UPDATE 2-New York sues banks over electronic mortgage system

* Accuses JPMorgan, Wells Fargo, BofA of fraud

* Seeks profits, damages from deceptive practices

* Claims MERS system saved industry $2 billion in fees

* Unclear what NY suit means for larger mortgage deal

NEW YORK, Feb 3 (Reuters) - New York State Attorney General Eric Schneiderman on Friday sued three major U.S. banks, accusing them of fraud for using an electronic mortgage database that resulted in deceptive and illegal practices.

Schneiderman filed the lawsuit against Bank of America Corp , Wells Fargo & Co and JPMorgan Chase & Co in New York state court in Brooklyn.

The lawsuit is over the banks' use of MERS, the Mortgage Electronic Registration System the industry created in the mid-1990s to track the ownership and servicing of residential mortgage loans.

Schneiderman claims the system is plagued by inaccuracies. The lawsuit also names MERS and its parent as defendants.

"The mortgage industry created MERS to allow financial institutions to evade county recording fees, avoid the need to publicly record mortgage transfers and facilitate the rapid sale and securitization of mortgages en masse," Schneiderman said.

Schneiderman's lawsuit claims that banks saved $2 billion in recording fees by using MERS.

The suit also said the use of MERS resulted in the filing of improper NY foreclosures and created "confusion and uncertainty" over property ownership interests.

Over 70 million mortgage loans, including millions of subprime loans, have been registered in the MERS system, rather than in local county clerks' offices, according to the lawsuit.

Schneiderman is seeking to stop the banks from filing New York foreclosure actions in MERS name, and executing false or defective mortgage assignments in state foreclosure proceedings. He is also seeking to obtain the profits the banks obtained through MERS, along with other damages.

JPMorgan spokesman Patrick Linehan declined to comment on the lawsuit. Wells Fargo spokesman Ancel Martinez said the company was reviewing the lawsuit. Bank of America spokesman Rick Simon declined comment.

Merscorp and its subsidiary MERS comply with the law and mortgage regulations, spokeswoman Janis Smith, a spokeswoman said in a statement.

"We refute the attorney general's claims and will defend the case vigorously in court," Smith said.

MERS was sued by Delaware in October and similarly accused of deceptive practices that led to unlawful shortcuts in dealing with the foreclosure crisis.

MORTGAGE SETTLEMENT NEARS

Schneiderman filed the suit in his capacity as New York attorney general, but he also serves as co-chair of a working group President Barack Obama formed last month to investigate misconduct in the pooling and sale of risky home loans.

Schneiderman is also a central figure in widely publicized negotiations to reach a federal-state settlement with the top U.S. banks over mortgage abuses.

A key question is whether holdouts, including Schneiderman and California Attorney General Kamala Harris will join the settlement.

Danny Kanner, a spokesman for Schneiderman, declined comment on what Friday's lawsuit may mean for the prospects of the settlement, which could be announced as soon as next week.

In exchange for up to $25 billion, the banks are expected to resolve state and federal lawsuits about servicing misconduct and faulty foreclosures. The states have until Monday to decide whether to sign on.

A draft settlement circulated to the states would have released the banks from liability for their use of MERS - claims at the heart of the new lawsuit.

The New York lawsuit suggests Schneiderman and other attorneys general opposed to the settlement may have been successful in working to narrow the broad releases of liability.

Last week Schneiderman told Reuters that the releases in the settlement had "become narrow enough" so that a "full investigation" by the new mortgage crisis unit could move forward.

However, Schneiderman said last week he was not yet ready to sign on to the settlement.

On Thursday, California AG Harris told Reuters that she is not focusing on the Monday deadline for states to sign up.

"I'm less concerned with the timeline than the details," Harris said on the sidelines of a Harvard Women's Law Association conference in Boston.

Harris said any settlement should address the priorities she has previously laid out, like enforcement.

She also said she was aware of Schneiderman's lawsuit against banks over MERS, but that MERS was less of a priority in the scope of California's mortgage problems than it was in other states.

"But we support that MERS work," she added.