Judge Rules Microsoft Violated Sherman Antitrust Act

The judge will next set a schedule of hearings before issuing his remedies.
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Updated from 5:07 p.m. EST

Microsoft

(MSFT) - Get Report

violated U.S. antitrust laws, illegally tying products together and unfairly expanding its monopoly to drive software competitors out of business, a federal judge ruled Monday.

The ruling is the second stage of a three-part verdict, and the judge's findings of fact,

issued on Nov. 5, largely presaged his determination of which laws the company violated. Still, the smallest developments in the closely watched case have roiled the stock market fortunes of the company and its investors for months.

Microsoft said it plans to appeal the judge's ruling, saying that it was confident it would prevail in the case. However, the company said an appeal could only be filed after Judge Jackson decides on legal remedies to take against the software giant, and that could take several months.

Private negotiations in the case broke down Saturday, sending the company's shares plunging 15 7/16, or 15%, to 90 13/16 by Monday's close in extremely heavy trading of 128 million shares. After-hours trading was halted until about 5:45 p.m. EDT. The shares were trading at 92, according to

Instinet.

.

Jackson found the company maintained its monopoly power by anticompetitive means and attempted to monopolize the Web browser market by unlawful tying. He found that the company did not enter into unlawful marketing agreements with other companies.

The ruling "is scathing," said New York Attorney General Elliot Spitzer, whose state leads the case alongside the

Department of Justice

. "The judge has pulled no punches. There is no window here for Microsoft."

Spitzer said the judge's virtual invitation to states to find the company liable under their own laws multiplies the company's legal woes: "The availability of remedies that we have under state law just increases the pressure on Microsoft."

Spitzer declined to say whether the states will push for a breakup of the company, but said the tone of the decision gives states the upper hand if settlement negotiations are to resume. "It will be up to Microsoft at this point to reinvigorate the discussions," he said. "The language reads almost as a criminal indictment rather than a civil ruling."

Though he conceded that the tone will not affect any appeals court decisions, he said, "The severity of Judge Jackson's language certainly gives some hint of the remedies he would consider."

Microsoft founder and chairman William H. Gates said the company "did everything we could to settle this case and will continue to look for opportunities to resolve it."

Gates said the case "turns on its head everything consumers know."

"It is important to note just how much the high technology industry has changed just in the two years since this lawsuit has been filed," he said. "It's clear that Microsoft and every other company must compete and innovate in order to survive and prosper."

"Until the appeal is over, nothing is settled," added Steve Ballmer, Microsoft chief executive. "We've learned that from experience."

Microsoft's market value fell $80 billion Monday. Gates, who owns around 785 million shares, lost around $12 billion on paper in a day.

According to Jackson's document, "In essence, Microsoft mounted a deliberate assault upon entrepreneurial efforts that, left to rise or fall on their own merits, could well have enabled the introduction of competition into the market for

Intel

(INTC) - Get Report

-compatible PC operating systems."

Jackson wrote, "While the evidence does not prove that they would have succeeded absent Microsoft's actions it does reveal that Microsoft placed an oppressive thumb on the scale of competitive fortune, thereby effectively guaranteeing its continued dominance in the relevant market."

The Department of Justice will seek a "remedy with an enduring impact," said DOJ antitrust chief Joel Klein. He, too, declined to comment on specific provisions, saying, "We're going to look at all our options in light of the judge's ruling."

In a news conference with Klein, Pennsylvania Attorney General Richard Blumenthal attempted to mend the states' reputation in the proceedings. Mediator Richard Posner pointedly left the state attorneys general out when praising the diligence of Microsoft and DOJ negotiators.

"Whatever differences

between the state and federal negotiators really have been dwarfed by the commonality of cause," Blumenthal said, adding that the plaintiffs are "very much on the same page going forward."

What began as a quickly abandoned

Federal Trade Commission

investigation a decade ago has become a landmark antitrust case with implications for nearly every sector of the new economy, carrying the potential to elucidate, for the first time, the way longstanding fairness standards will apply in the digital age.

For Microsoft itself, market analysts and constitutional scholars consider possible an array of resolutions, ranging from the breakup of the company advocated by some state attorneys general to limits on Microsoft's business practices.

"This thing will drag on for at least another year," said Aaron Scott, analyst for Advest. Still, in the short term, "expect a massive hit on the stock," he said. Scott rates the shares buy, and his firm has not done underwriting for Microsoft.

The judge will next set a schedule of hearings before issuing his remedies, and a settlement is still technically possible. But pressure to settle weighed on the company more heavily before the expected ruling that the company violated antitrust laws. This portion of the verdict can likely be used against Microsoft in subsequent lawsuits filed by competitors and software purchasers, legal analysts say.

While some analysts have noted that continuing litigation could give the company time to develop its transformation to an online software company, a remedy could go into effect before an appeal is determined, said Joseph Angland, a partner in the antitrust group of the law firm

Dewey Ballantine

.

Despite the harsh wording of the ruling, a breakup of the company is highly unlikely, he added, because antitrust law is predicated on governing conduct, leaving the scope of companies to the markets' whims.

"It's only in the most dire circumstances where somebody says there's no way we can get competition back without busting the company up," Angland said.

In the consolidated case, the

Justice Department

, 19 states and the District of Columbia sued Microsoft under sections 1 and 2 of the

Sherman Antitrust Act

. The government contended that Microsoft violated U.S. antitrust laws by engaging "in a broad pattern of unlawful conduct with the purpose and effect of thwarting merging threats to its powerful and well-entrenched operating system monopoly," according to Justice Department documents.

Justice Department officials concluded that such behavior harmed consumers by depriving them of choice and advances in the software industry.

The government said Microsoft tried to eliminate competition by offering in a meeting on June 21, 1995, to divide the browser market with

Netscape

. Then, when Netscape refused, the government asserted, Microsoft took a number of steps to eliminate the competition.

Those efforts included unlawfully intertwining Microsoft's Internet Explorer Web browser with the Windows 95 and Windows 98 operating systems. They also included arranging anti-competitive and exclusionary arrangements with Internet service providers and online services to install only the Microsoft browser and preclude the use of the Netscape browser.

In addition, the government alleged that Microsoft tried to sabotage

Sun Microsystems'

(SUNW) - Get Report

Java cross-platform capabilities, which it saw as a threat to the popularity of its Windows operating system.

Microsoft denied all the charges, characterizing the government's case as "specious," "fiction," "fantasy," "silly" and "pure baloney."

Among other rebuttals, it contended that Netscape has been able to distribute millions of copies of its software. It argued that it does not have a monopoly because it faces significant competition from Netscape, which was acquired last year

by America Online

(AOL)

for $10 billion. Microsoft contended that Internet Explorer was an integral part of Windows, negating the allegation of illegal tying.

The company said its competition also includes

Red Hat

(RHAT)

, a company with a market value exceeding $8 billion that develops open-source software, including the Red Hat Linux operating system. Microsoft also pointed out that even the government's chief economic witness said the company's conduct had not harmed consumers "up to this point."

Several companies specializing in Linux software have made impressive initial public offerings in recent months.

Jackson's preliminary findings held that the giant software maker enjoys monopoly power in the personal computer market. In his findings, the judge said Microsoft's actions stifled innovations in the industry and deterred investments in rival technologies. He also found that the actions of Microsoft had the potential to harm consumers.

"Microsoft enjoys so much power in the market for Intel-compatible PC operating systems that if it wished to exercise this power solely in terms of price, it could charge a price for Windows substantially above that which could be charged in a competitive market," the judge wrote. "In other words, Microsoft enjoys monopoly power in the relevant market."

In his findings, the judge said that

Apple Computer

(AAPL) - Get Report

was too small to compete effectively against personal computers that used Microsoft Windows, and that Linux software does not pose a threat to Windows. He said computer makers believed they had no choice but to use Windows.

In an unusual move widely interpreted to push the two sides toward a settlement, Jackson quickly named an authoritative mediator in the case, Judge Richard Posner of the

Seventh U.S. Circuit Court of Appeals

. Posner, widely respected in the antitrust field, reportedly held separate talks with each side, attempting to learn the intracacies of the software industry while nudging the sides closer to an agreement.

Posner ordered a veil of silence during the negotiations, and both sides pledged to carry out negotiations in total secrecy.

But intense interest and mounting speculation were mainstays during the four months of secret negotiations. Investors were confused, and Microsoft's stock was buffeted by reports and rumors of a possible settlement. These included a vaguely sourced

report in

USA Today

on Jan. 12,

rumors that emerged Dec. 14 from the options pit of the

Pacific Stock Exchange

and, more recently comments that

Bloomberg News

attributed to Microsoft Chairman William H. Gates Gates after the introduction of the Windows 2000 operating system.

A downloaded copy of the conclusions of law in

U.S. v. Microsoft

is available at the

Government Printing Office

Web site at

http://usvms.gpo.gov. The report is available in Adobe PDF and HTML formats only.

See our

index page for a full roundup of Microsoft antitrust coverage.

Check out the Microsoft saga in the

Microsoft Trial Timeline.

Carolyn Koo and Justin Dini, reporters for

NYTimes.com/TheStreet.com

, contributed to this report.