After 2 solid days of total frustration, I can report the following:
disable-output-escaping does not work when you are doing a tranform
using an XmlReader or XmlWriter.
This makes sense if you think about it. The attribute introduces the ability
to create malformed XML. Use a TextWriter or a simple stream or something. This
works:
>xslt.Transform( xml, args, context.Response.Output, null );
>