Jared,
I hadn't encountered this issue personally, but I did a little research on the topic. I found the following bug it looks like you're running into:
NIM068774: When using a Windows 7, 64-bit, machine and ArcReader Version 10, the markup tools, Highlighter and Eraser, will not allow the user to change the color or eraser style when using the toolbar. The cursor disappears when trying to change the color.
There was also a related bug in service pack 3 with the markup tools, but it didn't exactly look like the issue you are running into.
However, I cannot seem to reproduce the issue on my Windows 7 64-bit machine. I tested with ArcReader 10.0 SP0, SP2 and SP4, all worked appropriately.
The workaround is to access these tools from the Tools menu > Markup > Pen / Highlighter / Eraser. Do the tools work for you from here?
I have a few questions for you regarding this issue:
1. What operating system are you using? Do you have the capability to test on a different OS?
2. What service pack for ArcReader are you using? If you don't have SP4, does upgrading make a difference?
3. Does this happen on a different user profile?
4. Does this happen in all pmf's? If you save a blank mxd and create a pmf from it, does the problem occur?
5. Which service pack of ArcGIS Desktop are you using?
I have no doubt that you're running into the bug above, but I'm curious why I don't seem to be having the issue. Maybe the answers to my questions will provide a little insight.
Thanks.