I did some searching and only found one post that came close to addressing my problem. Unfortunately the solution given (swithching from 32 to 16 bit color depth), does not work in my case. So here goes.
I didn't want to spend time downloading all the cutscene AVI files if I already had them in MVE. Not when I learned I could convert themself anyway from
KARAJORMA'S FREESPACE FAQ. Except MVE2AVI is not doing the job. When I try and convert an MVE to AVI (i.e. fsp INTRO.MVE), the resulting AVI is very distorted. But when using MVE2AVI to play an MVE (i.e. fsp INTRO.MVE -nosave), playback is flawless.
Now I suppose, given all the time I've wasted trying to find a solution on my own I should just download the AVI files. I probably will, too. But I still want to find out why I'm having this problem. If for no other reason then personal satisfaction. My speculation is that the culprit is the ddrw16.dll file. But since it would appear this is a legacy 9x DLL, I don't have a clue what I can do about it. Any suggestions?
FYI, I'm using Windows XP SP2 with DX 9.0c. On my older Win2k (SP4+DX9.0c) box I get the following error dailog no matter what I do.
Caption: Win95 Interplay MVE File Player
Message: DirectDraw Init FAILED