Feds, Microsoft edge toward settlement

But reaching a final agreement could depend on whether both sides can agree on minute details that would restrict Microsoft's business practices in the consent decree that must be approved by U.S. District Judge Colleen Kollar-Kotelly.

Some sources suggested that the agreement is quickly shaping up from a rough proposal to a serious settlement that both sides can sign off on. With a Friday deadline looming, both sides have incentive to quickly fill in the gaps.

On Thursday evening, the Justice Department issued a statement that Attorney General John Ashcroft and Assistant Attorney General Charles James would hold a news conference at 7 a.m. PT on Friday regarding an antitrust matter. No further details were available.

The Justice Department could face difficulties with the 18 state attorneys general who have been its allies, many of whom have been pressing for more drastic remedies against Microsoft. They must approve any tentative agreement, which, as it is taking shape, may lack the bite they are looking for.

For instance, one version of the proposal does not address some of the middleware issues central to the case, provide greater access to Windows code or allow PC makers any more freedom in customizing the desktop than icon changes Microsoft made in July, said sources familiar with the matter. It also would not restrict Microsoft from tying products together in a way that would essentially limit consumers' options as the company did with Windows 98 and Internet Explorer.

The proposal has changed many times during the last 48 hours, said a source familiar with the discussions.

Glenn Manishin, an antitrust attorney with Kelley Drye & Warren in Vienna, Va., said that if the leaks about the proposed settlement are true, the Justice Department is preparing to do nothing more than slap Microsoft's wrists.

"This is a toothless remedy that doesn't even come close to getting at the core violations the Court of Appeals unanimously affirmed 7-0," he said.

Another observer agreed.

"At least from the press reports, the agreement is minimal," said Andy Gavil, an antitrust professor at the Howard University School of Law. "It's not a walk, but it's sort of the minimum you would need to pass a red-face test...Can you make (the case) without blushing before the judge?"

Rumblings among the states
The Justice Department and Microsoft appear to have largely worked out the tentative agreement without the states, said sources familiar with the matter. Rumblings from within the states' camp indicate that they might not be in agreement with the proposal, said sources familiar with the matter.

One source described the states as "waffling." One issue appears to be resources, said another source: If California decides to pursue the matter, other states are more likely to follow.

Leaks about the discussions appear to have come after the 18 states were briefed on the rough proposal and several Washington-based trade groups approached the media about the talks' progress.

Both sides were mum on any possible agreement, tentative or final.

"We don't have anything to say today," said Bob Brammer, spokesmen for Iowa Attorney General Tom Miller and one of the leaders of the states coalition. "I can't comment on any developments."

The Justice Department could not be reached for comment. The case began in 1998 when the agency and the states sued Microsoft, charging it with abusing its monopoly in the operating system market to crush rival Netscape Communications in the emerging browser market.

"We're working very hard in the settlement process, but we're not going to comment on any aspect of the discussions," said Microsoft spokesman Vivek Varma.

Subject to change--or collapse
Legal experts cautioned that this week's settlement discussions could collapse at any time and that the current proposal is likely one of many examined by the government. Leaks about settlement so close to a court-imposed deadline also could indicate that the parties may be divided, with some participants hoping to sabotage the discussions.

In addition, trade groups representing Microsoft competitors could hope to trip up negotiations or increase pressure on the states to push for a harder agreement.

This wouldn't be the first time settlement appeared within reach only to later fall apart unexpectedly. Negotiations mediated by esteemed federal Judge Richard Posner collapsed in April 2000 with a Microsoft settlement offer on the table.

A series of leaks about the discussions later attributed to the states preceded the collapse of settlement talks. Eric Green, a law professor from Boston University, is mediating the current round of discussions.

"This mediator, knowing full well the prior mediation collapsed, at least in part because of the dissatisfaction of the states to the proposed settlement, will work very hard to keep that from happening again," said Rich Gray, a Silicon Valley-based attorney closely following the case.

But keeping the states in line may be difficult, particularly if the Justice Department is ready to settle on its own, legal experts warned. In September, the Justice Department unexpectedly took breakup and the tying claim--whether Microsoft illegally integrated Internet Explorer into Windows 95 and 98--off the table. Sources close to several of the states said they were not consulted beforehand.

Days later, California and New York issued a joint press release warning they would independently continue the case. Any or all of the states could continue to pursue the case even if the Justice Department and Microsoft reach an agreement later approved by Kollar-Kotelly.

"In a perverse way, it maybe creates an incentive for the states to break free," Gavil said, referring to a possible Justice Department-Microsoft settlement. "They can only get something more. They're not going to get anything less from the judge than what Microsoft agreed to with the federal government."

But the states could face stiff resistance from Kollar-Kotelly, who in demanding discussions said that dragging out the case made no sense given the national security crisis that began Sept. 11.

The states' new ally
Last week, the states hired Brendan Sullivan, with the law firm of Williams & Connolly here, to lead their portion of the case.

"The hiring of Brendan Sullivan is interesting timing, particularly if the feds have reached a settlement," Gray said. "That strengthens the states hand in a settlement and the option they could go it alone."

In a statement announcing Sullivan's hiring, California Attorney General Bill Lockyer reiterated that the states were prepared to go to trial if necessary to protect consumers and businesses.

Should federal or state trustbusters reach a settlement with Microsoft, Kollar-Kotelly would have to review the agreement under the Tunney Act. Sullivan would represent the states during that hearing.

If some or all of the states are not in agreement with the Justice Department and Microsoft, "the states will say that this is a sellout and wimpy settlement," said Bob Lande, an antitrust professor with the University of Baltimore School of Law.

Kollar-Kotelly's inexperience with the case could work to the advantage of a settlement, Lande warned.

"You have a judge that doesn't know the facts of the case yet and who said in the strongest possible terms, 'Please, please, please settle,'" he explained. "Forgetting the merits of the case, it would be easy for her to rubber stamp whatever the DOJ and Microsoft come up with. If the states want to howl, well, too bad."

Kollar-Kotelly took on the landmark antitrust case in late August. In its June ruling upholding eight separate antitrust claims against Microsoft, a federal appeals court removed U.S. District Judge Thomas Penfield Jackson from the case.

Ultimately, Lande believes a Microsoft-Justice Department settlement could be approved even without the states.

"The easy way out is to rubber stamp, and I'm afraid the judge just might do that," he said. "The states must be thinking the same thing, too, so this puts a lot a pressure on them, particularly the states that aren't as gung ho. So we may see some states dropping out."

In the event that some states continue without the Justice Department, no settlement is reached or no agreement is approved by Kollar-Kotelly, a remedy hearing would likely follow. One is tentatively scheduled for March.

Wall Street encouraged
On Wall Street, analysts saw news of a possible settlement as "encouraging," and investors pushed Microsoft shares up $2.42, or 4 percent, to $60.57 in early trading Thursday.

Goldman Sachs analyst Rick Sherlund said in a research note to clients that word of a settlement is important because it will force states that are pursuing a case against Microsoft to proceed independently of the Justice Department.

If the federal agency accepts a settlement, the states may have a tougher time pursuing Microsoft, according to Sherlund.

"We would expect to see the states argue for tougher action, but it is unclear how this might play out. It is certainly a positive for Microsoft to have the DOJ move on and argue to the judge that they have reached a satisfactory agreement," he wrote.

Analysts said the settlement isn't likely to boost Microsoft's business, but it does remove the uncertainty around the antitrust trial, which in turn could elevate the company's shares.

Amid the cautious optimism, many analysts are putting the greater emphasis on caution.

"Although a settlement as described would be positive for the company, we believe it would be premature to conclude that the company's legal issues are behind it," said Merrill Lynch analyst Henry Blodget. "We also continue to believe that the legal situation is far less of an issue for the stock than the long-term earnings growth rate."

If nothing else, the states pushing forward could solidify any eventual remedy, even if it goes no further than a Justice Department-Microsoft consent decree, said Gavil, the Howard University law professor. Conflicting interpretations of a 1995 consent decree between the two paved the way for the current case and another in 1997. But a remedy imposed by a judge would carry more weight than a settlement and offer less room for interpretation.

"Future disagreements will be a function of interpreting the intentions of the parties in the settlement agreement," Gavil said. "That's how Microsoft dodged the bullet in the first consent-decree case, because it was interpreting the intent of the agreement instead of the intent of the court."

Staff writer Larry Dignan contributed to this report.