Wow, been a year.. but finally found some time to disassemble the Macintosh Drag and Drop system extension as well as the 8 * 24 GC control panel.
I was able to reproduce the following two artifacts when running the 8 * 24 GC with acceleration enabled while at the same time having the Macintosh Drag and Drop system extension installed on System 7.1:
- Finder: drag an item from desktop or one folder to another open folder - the destination folder window gets a colored hilite border within the window to let you know you can drop there. That colored hilite border gets corrupted with artifacts as you drag across it.
- Finder: drag an item over another folder - the destination folder icon itself is highlighted to let you know you can drop there and that destination folder icon gets corrupted with artifacts.
Tracing the code within the Macintosh Drag and Drop system extension, I found where the drag handling is done. The extension handles drawing the XOR'd drag outline while you're dragging. The drawing of the window hilite border or the hilited folder icon when dragging is done by the Finder, not by the system extension.
On the 8 * 24 GC, the driver patches QuickDraw traps to replace it with "accelerated code" and that acceleration executes on the AMD chip on the 8 * 24 GC card. The acceleration happens asynchronously unlike what normally happens without acceleration which is everything is serialized in software in the Mac. It looks like the Macintosh Drag and Drop extension's XOR drawing of the drag outline is not getting sequenced correctly with the Finder's drawing of the window/folder hilites. The Finder's hilite gets queued up asynchronously on the 8 * 24 GC card and the DnD extension reads the current frame buffer and while its calculating the XOR, the Finder's hilite executes on the 8 * 24 GC card, updates the frame buffer, and then the DnD system extension draws and the result is that the XOR doesn't land right.
I tried looking for ways to flush the queue on the 8 * 24 GC card but could not find a good way to do that.
In the end, I settled on a dumber method... I patched the Macintosh Drag and Drop extension such that when a drag operation starts, I disable acceleration on the 8 * 24 GC card and after the drag operation ends, I re-enable it (if it was previously enabled before the drag started). I was able to disassemble the 8 * 24 GC control panel and find how the enabling/disabling of acceleration works.
The result is that I have a patched Macintosh Drag and Drop extension that no longer causes the artifacts for the above two repro cases, and given it's enabling/disabling acceleration during drags, I think it should theoretically resolve the issue for other cases.

The patched version has a little GC rocket on the icon.
I am still working out a few things... there's a few more XOR drawing functions inside the DnD system extension and I'm looking at what those are for. It looks to be an animation but need to figure out what it is and when it's called. I haven't been able to cause that code to execute yet.
I will upload the patched version when I'm finished toying with it. But this helps the issue for System 7.1. System 7.5+ is another story as Drag Manager is built into the System file. I'd need to either generalize the patch as a separate extension that overrides Drag Manager and works on both System 7.1 and System 7.5+ or I'd have to patch various System 7.5+ files which I don't want to do.
Will circle back after figuring out what the other drawing calls are as I didn't patch those. I only patched the main drag handler.