Do not name any dll "Security"
We have been fighting MSDE for the past 24 hours. Our .Net Windows Client typically uses Sql Server that runs on a box inside the LAN. We were trying set up a laptop to run the app locally using MSDE and a local copy of the database.
Well, after jumping through many hoops we finally got down to this:
SQL Server Driver Cannot Initialize SSPI Package
I found this KB:
http://support.microsoft.com/kb/253577
What do you know, our encryption dll is named Security.dll. The client passes in an encrypted connection string and it gets decrypted by a dll named Security. I renamed this, did a build and guess what, all worked.
We also had to run svrnetcn.exe to enable tcp.