UPDATE 1-NJ man gets 14 years for $140 mln mortgage fraud

* Michael McGrath pleaded guilty in NJ court to conspiracy

* McGrath's U.S. Mortgage Corp went bankrupt in Feb 2009

* Credit unions say loans sold fraudulently to Fannie Mae

* Fannie Mae says no duty to verify sales were fraudulent (Adds sentencing, restitution details; defendant's hometown) By Jonathan Stempel

NEW YORK, Feb 24 (Reuters) - A New Jersey man was sentenced to 14 years in prison for running a $140 million scheme that defrauded credit unions on loans sold to Fannie Mae (FNMA.OB), and led to bankruptcy for his mortgage company.

Michael McGrath, 47, had pleaded guilty in June 2009 to two counts of conspiracy, including one to commit mail and wire fraud and one to commit money laundering.

The defendant had run U.S. Mortgage Corp, a Pine Brook, New Jersey, lender and broker that filed for Chapter 11 protection in February 2009, and was a principal at its CU National unit serving credit unions.

At a hearing in the Newark, New Jersey federal court on Thursday, U.S. District Judge Katharine Hayden also sentenced McGrath to three years supervised release.

She also ordered restitution in a sum to be determined, but which prosecutors expect will exceed $136 million. McGrath also forfeited $14 million of previously seized or frozen assets.

Federal prosecutors said McGrath admitted to conspiring with others from January 2004 to January 2009 to fraudulently sell credit union loans, and use proceeds to finance U.S. Mortgage's operations and investments for himself.

The Montclair, New Jersey resident also admitted to diverting funds that should have been paid to credit unions on mortgage loans he sold to Fannie Mae, which prosecutors said helped offset his own bad mortgage investments.

McGrath faced as much as 30 years in prison under federal guidelines, though his plea agreement called for a term as short as 12-1/2 years, his lawyer John Vazquez said.

"He expressed extreme remorse" at Thursday's hearing, and "has done everything he could to mitigate the harm," including helping the credit unions and Fannie Mae recover more than $13 million so far, Vazquez said.

Four credit unions are still pursuing civil litigation against Fannie Mae to recover more than $64 million of loans they originated, and which they say were sold fraudulently to the mortgage financier via U.S. Mortgage, court records show.

In one case, where the Picatinny Federal Credit Union seeks to recover 52 loans totaling $13.3 million, Fannie Mae in a Feb. 14 court filing said it had been unaware when it bought the loans of the U.S. Mortgage fraud.

Moreover, Fannie Mae said it had no duty to investigate, and that none of the "red flags" that Picatinny said should have been found at U.S. Mortgage involved loans it bought.

"Fannie Mae buys millions of notes each year," the filing said. "Its business would grind to a halt if it had to investigate every signature on every note."

A lawyer for Picatinny did not immediately return a call seeking a comment, following McGrath's sentencing.

The federal government seized Fannie Mae and the smaller Freddie Mac (FMCC.OB) in September 2008 as losses mounted from bad mortgage loans. They have since received a net $131 billion of taxpayer aid, a sum expected to grow. [ID:nN1492020]

The criminal case is U.S. v. McGrath, U.S. District Court, District of New Jersey, No. 09-00436. The Picatinny case is Picatinny Federal Credit Union v. Federal National Mortgage Association in the same court, No. 09-01295. (Reporting by Jonathan Stempel in New York; editing by Matthew Lewis and Andre Grenon)