Having samba 3.0.6. man smb.conf, the section abdout encrypt passwords:
The problem is that smb.conf is being read BOTH by smbd and smbclient. So it is
not clear what the description of encrypt passwords is valid for: whether smbd,
smbclient or both.
It could control the behaviour of smbclient when starting the session or smbd.
Suggested fix: write there, which case this is a description of (or whether of
*** Bug 1699 has been marked as a duplicate of this bug. ***
This entry clearly says :
This boolean controls whether encrypted passwords
will be negotiated /with the client/.