Breakup of Microsoft Is Overturned on Appeal

TIMES STAFF WRITERS

In an anxiously awaited ruling, a federal appeals court Thursday unanimously overturned the proposed breakup of software giant Microsoft Corp.

But the ruling kept intact much of a lower-court judge's findings that the company had maintained an illegal monopoly, even as it harshly criticized his conduct in the case.

The 125-page ruling by the seven judges of the U.S. Court of Appeals for the District of Columbia left both the company and government officials claiming a significant victory in the 3-year-old case.

Legal experts suggested that the decision could prompt both sides to revive settlement negotiations. The decision makes it increasingly unlikely that Microsoft will be able to escape any sanctions for its anti-competitive behavior, but also makes it unlikely that a dramatic restructuring of the company would pass judicial muster.

"It's a compromise decision," said Steven D. Houck, a former member of the legal team representing state attorneys general from 18 states and the District of Columbia in the case. The unanimity of the ruling was remarkable for a court with a "wide divergence of political views," Houck said, noting that the judges "upheld the heart of the case, which was the maintenance of an illegal monopoly."

From Microsoft's standpoint, perhaps the most positive aspect of Thursday's decision was a reversal of the corporate dismemberment order issued by U.S. District Judge Thomas Penfield Jackson a year ago. Although they ordered that a lower court fashion a suitable remedy for the company's illegal conduct after holding new hearings, the appellate judges strongly hinted that they would not favor dividing the company into two independent enterprises.

"The ruling removes the cloud of breakup," said Bill Gates, Microsoft's chairman and co-founder. He and other company executives also signaled a renewed willingness to consider a negotiated settlement, several attempts at which have foundered in the past. The company will "work hard to resolve the remaining issues without continued litigation," Gates said Thursday.

Appellate Ruling Latest Turn in 3-Year Case

The last settlement talks fell apart 14 months ago after Gates rebuffed government demands for a breakup. He also objected to the government's insistence that Microsoft share more of its source code--the internal design of its software--with outsiders.

Microsoft might well believe that with a Republican in the White House it will be negotiating with more compliant Justice Department officials than the Clinton appointees who initially brought the antitrust case. But any settlement would have to be supported by the state attorneys general who joined the case. They gave no indication Thursday that their position has softened.

"This is not a political case now, but a straightforward legal case," Houck said. "It would be very hard, even shocking, for the Department of Justice to back off now."

U.S. Atty. Gen. John Ashcroft, for his part, called the ruling "a significant victory."

Perhaps the most unusual aspect of the appeals court's ruling was its blunt assessment of Jackson's conduct. The judges disqualified Jackson from presiding further over the case because of what they termed his "deliberate, repeated, egregious and flagrant" violations of judicial ethics during trial. But they stopped well short of granting Microsoft's request that all of his rulings in the case be reversed.

Instead, by upholding Jackson's findings that Microsoft maintained a monopoly in the computer operating system software market through anti-competitive conduct, the appeals court left in place the threat of severe sanctions. It also might have strengthened the hand of any other potential plaintiffs inclined to claim that Microsoft's competitive behavior damaged their businesses.

"This decision basically gives the go-ahead to the private plaintiffs suing Microsoft," said Herbert Hovenkamp, an antitrust expert at the University of Iowa law school. There are more than 100 private antitrust cases pending against Microsoft.

Other observers thought the ruling represented only a temporary victory for the company.

"This is a clear win for Microsoft, but it's also the high point," said Bill Whyman, president of Precursor Group, a Washington market analysis firm.

The continuing legal scrutiny of the company will hinder such strategic initiatives as .Net, which is designed to integrate Microsoft's products and services with the Internet, Whyman said.

"Either through settlement or court remedy," he said, "Microsoft is likely to get stuck with a set of conduct restraints that will complicate its roll-out of .Net."

Nevertheless, investors greeted the ruling with enthusiasm. Microsoft shares rose $1.60 to close at $72.74 on Nasdaq. So far this year, Microsoft shares have gained 68%, whereas the tech-dominated Nasdaq composite index is down 14%.

The appellate ruling was the latest turn in a three-year antitrust case in which the Justice Department, states and the District of Columbia allege that the giant software company engaged in a raft of illegal acts to maintain its monopoly over operating system software for personal computers. The company's Windows software is the basic software running on more than 90% of all PCs in the world.

To further that monopoly, the plaintiffs charged, Microsoft intimidated computer makers and Internet service providers through business threats, restricted their ability to incorporate competing software in their products, and moved to destroy such potential rivals as Netscape Communications, the developer of a Web browser with the potential to undercut the dominance of Windows. (Faced with a snowballing loss of market share to Microsoft's Internet Explorer Web browser, Netscape allowed itself to be acquired in 1999 by America Online.)

Ruling Upholds Monopoly Charges

The trial phase of the case ended just more than a year ago with Jackson's order splitting the company into two parts, one to develop and market operating system software and another to sell applications such as the popular Office suite desktop PC programs.

On the three major charges that were part of the complaint, the appellate court largely agreed with Judge Jackson's finding that the company maintained its Windows monopoly through illegal conduct; rejected his finding that the company illegally attempted to extend its Windows monopoly to the Web browser market; and asked a lower court to reexamine his finding that it illegally incorporated the Explorer Web browser in Windows, a practice known as "tying."

Tying--combining two separate products to extend a monopoly position in one to the market for another, such as requiring theaters wishing to show a popular film to buy a particular film projector--has traditionally been viewed as an antitrust violation per se.

But the appellate judges ruled that this standard might be obsolete in cases involving software, where the integration of new functions into existing programs might be a natural byproduct of technological innovation. The lower court, the judges said, will have to consider whether the tying of Explorer to Windows led to an actual restraint of competition, a harder standard to reach.

One troublesome issue for Microsoft is how Thursday's ruling will affect its most important forthcoming product, a new version of its popular operating system for personal computers called Windows XP.

With the program due to be released Oct. 25, Microsoft already has drawn fire from business competitors for bundling numerous new functions in the system that could give it a foothold in new markets. Among these are a player for digital music and video, Internet telephoning software and a Web registration function that stores users' credit card numbers and passwords.

Legal experts said the ruling might open the door for the government plaintiffs to challenge the marketing of XP.

"The history of XP and the potential XP represents to continue Microsoft's domination of new markets" will be aired at any further hearings on a remedy for its monopolistic behavior, said New York state Atty. Gen. Eliot Spitzer during a conference call after the ruling's release. But he said the plaintiffs have not yet decided whether to seek a restraining order delaying the release of Windows XP.

Several of the state officials said they still favor breaking up the company, in part because Microsoft has a record of violating more conventional antitrust remedies such as injunctions forbidding the repetition of illegal behavior.

"We think there are strong arguments for a breakup," said Iowa Atty. Gen. Tom Miller. "As we've looked at other remedies, we've found they don't work in this setting against a company like Microsoft."

But the appellate judges strongly signaled their distaste in principle for splitting up Microsoft's operations. For one thing, they said, such divestiture is generally suited only to companies that have been built through mergers and acquisitions, and thus can be easily dismantled along "preexisting internal lines of division." Microsoft, by contrast, expanded through natural growth. The judges also hinted they feel divestiture might be too draconian a remedy for Microsoft's behavior.

Moreover, they criticized Jackson for mandating the breakup without adequately specifying his reasons for favoring that particular remedy or holding a hearing on alternative sanctions.

That criticism was part of a comprehensive denunciation of Jackson's performance that took up nearly a third of the lengthy ruling. Jackson did not return phone calls Thursday.

As early as September 1999, or nearly a year before his final ruling, Jackson began giving secret interviews to news reporters on condition they not be published until after the trial phase had ended. The interviews, appearing in a flood immediately following the order to split the company into two, revealed his long-term skepticism about Microsoft's case and the truthfulness of Gates and its other witnesses, and his desire to "get its attention" by imposing a sensational penalty.

The conversations exposed Jackson to influences and information that had not been aired in court and to which Microsoft could not respond, the judges said, because many of the interviews predated and foreshadowed his own rulings.

"The public cannot be expected to maintain confidence in the integrity and impartiality of the federal judiciary in the face of such conduct," the judges said. "We believe the line has been crossed."

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Times staff writers Henry Weinstein in Los Angeles and Joseph Menn in San Francisco contributed to this report.

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Microsoft Case at a Glance

In their 125-page ruling, the judges of the appellate court:

*

* Upheld Judge Thomas Penfield Jackson's ruling that Microsoft maintained its Windows monopoly through illegal conduct. Left open the possibility of future sanctions, but strongly indicated they did not favor dividing the company.

* Rejected Jackson's finding that the company illegally attempted to monopolize the Web browser market.

* Sent back to the lower court his finding that it illegally incorporated the Explorer Web browser in Windows.

* Disqualified Jackson from presiding further over the case due to his "flagrant" violations of judicial ethics during the trial, but found no "evidence of actual bias."

*

What's Ahead

* The parties in the suit can now appeal to the Supreme Court, initiate settlement talks or plead their cases before a new judge.

* Microsoft executives have signaled a willingness to work for a settlement.

--Compiled by NONA YATES/Los Angeles Times

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