The Next Big, and Probably Bad, Week for Microsoft

With mediator Judge Richard Posner's announcement Saturday that he's given up on helping Microsoft(MSFT) and the Department of Justice find some common ground for a negotiated settlement of the Justice Department's antitrust action against the company, the game now shifts to figuring out what tough trial judge Thomas Penfield Jackson's Conclusions of Law findings will be.

And, in the third phase of this three-part trial, the penalty phase, just what punishments Justice will ask for, and Jackson will assess.

Those of us who had hopes for a settlement -- including me -- fell into the trap of assuming reasonableness on both sides: At Microsoft, an understanding that the publication of Jackson's Conclusions of Law document, expected to be a harsh indictment, would have legal implications reaching far beyond even the huge dangers of this trial; and at Justice, that the marketplace would help shape the future behavior of a chastened Microsoft, aided by court-imposed conduct rules, no matter how egregious they believed Microsoft's past actions have been.

Strike three, we're out. Reasonableness did not prevail.

It was clear in Judge Posner's civilized, generous statement that he was not going to try to lay the blame for the failed negotiations on either side: "I particularly want to emphasize that the collapse of the mediation is not due to any lack of skill, flexibility, energy, determination, or professionalism on the part of the Department of Justice and Microsoft Corporation," he said.

If the judge isn't going to lay blame for this failure, we probably shouldn't either. I keep hearing stories from reliable sources about how a few hard-line state AGs in the end made a settlement impossible ... but we cannot, at least not yet, confirm that. And we may never be able to.

On the other hand, Posner didn't let the sides -- both of them, or all of them, including the 19 states attorneys general participating in this action -- off entirely regarding their behavior during the four-month-plus negotiations: "Despite my strenuous efforts to maintain the confidentiality of the mediation, there has been a good deal of leaking and spinning, and this leaking and spinning have given rise to news reports that have created a misleading impression of several aspects of the process and that should be heavily discounted by anyone interested in hewing to the truth."

Both Microsoft and the Justice Department issued the predictable statements about how hard they tried and how much they regret the collapse of the negotiations.

The reality here is, I suspect, exactly as Posner put it: the differences between the two sides are just too great, and that includes critical differences over the outcome of the remaining stages of the litigation.

For us, as investors, a quick checklist:

• Jackson's Conclusions of Law We can now expect to see Judge Jackson's findings sooner, I suspect, than this coming Friday. His announcement last week that they would be published this Friday was based on giving the negotiation process 10 days to run. Since that process has definitively ended, there's no reason for Jackson to hold them until Friday.
• Monday's Market Action The market, to put it mildly, did not need this. Friday's Nasdaq rally was more of the end-of-quarter window-dressing fashion, I think, than a reversal after a true bottom on Thursday. But I did have hopes that we'd see a moderately positive Monday. Heck, I still do hope -- but forgive my irrational exuberance. Since everyone but the Budweiser frogs expected a settlement to be positive for Microsoft, and the failure of a settlement to be a big negative, we can expect to see Microsoft sag tomorrow ... and the Nazzdog to follow its lead.
• The Penalty Box Now that we're about to enter the penalty phase of the trial, and despite Posner's relatively generous remarks about both sides' integrity during the negotiations, I think Jackson will push this one through to a conclusion quickly. I believe that with the failure of the negotiations, he will be even more disposed to find against Microsoft, and to assess more stringent penalties than before.
• Conduct or Structure? The gap between the odds that we'll see a conduct-only remedy proposed and granted -- that is, a new set of rules by which Microsoft must compete, with continuing governmental oversight -- and the odds of a structural remedy being handed down (think, breakup) seems to me to have widened. Now, with Jackson's findings late last year that Microsoft did have a monopoly, and the findings this week, I suspect, that it illegally used that monopoly, I think it would be politically untenable for the Justice Department to seek less than a structural remedy. And less than politic for Judge Jackson to turn down that request. Ergo, Microsoft gets hit with a big loss.

The Trial That Would Not End picks up steam again this week, and Microsoft investors will pick up their anxiety level. Maybe the rest of us, too: This isn't good for tech stocks, period.

And for those looking further ahead, a harsh limitation on Microsoft's future in the form of an ugly precedent -- and maybe new rules of the road for all highly successful tech companies -- isn't so hot, either.

Not all tech CEOs agree. The phone lines were humming this weekend from the Valley to Washington, as members of the ABM (Anyone but Microsoft) bloc that were in many ways Justice's real clients here, lobbied their Justice Department friends to sit tight and not accept Microsoft's most recent counteroffer.

But, when they have the albatross of this sad case hung around their necks in the years to come, I think they'll see the error of their ways. If too late to matter.

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