I added this to my portal.css file:

.DnnModule {z-index:1;}

It fixed the issue for IE8 and IE9 - as well as Firefox 5 and Google Chrome.

However, the problem persists in IE7.

If you have a look at this page with IE7 - the issue appears in the DDR menu I have embedded in the skin.

http://dynamicsvrs.com/Documentation/Variance-Worksheets/Variance-Worksheet-Overview.aspx

Any advice would be appreciated.

I made a demo site in address: http://demo.dotnetnuke.com/saeedalhs/ 
the menu doesn't work fine as it leave a lot of empty spaces between sub menus. More precise, I make a root menu (Goals) and some sub - menus and it works fine, but when I add some sub-sub-menus to one sub-menu, it takes for other sub-menus as much [empty] space as needed to display the added sub-sub-menus. take a look at address above.

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Is the maximum value for z-index is 1000?