I see over on xbox live they have a thread with eveyrone posting what drives do and don't work. It gets a bit wordy.
To my understanding, the basic requirements are ...
USB 2.0 compliant
1024MB free space minimum.
I think the problem a lot of people are having is when they they buy cheapy "1GB" USB drives that actually do not have 1024MB storage. I could be wrong. I'll take a look at the xbox.com forum later.