to filing their own lawsuits, customers can also be targets.

For example, legal wrangling is still going on three years after the trustee liquidating Sentinel Management Group's brokerage sued a raft of customers for making allegedly fraudulent withdrawals from their accounts.

Bit there is one thing Giddens could do to minimize litigation: find the missing $600 million.

If it truly was vaporized in some way, it could take a while to figure this out, Lubben said. It would be a lot faster if it turns out it was in a shoebox under the couch.

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

The brokerage liquidation is In re MF Global Inc, in the same court, No. 11-2790.

(Reporting by Nick Brown in New York, editing by Matthew Lewis)