Jason M,
I was recently able to get the latest Microsoft provided JDBC driver to work with the following settings:
Database Class:
com.microsoft.sqlserver.jdbc.SQLServerDriver
Database Connection String:
jdbc:sqlserver://SQLSERVERNAME:1433;DatabaseName=pwmDB
You also have to copy the correct JAR file into pwm/WEB-INF/lib/ ... since I was using JDK 1.6, I had to use the sqljdbc4.jar file. Also, adding a new JAR file to your lib folder usually requires a reset of the application server (e.g. Tomcat).
I think your original issue may have been related to the "Database Class" string; the "sqlserver" and "jdbc" portions looked swapped.
FYI,
-Anson