April 30, 2000


Tangled Path Led to the Government's Decision to Seek a Breakup of Microsoft


WASHINGTON, April 29 -- When it all began two years ago, with the federal and state governments filing their landmark antitrust suit against Microsoft, Kevin O'Connor, an assistant attorney general in Wisconsin, was struck with a numbing fear: What would the plaintiffs do if they actually won the case against one of the richest and most powerful companies in America?

Photographs by Associated Press
Iowa's attorney general, Tom Miller, left, and Richard Blumenthal of Connecticut were among the state officials closely involved in the case.
"It's like the dog chasing the bus," Mr. O'Connor said. "What's he going to do if he catches it?"

The answer came Friday. The Justice Department and 17 states asked a federal judge to break Microsoft into two companies that would compete with each other and, they contended, change the rules of competition across the software industry. Today, government officials were relieved, behaving in some ways like a new parent after a long and tortured labor. And that it was.

Over the last few weeks, the Justice Department and 19 states were sometimes in warring camps that reconfigured themselves as events swirled around them. All think it something of a miracle that a vast majority wound up in agreement on a single remedy proposal. (Two attorneys general dissented.)

Within the Justice Department, the job was easier. On Sunday, April 2, the day after mediation efforts broke down, Joel I. Klein, the assistant attorney general who heads the antitrust division, convened his senior aides and polled them on their preferred remedies.

"And everyone said the same thing: ops-aps," said one person with knowledge of the discussion. Ops-aps is the term coined within the department for the proposal to create two new companies, one that would have the Windows operating system and another that would have the applications software, like word processing and spreadsheet programs.

A roughly similar idea had been offered during the settlement talks. But this point of consensus was reached only at the end of a long and bumpy road.


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Almost immediately after Mr. O'Connor worried about the dog and the bus in May 1998, the states had agreed to form a remedies committee, which began work well before the trial opened in October 1998. After almost a year of research, consultations with experts and intense internal discussions, they came up with a plan that was presented at the group's annual convention in Washington in March 1999.

The proposal called for forcing Microsoft to auction the source code for the Windows operating system to other companies, which would develop and improve it, creating competition in the operating system business.

The states were not interested in breaking up Microsoft, even though the antitrust trial was almost over and it was clear that Microsoft had put on a miserable defense in court.

Tom Miller, the Iowa attorney general, who was by far the most active of the 19 attorneys general, said the idea "was somewhere between conduct and structural" -- that is, between merely restricting Microsoft's behavior and actually restructuring the company.

But as the states quickly found out, there was one big problem. When they talked to the various companies that might be bidders in the Windows auction, they learned that none had any interest in bidding. The consensus was that the computer code was too complicated, and the price was likely to be too high.

"So we discarded that idea," Mr. Miller said. And another attorney general, Richard Blumenthal of Connecticut, said the government's ability to impeach the credibility of Microsoft executives who testified helped convince him and others about that time that remedies intended to modify Microsoft's conduct probably would not work.

"We saw that there was no moral core to their defense," he said. "It was all bluster and rhetoric, so I came away thinking that it was very risky to believe there would be even a scintilla of credibility on their part" when it came to hoping they would abide by conduct restrictions.

About the time the states were reaching this point in their thinking, Mr. Klein chartered a wide research project on remedies using department staff and academic experts. Over the summer, Justice Department personnel spoke with dozens of computer industry leaders, analysts, venture capitalists, lawyers and others to gauge their views on remedies. Mr. Klein carried out many of the interviews himself.

Some of those consulted were Microsoft allies; others were theoretically loyal customers, and still others were competitors. But "the broad consensus, when you took the competitors out of it, was that Microsoft could and would evade conduct remedies," a person with direct knowledge of the discussions said.

Still no decision was made. But then Judge Thomas Penfield Jackson issued his findings of fact on Nov. 5, declaring Microsoft a market-stifling monopoly, and opinions within the Justice Department began to coalesce. The department began looking for an investment banking firm to help explore the economic ramifications of a breakup or other structural remedy, an official said. On Dec. 2, it hired the New York firm Greenhill & Company.

Around that time, court-sponsored settlement talks opened, mediated by Judge Richard Posner, chief judge for the United States Court of Appeals in Chicago. By the time he asked for remedy ideas early this year, the Justice Department was ready. The department proposed splitting Microsoft into three companies. One would hold Windows 98, and another would have Windows 2000, the new operating system recently released, primarily for big corporate users. A third company would hold the rest of Microsoft's businesses.

This was intended to create immediate competition in the operating system business, and the states joined in advocating the idea. But after a period of discussion, Judge Posner said he had spoken to Microsoft, and the company had made it clear it was not willing even to discuss the proposal.

One official said Judge Posner also raised his own objections, saying he believed an appeals court would not look favorably at the idea. "It would arouse tremendous resistance in Congress, allowing Microsoft to rally public opinion against the suit," the official added, paraphrasing the judge.

That breakup proposal was dropped. Instead, the Justice Department, Judge Posner and Microsoft, often represented by its chairman, William H. Gates, fell into intense negotiations over a set of conduct remedies. Judge Posner essentially locked the states out of the process, several state officials said.

As the states got word of the discussions, they grew distressed. They considered the plan under discussion wholly inadequate.

"The states just would not have agreed to it," Mr. Miller said.

As a result, he and others said, the attorneys general were relieved when the talks broke down on April 1. But they were also demoralized. The judge had issued a statement praising the negotiating parties but had pointedly failed to mention the states. And Microsoft blamed the states for the failure of the talks -- an idea state and federal officials denied.

"Morale was down," Mr. Miller said. But more important, in meetings with the litigants, Judge Jackson had made it clear he wanted to complete the remedy phase of the trial quickly. On April 5 he said he wanted a joint state-federal remedy proposal by the end of the month.

That was three days after the meeting in Mr. Klein's conference room in which the group had reached consensus on the ops-aps breakup strategy (though the department had much work to do on the details of its proposal). But the last the states had heard, the Justice Department was proposing a range of conduct remedies to Judge Posner.

And Harry First, a senior official in the New York attorney general's office, said the states figured "the judge didn't want two different opinions in front of him." The states also believed, "after Justice's performance in the settlement talks, that it was not at all likely they would go for a structural remedy," another state official said, so "we decided we would devise as long a list of conduct remedies as we could."

By mid-April the centerpiece of the states' evolving proposal was three ideas that Mr. Miller called "conduct plus" remedies. The first was to prevent Microsoft from adding new products to Windows unless they were distributed on a separate disk that users could chose whether to install. The second was to require Microsoft to divest itself of Internet Explorer, the Web browser that is part of Windows. It would be put in a separate company. And the third was to require Microsoft to create versions of its package of applications software, Microsoft Office, for other operating systems.

Those ideas and others were proposed at meeting of the attorneys general in Chicago on April 13. All the states but Louisiana attended. Even the states that opposed structural remedies, notably Ohio and Illinois, seemed to like the ideas. "They seemed pretty interested," Mr. Miller said. So the states prepared a list of conduct remedies, with those three ideas at the center.

At the Justice Department, meanwhile, officials were talking to industry leaders about the ops-aps idea, and other short-term conduct remedies to go with it.

Soon after, Mr. Klein took the idea to Attorney General Janet Reno for approval, and she gave it.

In the middle of all this, the states decided to send the Justice Department a copy of their proposal, unsolicited. "We wanted to get it to Justice as soon as we could," Mr. First said. Another official said, "We hoped it would prompt some discussion with them," because so far there had been no substantive contacts.

The Justice Department did not respond substantively even to this, though Mr. Klein did tell Mr. Miller, "I can see you put a lot of work into this," Mr. Miller said.

Work continued on the state plan, but experts consulted by the states began pointing out significant problems with some proposals. For example, what if Microsoft simply reported, a year later, that it had been unable to create a version of its Office software for Linux, another operating system? What recourse would the attorneys general have?

Then, on April 17, Mr. Klein individually called Mr. Miller, Mr. Blumenthal and Attorney General Eliot L.

Spitzer of New York. He told them they would be surprised and pleased by the federal proposal.

"It's going to be more aggressive than what you are considering now," Mr. Miller quoted Mr. Klein as saying. One knowledgeable person said Mr. Klein was trying to signal his department's direction without being specific; he was afraid of leaks.

But none drew the conclusion that Mr. Klein seemed to intend.

"He didn't convey a whole lot," said Mr. First, who was on the call with Mr. Spitzer. "From my point of view, as we were trying to draft something, it was sort of meaningless."

Mr. Blumenthal said, "The conversation wasn't very specific."

And Mr. Miller said, "I thought maybe he was saying they were going to come up with some proposals in the midrange, conduct-plus sort of things." So the state research continued, but experts and analysts began poking more and more holes in the proposals. "It got very frustrating," one official said.

Finally, on April 20, Mr. Klein convened a conference call with his aides and the same three attorneys general. He told them exactly what the Justice Department intended to propose: the ops-aps idea along with a set of conduct remedies.

"I was somewhat surprised," Mr. Miller said. So were the others. "But the more I thought about it," he added, "I was pleased" -- particularly since the states' proposal was rapidly falling apart.

Mr. Miller said he asked Mr. Klein how he had come to his proposal. He said Mr. Klein told him: "We looked at conduct plus, like you did. But we came to the conclusion that it wouldn't work as well as we had thought."

Mr. Miller said the states had come to the same conclusion, "but we hadn't announced it." So the states embraced the federal plan, noting that many elements were identical to their own.

Now all of them have to wait for the decision of the judge. "It's not appropriate to speculate on how he will proceed or how he will rule," Mr. O'Connor said.

But with a chuckle, another official said, "I would bet he'll reach his decision more easily than we did."



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