NEW YORK, Jan 7 (Reuters Legal) - In a decision that may affect foreclosures nationwide, Massachusetts' highest court voided the seizure of two homes by Wells Fargo & Co and US Bancorp after the banks failed to show they held the mortgages at the time they foreclosed.

Bank shares fell, dragging down the broader U.S. stock market, after the Supreme Judicial Court of Massachusetts on Friday issued its decision, which upheld a lower court ruling.

The unanimous decision is among the earliest to address the validity of foreclosures done without proper documentation. That issue last year prompted an uproar that led lenders such as Bank of America Corp, JPMorgan Chase & Co and Ally Financial Inc to temporarily stop seizing homes.

"A ruling like this will slow down the foreclosure process" for banks, said Marty Mosby, an analyst at Guggenheim Securities. "They're going to have to be really precise and get everything in order. It doesn't leave a lot of wiggle room."

Wells Fargo and U.S. Bancorp lacked authority to foreclose after having "failed to make the required showing that they were the holders of the mortgages at the time of foreclosure," Justice Ralph Gants wrote for the Massachusetts court.

The court refused to allow the foreclosures on the grounds that the banks did not possess title to the underlying properties at the time they foreclosed. The banks had not yet completed the formal paperwork to carry out an assignment from the existing owner even though, for business purposes, the transfer had effectively taken place.

The court noted that, while mortgage loans could be pooled into promissory notes for investors, "the mortgages securing these notes are still legal title to someone's home or farm and must be treated as such."

In stating that the banks had to comply with what amounted to technical requirements, the court explained that since state law provided them with "substantial power" to foreclose they were expected to "follow strictly" the procedure for doing so.

In a concurring opinion, Justice Robert Cordy lambasted "the utter carelessness" that the banks demonstrated in documenting their right to own the properties.

In both of the foreclosures at issue in the court case, the underlying mortgages were subject to a lengthy chain of transactions between financial companies. In one of them, the property was at one point held by failed financial giant, Lehman Brothers.

Courts in other U.S. states are considering similar cases, and all 50 state attorneys general are examining whether lenders are forcing people out of their homes improperly.

Friday's ruling "will be certainly cited as persuasive authority by anybody in a similar scenario who's trying to hold onto his home," said Robert Nislick, a real estate lawyer at Marcus, Errico, Emmer & Brooks in Braintree, Massachusetts.

LEAVING PAPERWORK BEHIND

Analysts said the decision may also threaten banks' ability to package mortgages into securities, and may raise the specter that loans transferred improperly will need to be bought back.

"What they were doing was peddling these mortgages and leaving the paperwork behind," said Michael Pill, a partner at Green, Miles, Lipton & Fitz-Gibbon LLP in Northampton, Massachusetts, who represents homeowners and is not involved in the case.

A spokeswoman for San Francisco-based Wells Fargo, Teri Schrettenbrunner, had no immediate comment on the decision.

U.S. Bancorp spokesman Steve Dale said the decision has no financial impact on the Minneapolis-based bank, which has "no responsibility" for the terms or means of transfer of mortgages used in the securitization trusts it oversees as trustee.

NOT IMMUNE

In the Massachusetts case, U.S. Bancorp and Wells Fargo had said they controlled through different trusts the respective mortgages of Antonio Ibanez and the married couple Mark and Tammy LaRace, who lost their homes to foreclosure in 2007.

The banks foreclosed upon the homes and bought them in the resulting sale, and then sought orders confirming they had title pursuant to the Servicemembers Civil Relief Act, legislation that restricts foreclosures against active members of the military. A lower court judge ruled against the banks, and Friday's decision upheld this ruling.

Massachusetts is one of 27 U.S. states that do not require court approval to foreclose.

"It is the first time the supreme court of a state has looked straight at securitization practices and told the industry, you are not immune from state statutes and homeowner protections," Paul Collier, a lawyer for Ibanez, said in an interview.

The Supreme Judicial Court also rejected the banks' request that the ruling apply only in the future.

"I'm ecstatic," Glenn Russell, a lawyer for the LaRaces, said in an interview. "The fact the decision applies retroactively could mean thousands of homeowners can seek recovery for homes wrongfully foreclosed upon."

Russell said the LaRaces moved back to their home after the 2009 ruling, while Collier said Ibanez has not. "U.S. Bancorp will have to compensate him in exchange for the deed, or will have to walk away," Collier said.

SECURITIZATION

Analysts said the decision will make it harder and more costly for banks to foreclose, and weigh on their share prices and perhaps even the nation's economic recovery.

"If banks can't prove ownership, it will clog up the foreclosure process," said Blake Howells, head of equity research at Becker Capital Management in Portland, Oregon. "The inventory on foreclosures will keep a lid on housing prices for some time."

Gants did suggest in his opinion how banks might properly transfer mortgages via securitization trusts.

"The executed agreement that assigns the pool of mortgages, with a schedule of the pooled mortgage loans that clearly and specifically identifies the mortgage at issue as among those assigned, may suffice to establish the trustee as the mortgage holder," Gants wrote. "However, there must be proof that the assignment was made by a party that itself held the mortgage."

The case is U.S. Bank N.A. v. Ibanez and Wells Fargo Bank NA v. LaRace et al, Supreme Judicial Court of Massachusetts, No. SJC-10694. The slip opinion states that U.S. Bank was represented by R. Bruce Allensworth, Phoebe Winder and Robert Sparkes, III, of K&L Gates in Boston. Paul Collier of Kirkland & Ellis in Boston and Max Weinstein of Harvard Law School appeared for Ibanez. Glenn Russell, Jr. of Fall River, Massachusetts, appeared for LaRace.

(Reporting by Jonathan Stempel and Dena Aubin of Reuters; Additional reporting by Joe Rauch and Dan Wilchins or Reuters and by Jeff Roberts of Reuters Legal)