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When connecting from an ArcGIS Desktop 9.2 client to an ArcSDE 9.3 geodatabase for SQL Server Express, server administrators are able to downgrade the version 9.3 geodatabase.
Because connections to ArcSDE geodatabases for SQL Server Express are always direct connections, ArcGIS Desktop checks the release number of the geodatabase and compares it to the release number of the direct connect libraries being used by the connecting client. When these are incompatible, the user is prompted to upgrade.
Due to a bug in sdesetup, the 'upgrade' succeeds in changing the ArcSDE 9.3 geodatabase to an ArcSDE 9.2 geodatabase.
The bug in sdesetup that was allowing the client to downgrade the geodatabase was fixed in ArcGIS Desktop 9.2 Service Pack 4 (SP4), however, the prompt still appears in this configuration (SP4).
This was fixed in ArcGIS 9.2, Service Pack 6. Upgrade any Desktop clients that connect to the ArcSDE SQLServer Express geodatabase to SP6 to eliminate the possibility that an administrative user could downgrade the geodatabase. See the link in the related section for the Service Pack downloads page.