I haven't yet reverted back to SP2 as you suggested SUpER CoP but have made an interesting new finding regarding this problem.
I booted in Safe Mode and tried to format the flash drive. Interestingly, it succeeded! After the format I tried to copy and read files to and from the flash drive and it all worked fine. Then I restarted in Normal mode without ever unplugging the flash drive and was so happy to see that the flash drive was working!
Now comes the sad part... Once I safely removed it and reinserted it in normal mode (not safe mode), I got the disk not formatted error again! :( The size of the disk is shown as 0 bytes and the file system appears to be RAW.
I tried Safe Mode again and was able to access it, nice and good.
I think, it is clear now, that this is not a hardware issue. (I am using an Acer Aspire Netbook, by the way). But if it is a software problem then why didn't it get fixed once I formatted C:\ and re-installed windows?
PS... I did not format my hard disk completely. My D:\ Drive had important data that I want to preserve.
Probably the problem might get solved once I revert to SP2 but I want to keep trying a little while longer with SP3. Thanks for the support guys! You people are great! :)