Yes. The attribute password in the SDEWORKSPACE tag in the AXL map configuration file can be encrypted by using ArcIMS Author.
Only ArcIMS Author 9.2 and later versions can be used to make Direct Connect to ArcSDE.
<SDEWORKSPACE name="sde_ws-0" server="myserver" instance="sde:sqlserver:mymachinename" database="vtest" user="myusername" encrypted="true" password="LXEMUR" />
Before ArcIMS 9.2, as Direct Connect could not be set up using ArcIMS Author and SDEWORKSPACE tag was manually edited using a text editor, the password attribute cannot be encrypted, it is saved as plain text, and the attribute encrypted needs to be set to false.