Run the System Analyze function of the latest (1.1.3) version of TechTool
. Hopefully, it will report back as "No Trouble Found." Now go to the Keyboard control panel and check the "Use Command-Option-Space bar..." option. Then return to TechTool and run System Analyze again. It will now report that the System file is damaged (at least it did for me and for Tony Aguila, who first reported this).
Update: This problem appears to be limited just to Mac OS 7.6.