Google has come out and announced that he will be working in speech recognition and the president of Google China.
Google has also announced they are working on "speech search," say what you want and Google will give it to you.
Microsoft has said Dr. Lee worked in speech recognition, the MSN search algorithm, and the framework for their China strategy.
Sounds like a direct violation of the non-compete to me.
As for the case going federal, I don't think it really hurts MSFT, but I don't see it doing any good. The only reason to go federal is to keep the case from going to California. Honestly, the chances of it going to Cali are very slim. Non-compete was written and I'm sure it states that all violations will be held in Washington State Court System or a higher authority (every contract ever has a clause like that), MSFT is based in Washington, GOOG has offices in Washington. Washington seems the obvious choice here.
Luckily enough for Dr. Lee, his contract with GOOG requires GOOG to pay and assist for his defense in this (thus the reason GOOG is filing evidence that would be Lee-only privy) and if the courts decide the non-compete stands, GOOG is obligated to pay him for one year.
Not a bad deal for Dr. Lee, and he could probably still make off with a bit of money in a slander case, based on the way MSFT has described him in this situation.