Okay, let's clear up a few things.
1) It's not an unusual practice to create a development database and then copy or move it to another environment. What I've done in the past is detach the database, copy the data files, and then attached at the new location. This is the sort of thing he's trying to do and it tends to be a lot faster than using wizards to script out all the database objects, all the data, etc., and apply them to a different location. A LOT faster. The same is true of this method versus backup/restore. The detach, copy, attach tends to be faster than that, too. In fact, Andy Warren has an article about moving databases in this fashion because it is so much faster.
2) NTFS - New Technology File System. It is one of two file systems Windows 2000/XP/2003 natively support for hard drives (the other is FAT and its variants). By default, all drives should be NTFS because of the security and integrity features. This has nothing to do with an Active Directory domain controller, which is what I think you mean. NTFS is what allows permissions at the file system level. Operating systems like FAT and FAT32 do not.
3) SQL Server does not control the folder any more than IIS controls C:\Inetpub. SQL Server isn't altering the permissions on the folder. In fact, it is ignoring them. SQL Server is breaking inheritance from the folder to the files and setting its own permissions on the files. And that's the issue.
Maybe the following links will clarify things:
K. Brian Kelley