I have further information that may help track down the source of this
problem. The SML shell script in question consisted of
#!/bin/sh
<MS-DOS exe> <args> 2>/dev/null
When I removed the re-direct of stderr, the problem disappeared!
Inferior SML mode now works again. However, other MS-DOS binaries (such
as texify.exe from MikTeX) still exhibit the problem.
I have also observed that signals do not appear to be working properly
with inferior modes. In particular sending an interrupt signal causes
emacs to respond in the minibuffer with Kill (nnn, 2) failed: operation
not permitted.
Robert Harper