I've got a client running Terminal Server 2008 R2, connecting from Windows XP terminal services client (not sure of the local RDP version, I think they've got all their service packs though) and whenever they copy text from the terminal server and paste it back on their machine, all they get is 5 Squares (regardless of what they copy or where they copy it from).
I'm debugging this for an application I am responsible for, but I get the same problem from Notepad as I do for my program, so I think it's a server problem (still my problem, eh?).
The option to use clipboard resources is checked.
Double check the updates as suggest by Robin, also ensure you are running Remote Desktop Connection 7.0 on the XP machines (http://www.microsoft.com/download/en/details.aspx?id=20609). There are some major improvements, you can see this KB for details.
This is a known problem.
You have 2 solutions:
try RDP Client 7.0 link
Hotfix for RDP 6.1 link