Thanks for the suggestions Gabriel.
Well, based on the links you have provided, I ended up doing this...
1. Downloaded the sqljdbc_auth.dll from the Microsoft JDBC Driver 4.0 site.
2. Placed this dll file in [WAS_home]\java\bin
3. Restarted WAS and tried to retes datasource connection to the sql server 2008 R2
4. The current error was gone but I got this new one
"
The test connection operation failed for data source Microsoft SQL Server JDBC Driver - DataSource on server server1 at node calzoneNode03 with the following exception: java.lang.UnsupportedOperationException: Java Runtime Environment (JRE) version 1.6 is not supported by this driver. Use the sqljdbc4.jar class library, which provides support for JDBC 4.0.. View JVM logs for further details."
This is weird since I already had sqljdbc4.jar as my driver.