Well, anyone that owns a Live-Enabled game and the game has an updated engine sent out then these users will be connecting via the HDD Flagged XBE. Therefore, they cannot prevent this by checking the Media Type of the XBE otherwise all those games with updated engines will not be allowed to login to the service. This is what leads me to believe the check on xboxdash.xbe. There are other *possibilities* of checks that could be done to prevent this such as Launch Partition, File Name etc.
I'm unsure on how the XBE is actually launched from the gamesave DIR however. Anyhow, it could just check for a default.xbe within the gamesave DIR on boot of the game, if it exists - launch it.
I know this because if you attempt to go live with the outdated XBE it will ask for the update. If you connect with the HDD-Flagged (Updated XBE) - it will not ask for this - even if the gamesave doesn't exist. I assume it detects the difference between the two based upon Version Numbers.
On to your other question. Yes, this is why users had their accounts terminated rather than banned. Anyone who was seen using this Flaw was flagged and terminated. They were flagging people for almost 2 months prior to the actual termination.
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EDIT* Someone might try placing another HDD Flagged *VALID* XBE within the gamesave DIR of a Live game that already has the updated engine downloaded. Rename whichever XBE you have chosen (settings_adoc.xip would be an excellent choice due to it's valid signature and lack of support files) and place it as the default.xbe within this DIR. Boot the retail copy of the game and see if it attempts to launch the default.xbe you have placed there. If it doesn't I need to look into exactly how these updated engines are being launched.
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EDIT2* If they are actually executing the XBE's in this manner, what would prevent one from placing a UXE Bootstrap here and launching your custom dashboard with a live game of your choice?

A setup valid even under the new security measures...