This sounds like a trojan I encountered on a clients computer recently,
called "Smitfraud" or "pcguard"
the display settings were greyed out just as you describe.
I downloaded a registry file that fixed the display settings.
This page has some info on removal:
http://www.geekstogo.com/forum/malware_problem_pc_guard_intel32exe-t48870.html
 or search for "smitfraud" and you will find the fix.

----- Original Message -----
From: "Phillip Williams" <[log in to unmask]>
To: <[log in to unmask]>
Sent: Wednesday, August 03, 2005 8:24 PM
Subject: [PCBUILD] missing desktop


> Recently, my brothers pc has aquired this message in place of his  desktop
> background, "WARNING! a virus has been detected on your machine. Your
> system
> has been disabled. Please run anti-virus or adware software before using
> the
> system." This may not be the exact wording but tou get the idea. All other
>> .
> He's running xp sp1 with Avast and Spybot. And I loaded and ran
> Hijackthis
> but could find nothing listed which "seemed" related to the desktop.
> Avast or
> Spybot had several entries in system restore but deleting didn't  help.
> If I go to desktop properties the background options are all  "greyed-out"
>

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