Appeals Court Overturns Microsoft Breakup Decision

Updated from 2:13 PM

In a sort-of victory for the world's largest software company, the U.S. Court of Appeals overturned a ruling to break up Microsoft(MSFT Quote) in the government's antitrust case against the software giant, while removing from the case the judge that ruled against the company. The case will now be sent back to a lower court.

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In a unanimous 7-0 ruling, the appeals court reversed Judge Thomas Penfield Jackson's findings that Microsoft illegally tried to monopolize the market for Internet browsers, one of the key aspects of the government's case. But it left open the question of whether Microsoft engaged in monopolistic activities by tying its Internet browser to its ubiquitous Windows operating system, and upheld the view that Microsoft violated antitrust law in the way it upheld its Windows monopoly.

While Microsoft portrayed the breakup reversal as a victory, it by no means puts to a final rest the legal issues plaguing the software company.

"The ruling lifts the cloud of breakup that's been over the company," Microsoft Chairman Bill Gates said during a press conference. "We feel very good about what the court has written."

Anyone who's reading this story on a PC knows that Microsoft has maintained a monopoly through Windows for quite sometime, but having a federal court say they maintained it illegally is another matter entirely. In that sense, some legal experts view the decision as more of a victory for the Justice Department than Microsoft. Newly confirmed antitrust chief Charles James agreed, calling it a "significant victory."

"Net, I'd say this a win for the government," says Dana Hayter, an antitrust attorney at Fenwick & West in San Francisco. "Microsoft did lose on the monopoly part, and my guess is that it would appeal this to Supreme Court. The question is what will Bush adminstration do with this victory."

The reigning opinion on that point was that the Bush administration, viewed as more business-friendly than that of former President Bill Clinton, would try to get the case settled, especially since many of the government's lawyers -- including Joel Klein and David Boies, who tried the original case -- left Washington with the changing administration.

"At this point, the case is really teed up for settlement," says Ernest Gellhorn, a law professor at George Mason University who has closely been following the case. "The government needs to find new prosecutors. It's no easy job to shift people to retry a case, and the case will require substantial retrial on the tying and remedy issues. It will be six months to a year before the trial would be accomplished--I'd be more confident with saying a year."

Gates' remarks signaled that his company was clearly open to further settlement talks. He said that the company would review the ruling over the next several days before deciding what to do next.

"I'm not going to make any predictions of what might come out of it, but I do know that Microsoft has always wanted to pursue that direction, and that it has at every step of the process. Now, there' the opportunity to do that again."

After the ruling was released, White House spokesman Ari Fleischer told the Associated Press that President Bush would not act on the Microsoft case until a Justice Department review was completed. But Fleischer also reiterated Bush's general support of negotiation.

"The president believes people should work hard to enter into agreements and the president believes there's too much litigation in our society, generally speaking," Fleischer said.

Microsoft shares were halted pending the news, but shot up to 5.4% before the decision came out. When they were released at 2:50 p.m., they rose to $76.15 amid a rush of trading that jammed systems, and more recently traded at $73.26, up nearly 3%.

The court used a stinging tone to rebuke Jackson for his conduct during and after the trial phase of the case, and removed him from further involvement in the case while questioning whether he damaged the judicial process.

The court said that Jackson "engaged in impermissible ex parte contacts by holding secret interviews with members of the media and made numerous offensive comments about Microsoft officials in public statements outside of the courtroom, giving rise to an appearance of partiality."

"Although we find no evidence of actual bias, we hold that the actions of the trial judge seriously tainted the proceedings before the District Court and called into question the integrity of the judicial process," the court added.

After the trial, Microsoft maintained Jackson had been biased against it, and should be removed from the case for his many comments to the press during and after the trial.

Market watchers had been expecting a ruling on Microsoft's appeal in the case for months, and largely expected Jackson's findings to be reversed, especially his order that the company be broken up. The Bush administration's less hawkish stance on anti-trust concerns was also attributed to why the software firm would likely survive as one.

The ruling couldn't come at a better time for Microsoft, and could hardly be more positive for the company, short of the appeals court throwing the case out completely. Since the beginning of this year, Microsoft shares have surged as many market watchers have considered the case largely over. New product initiatives, including the company's pending release of the Windows XP operating system and its new Xbox video game console this fall, have also helped stoke the shares.

Shares of the software maker are up 71% since December 20. But many analysts have said that the stock would be up even more , if it didn't have the specter of the appeals case hanging over it. Now, that specter appears to be removed, for the time being, at least until the case is taken up by a lower court. Even in that proceeding, however, the breakup of Microsoft would not be an option after the appeals court ruling.

To be sure, though, Microsoft isn't out of the woods yet.

"Anyone who thought this was going to be the end was sorely mistaken," says Melissa Eisenstat, an analyst with CIBC World Markets, who rates Microsoft shares a buy. "This is just kind of a new chapter. I think the outcome today was exactly as we expected it to be -- both sides lost something, and both sides won something." (Her firm hasn't done underwriting for Microsoft.)

Other analysts said that while the news might give the stock an initial pop, it could face pressure down the road.

"There's still overhang on Microsoft's shares," says Aaron Scott, an analyst at Tucker Anthony Sutro who rates the shares a buy. "This thing can still go to the courts again. You've got that overhand, and that will continue until this thing is completely done. You've got another year and half, at least, before there's no overhang there."

In May of 1998, the Justice Department and attorneys general from 20 states sued Microsoft for hindering competition and innovation in the software industry through its Windows operating system monopoly. One state later dropped out of the suit.

In October 1998, a circus-like atmosphere descended over the E. Barrett Prettyman federal courthouse in Washington, where the anti-trust trial was held though out the winter. During the months-long trial, dozens of damning emails emerged, and Microsoft founder Bill Gates became vilified as a bullying monopolist, largely the result of snippets of his evasive video-taped deposition dripping out daily in front of the court. The company's stock reacted accordingly.

In April 2000, Judge Jackson found that Microsoft violated the Sherman Antitrust Act by maintaining "monopoly power by anticompetitive means." He also ruled that the company violated another section of the law by tying its Web browser to its operating system. While the appeals court did not dispute the first part of that ruling, it did reject the notion that Microsoft illegally tied its browser to its operating system. In June 2000, Jackson ordered the breakup of the company, which the appeals court has now also overturned.

Now, the case can go back to lower court to debate new remedies to be imposed for Microsoft maintaining a monopoly. The actions of the 19 state attorneys general, who have floated the possibility of new actions against Microsoft related to Windows XP, are also up in the air.

A feature of Windows XP, known as "smart tags," has stoked controversy in recent weeks. As the company originally envisioned it, smart tags would have added links to Web pages that were not originally intended by the Web page's publisher. For instance, if a story on TheStreet.com mentioned Microsoft's stock, smart tags could have conceivably added a link into the story directing the reader to Microsoft's competing Money Central Web site. In Thursday's Wall Street Journal, technology columnist Walter Mossberg, who originally took the company to task over smart tags three weeks ago, reported that the company had abandoned plans for smart tags after receiving overwhelming criticism. Many had pointed to the ill-timing of smart tags as a potential vehicle to incite more anti-trust ire just as the appeals court ruling was set to come out.

Today, however, Microsoft and its investors will bask in the court's decision to not break the company up.

Senior Writer Tish Williams contributed to this report.