Former American International Group Inc. Chief Executive Officer Edward Liddy will face a key question on the witness stand in a trial over claims shareholders were cheated of at least $25 billion in the insurer’s bailout: was he or the government running the show?

The U.S. had a hand in everything from press releases to selection of board members after the Federal Reserve Bank of New York loaned the company $85 billion and took most of its stock, according to testimony and documents in the case brought by Maurice “Hank” Greenberg’s Starr International Co.

With Liddy’s testimony set for today, Starr’s lawyer, David Boies, has confronted witnesses this week with documents to bolster his case that the government illegally took control of the company rather than acting as a detached steward.

Starr, AIG’s biggest shareholder before the 2008 bailout and led by its former CEO Greenberg, accuses the U.S. of imposing illegally severe conditions that included failing to compensate shareholders. Starr contends the government wanted control of AIG’s assets to facilitate a “backdoor bailout” of the insurer’s investment bank trading partners including JPMorgan Chase & Co. and Goldman Sachs Group Inc. and that it manipulated the company’s governance to avoid a shareholder vote on the rescue package.

After the bailout, regulators vetted AIG’s filings with the Securities and Exchange Commission, recruited board members and told Liddy he “should stay away from characterizing the government’s views and judgments” in a speech, according to documents introduced as evidence yesterday.

Liddy Successor

In a February 2009 e-mail, a Federal Reserve official told Treasury Department counterparts that his bosses wanted the New York Fed “to have people lined up to replace the board of directors and assign a successor to Liddy.”

Boies confronted Sarah Dahlgren, the New York Fed’s monitor of AIG after the bailout, with an April 2009 e-mail to her from one of the bank’s attorneys asking for comment on a draft version of an AIG proxy statement and noting an upcoming call to discuss the document.

Were AIG officials invited to participate in the call?, Boies asked.

They’re “not on the invite list, no,” Dahlgren replied.

Dahlgren testified that the New York Fed prepared remarks for Liddy, who was handpicked by the government, for his first meeting with AIG management, on Sept. 17, 2008, a day after the Fed authorized the bailout.

“At Mr. Liddy’s request, on the night of the 16th we proposed some bullet points,” Dahlgren testified.

14 Percent Interest

The government had no legal right to take 80 percent of AIG’s equity as a condition of the initial bailout loan and it imposed a punitive 14 percent interest rate, according to Starr’s complaint.

The government contends that the AIG board voluntarily agreed to the rescue deal and that the New York-based insurer’s only alternative was bankruptcy.

In testimony earlier in the trial, regulators including Timothy Geithner, at the time the head of the New York Fed and later U.S. Treasury secretary, said that the Federal Reserve didn’t want to be an owner of AIG because the central bank’s access to market-moving financial data would be perceived as giving the insurer an unfair advantage.

The government’s solution to that problem was to put its AIG stock in a trust in the Treasury Department for the benefit of taxpayers.

Shares Trust

Boies questioned the independence of that arrangement, introducing an April 2009 e-mail from Douglas Foshee, one of the trustees of the trust, about a pending AIG regulatory submission.

Foshee asked Dahlgren if she had any “information on when the company wants to file and when Treasury will let them file.”

Under questioning by Mariana Acevedo, a Justice Department lawyer, Dahlgren testified that government involvement stopped short of issuing explicit instructions to Liddy and that it didn’t interfere in a company plan for restructuring.

“We did not direct Ed Liddy to take or not take any particular action,” Dahlgren told Court of Federal Claims Judge Thomas Wheeler, who is hearing the case without a jury.

Acevedo asked Dahlgren about New York Fed involvement in a Sept. 28, 2008, company document for selling assets labeled AIG Global Restructuring Plan. “We had no role in developing this plan,” Dahlgren testified.

Screening Documents

Dahlgren testified that regulators won AIG’s agreement to screen sensitive documents such as regulatory filings after the company mischaracterized the terms of the bailout in an SEC filing and had to correct it.

In testimony on Oct. 14, a pair of senior New York Fed officials backed away from comments critical of the interest rate made in e-mails around the time of the bailout.

The rate was set by Geithner, according to trial testimony. It was lowered weeks later after AIG came under further financial pressure

Margaret McConnell, a former deputy chief of staff to Geithner, told Boies that her October 2008 statement that the interest rate was “crazily high” and forced on the New York Fed by others was imprecise.

There was some feeling among New York Fed officials “that the rate was just too high,” McConnell testified. “I think I was a little frustrated. I don’t know if it’s an accurate depiction of the situation.”

Hazy Memory

McConnell’s memory was hazy about the meaning and context of a string of e-mails and her handwritten notes of meetings and phone conversations, many pertaining to government involvement in AIG affairs after the bailout.

A March 2009 e-mail to McConnell from another New York Fed official stated that Liddy “has no decision-making authority and is paralyzed at this point by the USG’s role.”

McConnell said she didn’t remember the e-mail and pointed out that restrictions on corporate governance accompanied U.S. financial assistance to other companies during the financial crisis.

“I don’t recall it being unique to AIG,” she told the court.

Susan McLaughlin, who oversaw the discount window for the New York Fed, told Boies that she had been “a little frustrated and also not so aware of the facts” surrounding the loan when she wrote in an e-mail that the interest rate seemed high and that “it is wrong this was done without” the input of her group.

Looking back, McLaughlin said she now thinks the interest rate was “pretty representative of how risky loans were being priced” at that time.

The case is Starr International Co. v. U.S., 11-cv-00779, U.S. Court of Federal Claims (Washington).