This is not a Z-order problem. The problem is that you cannot draw inside the client rectangle of another window. The "Text" window in your case. A window like your form has a WS_CLIPCHILDREN style flag.
I'm not quite sure how a Windows Forms designer can draw selection markers around controls. But when I look at the designer with Spy ++, I see two other invisible windows that are the size of the design area. They are called "OverlayControl" and "AdornerWindow". I assume that the designer is actually drawing pens in one of these windows (possibly OverlayControl) and that the Windows background is transparent.
, . .