A sweeping insider trading case that shook the hedge fund world is finally set for trial, with onetime billionaire Raj Rajaratnam fighting to stay out of prison in a courtroom drama over corporate secrets, tapped telephones and friends-turned-government witnesses.

Jury selection in the case against the Galleon Group founder in New York starts on Tuesday. The trial, expected to last up to two months, comes as U.S. authorities push on with other probes into stock trading in the $1.9 trillion hedge fund industry based on leaked company earnings and deals.

Rajaratnam is accused of making $45 million in illicit profits through tips from former friends and associates at the highest levels of Corporate America. Once named the richest person born in Sri Lanka, the 53-year-old U.S. citizen has vowed to clear his name at trial. Galleon managed $7 billion at its peak.

All signs are pointing to a battle royal, said Chicago securities attorney Andrew Stoltmann, who is not involved in the case. Just by being a hedge fund manager he is a gambler by trade. The mentality is a little bit different than what we see with other defendants.

At a hearing on Friday, prosecutors said they would play audio tapes of conversations between Rajaratnam and a former Goldman Sachs director, Rajat Gupta, as evidence to the jury that they conspired in 2008 to share confidential Goldman information and that Rajaratnam traded on it.

Rajaratnam, arrested in October 2009 and free on bail, faces up to 25 years in prison if convicted of conspiracy and securities fraud in Manhattan federal court.

The government's wide-scale use of phone taps sets it apart from past insider trading cases, which are notoriously difficult to prove. In announcing the case, prosecutors called it the biggest ever probe of insider trading at hedge funds, sending a warning to money managers that the government might be covertly listening to them.

The prosecutions are reminiscent of the blockbuster insider trading cases of the 1980s, when speculator Ivan Boesky pleaded guilty and cooperated with authorities. That led to criminal charges against Drexel Burnham Lambert, which was destroyed in the scandal, and Michael Milken, its former junk bond chief.

KEY RULING

While Rajaratnam lost a key ruling that will allow jurors to hear audiotapes of his telephone conversations secretly recorded by the FBI, his lawyers argue the tapes prove nothing. The tapes could be an issue for appeal if he is found guilty because there is at least some lack of clarity in the statute about whether it authorized wiretaps here (for insider trading), said Manhattan Institute think tank legal policy director James Copland.

Part of defense trial strategy is to tell the jury that the government has significantly expanded the bounds of what insider trading means, court papers show. Rajaratnam's representatives have said repeatedly that he intends to establish his innocence at trial before a jury of his fellow citizens.

The prosecution team must convince the jury that their evidence proves Rajaratnam knew that between 2003 and March 2009, he was trading on confidential information given to him by people who had a fiduciary duty not to disclose it.

Just because there is a wiretap it does not mean this evidence is going to be absolutely conclusive for the jury, said New York attorney Nathaniel Burney of Burney Law Firm LLC in New York, who is not involved in the case. There is a lot of room for skillful advocacy. The tapes could be misinterpreted or misunderstood.

The allegations extend far beyond Rajaratnam. Besides him, 25 former traders, executives and lawyers have been charged with being part of two overlapping insider trading networks. Nineteen have pleaded guilty, and some of those defendants are expected to testify against him at the trial.

Prosecutors told Judge Richard Holwell at Friday's hearing that former McKinsey & Co executive Anil Kumar and FBI Special Agent Diane Wehner would be the first government witnesses. Kumar pleaded guilty to sharing client secrets and receiving $2 million in payments from his friend Rajaratnam.

A graduate of the prestigious Wharton business school at the University of Pennsylvania, Rajaratnam had a deep network of acquaintances including people at Goldman Sachs Group, Intel Corp and McKinsey & Co.

Prosecutors said it was some of those contacts who spilled secrets that helped him gain an unfair edge over other traders, gleaning stock tips that helped Galleon prosper.

One friend, former Goldman director and McKinsey head Gupta, conspired with Rajaratnam, assistant U.S. Attorney Jonathan Streeter said in court on Friday. Gupta has denied accusations by securities regulators of disclosing Goldman secrets. He is not charged in the criminal case.

In the courtroom elevator on Friday, chief defense lawyer John Dowd, using the back of his right hand, patted Rajaratnam on the chest, and said: He's a good man.

Dowd declined to comment on the allegations about Gupta.

The trial is the biggest in the financial industry since two former Bear Stearns fund managers were accused of misleading investors over mortgage-linked securities as the housing market collapsed in 2007. The two were acquitted.

An acquittal of Rajaratnam would be another embarrassment for the government, which has given the case high priority.

Rajaratnam will go to trial in the same courthouse in lower Manhattan where Bernard Madoff pleaded guilty two years ago to a multibillion-dollar swindle. It was also where celebrity homemaker Martha Stewart stood trial in 2004 in another stock tipping case.

The government has released excerpts of the tapes and could present as many as 173 intercepted mobile phone audio recordings to the jury. The full extent of the evidence from the calls and text messages is not known, so there may yet be surprises at trial.

Another unknown is whether or not Rajaratnam will testify in his own defense.

If the defense is 'I didn't know the information given to me was material nonpublic information' the only way that story comes into the trial is through him, said Evan Stewart, a partner at law firm Zuckerman Spaeder who is not involved in the case.

Jim McCarthy, a spokesman for the defense, declined to comment on the possibility of Rajaratnam taking the witness stand.

The case is USA v Raj Rajaratnam, U.S. District Court for the Southern District of New York, No. 09-01184.

(Reporting by Grant McCool; Editing by Gary Hill and Richard Chang)