JUSTICE VS. MICROSOFT: THE SECRET TALKS THAT LED TO A TRUCE

What prompted intensive settlement talks between Microsoft and the Justice Dept., just hours before Justice and at least 18 states were set to file antitrust suits against the company? According to sources, Microsoft laid out a series of compromises it was willing to make in an attempt to head off the lawsuit. They included making adjustments to its contracts with Internet service providers, content providers, and online services that grant the partners favorable treatment in exchange for promoting Microsoft's Internet Explorer browser. Microsoft also offered to address Justice's concerns about a preference for its browser built into Windows 98. But, say sources, Microsoft continued to oppose government say-so over what it can put into its operating system software -- a position that trustbusters, over the long run, are likely to oppose. "The bottom line is that Microsoft convinced the Justice Dept. and the states that there was reason to sit back down at the settlement table," says one source.

Actually, the stand-down agreement between Microsoft, Justice, and state attorneys general followed a week of secret talks. While Justice sources downplayed the significance of the discussions as "just talk," the negotiations began with Microsoft Chairman William H. Gates meeting with Justice Antitrust Chief Joel Klein on the evening of May 5, according to sources. Twenty-four hours later, Microsoft and Justice agreed on a framework for resolving the issues through a consent degree. Justice then took that outline to the state AGs, who studied it overnight. Word came back to Microsoft at 7:30 the next morning that the AGs had signed on. As a show of good faith, Microsoft then agreed to put off shipment of Windows 98 until at least Monday, sources say.

The negotiations were conducted largely in a series of phone calls between Klein and William Neukom, Microsoft's senior vice-president for legal affairs. Justice kept the states informed about progress, according to sources close to the talks. Gates apparently kept in close touch with negotiations, even though he is staying at his family compound on Washington's Olympic Peninsula, where he had gone for one of his twice-annual "think" weeks.

The settlement talks are now expected to continue through the weekend. Neukom left Microsoft's Redmond (Wash.) campus on May 14 to fly to Washington, D.C., for face-to-face bargaining with Justice and a few AGs.

Even though Microsoft is willing to put off the release of Windows 98 to computer makers for at least a few days, the software maker says it still plans to release the product to consumers on June 25. "There are important principles at stake," says Microsoft spokesman Mark Murray. "Particularly, we want to protect the right of a company to innovate and improve its products."

One government source says even if a settlement is reached, Justice will continue a broader investigation into Microsoft's business practices. "The fact that Microsoft is negotiating with the Justice Dept. and apparently is prepared to make substantial concessions certainly undermines any argument that Justice has no case," says Senate Judiciary Committee hairman Orrin G. Hatch (R-Utah), an outspoken Microsoft critic.

By Steve Hamm in Redmond, Wash., with Michael France in New York and Susan B. Garland in Washington