They aren't prohibiting "Free Software", they are prohibiting software that is under a license that requires the distributor to pass certain rights along to the recipient. Hence GPL like licenses that require distribution of source code, and that you grant redistribution rights to everyone you distribute it to are being explicitly prohibited. (And in fairness I can see why those licenses would cause problems for Microsoft as distributors) On the other hand BSD like licenses that allow you to repackage and distribute without source and without passing rights forward are acceptable.
"The pathology is to want control, not that you ever get it, because of course you never do." -- Gregory Bateson