From Esri Support:
This is a known bug introduced with service pack 3:
Known Bug ID
[#NIM074479 Mark up tools (Red Line tool) no longer work after installing SP3 for ArcReader 10. ]
Workarounds are:
1. Uninstalling SP3
2. When service pack 3 is installed go to Tools > Markup, then choose the color. This will allow you to change the color and use the markup tools. You will notice buggy behavior with this workaround. As this may not be the most feasible workaround, I still recommend uninstalling the service packs.