I have setup test users and then put them into different groups. I have created address books based on these groups, and they populate with just the users I want. However, when they logon to OWA or Outlook client, how do I make it so their address book shows the address book I create specifically for them? They currently see everybody and can search everybody.

You'll have to set permissions for the users' address lists-- check out the set-AddressList task in the Exchange Management Shell. I don't see any explicit way to set permissions, though, so perhaps this isn't implemented yet (or, more likely, I just haven't found the right command to do exactly what you want!)

Thanks Paul, but unfortunatley as you even pointed out, there is no security type settings here. I have looked high and low, and just got back from an Exchange conference with Microsoft Exchange team members, who also couldnt answer my question. I think I asked at least 3 Exchange MS employee's and all were aware its possible with previous versions of Exchange, but had no clue how to do it in 2007. I am currently screwing around with ADSI Edit but not getting anywhere useful, and even if it did work, I would be hesitant to use that as a solution as its unknown what unknown ramifications may show up. Did Microsoft forget to allow permissions on address books? This seems quite an oversight!

Did you try the exchange 2003 methods for restricting access via the ADSI properties (msExchUseOAB and msExchQueryBaseDN)?