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Last week, DZ Bank AG, a German lender, filed a lawsuit against Bank of America Corporation (BAC - Analyst Report), for misrepresentation of documents while selling mortgage-backed securities (MBS). The lodged complaint indicts BofA of presenting modified documents related to the sale of over $546 million in residential mortgage-backed securities (RMBS).

The Allegation

The German lender accused BofA of issuing misleading statements with omissions related to MBS and concealment of risks associated with these securities. The plaintiff claims that the documents used for offering the securities contained fraudulent statements or omissions regarding the risks associated with the investments. Misinterpretation of these risks led to the investments, which incurred losses at current levels.

The case has been filed in the New York State Supreme Court in Manhattan and the company demands compensation for the damages. However, BofA has refrained from commenting on the issue.

Others Facing Similar Issues

This year, similar actions have been taken against other banking majors, including JPMorgan Chase & Co. (JPM - Analyst Report), HSBC Holdings Plc. , UBS AG , Citigroup Inc. (C - Analyst Report), Morgan Stanley (MS - Analyst Report) and The Goldman Sachs Group Inc. (GS - Analyst Report).

Legal Woes Continue

Trouble has been brewing for BofA for quite sometime now, as only recently it was sued by CIFG Assurance North America Inc, a bond issuer, for fraudulent representations and breach of contract over insurance policies tied to RMBS. The lawsuit was based on CIFG’s five financial guaranty insurance policies that pertain to the two-structure transactions that were arranged by BofA. These were backed by twenty-two risky RMBS.

In addition to this, BofA faces several other charges related to the sale of defective mortgage securities. Earlier in November, investors including Phoenix Light SF Ltd prosecuted BofA along with its unit, Countrywide Financial, over the sale of $261 million worth of flawed residential mortgage-backed securities using misleading statements.

Earlier in September, Phoenix Light had dragged BofA, along with JPMorgan, Goldman as well as Ace Securities – a wing of Deutsche Bank AG (DB - Analyst Report) – to court for losses suffered over faulty mortgage-backed securities. JPMorgan and Goldman are encountering a $1.8 billion lawsuit, whereas Ace Securities is facing a $300 million charge. BofA has been sued for losses amounting to $36.6 million over $69.8 million worth of MBS.

Litigation overhangs have been a common problem for major U.S. banks since the financial meltdown. In effect, these lawsuits are expected to tarnish their reputation and financials over time. However, investors and other financial institutions bearing the brunt of these faulty practices are expected to be fairly compensated.

BofA currently retains a Zacks #3 Rank, which translates into a short-term Hold rating. We believe that on account of such litigation overhangs, there is little possibility of any upward earnings estimate revisions; hence, the stock is expected to hold its current rank. We also maintain a long-term Neutral recommendation on the stock.

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