Needless to say it is completely unplayable. I can't even click the menu items because the clickable area is lost in the blue box.
Running in compatibility mode and running as administrator also makes no difference.
If anyone has any suggestions, I'd really appreciate it.
For anyone interested, I managed to fix this problem by doing the following things. I'm not sure if one or all of these things fixed the issue, so I'll list them all.
1. I renamed ddraw.dll in the Arcanum folder
2. I installed directx 9.0c
3. I added the -doublebuffer parameter to the shortcut.
Steps 1 and 2 also fixed a problem where the -window parameter would crash the game.