It is a well known problem that applets do not obey the proper z-ordering of HTML elements in the browser. The root cause is that applets are a heavyweight OS-level component and inherently overlay all content underneath them. Flash content can specify wmode="transparent" to attain proper z-ordering support, though there is a performance penalty for doing so. The new Java Plug-In should support a similar parameter though again there might be a performance penalty for doing so.

This RFE is related to 6633275 and it might turn out that the support for that RFE might solve this problem. However it is more likely that the mechanisms in that RFE would need to be adapted in the context of the new plug-in, since it is believed that the browser-side code needs to change to instantiate a windowless plug-in and use alternate mechanisms for drawing. Additionally, it is likely that this support might initially only work on a subset of platforms. It is believed that there is currently no proper support for windowless plugins on X11 platforms in Firefox, although this is being worked on in the plugin-futures Mozilla working group.

This issue was raised recently on the java.net forums:
http://forums.java.net/jive/thread.jspa?threadID=34806&tstart=0
Bora Ertung from NeuroDNA has pointed out that the following Mozilla bug has some good test cases around z-ordering issues of iframes:

https://bugzilla.mozilla.org/show_bug.cgi?id=381550
This is a part of windowless plugin effort, which tracked by 6862869