Catastrophic failure in constructor of XMLValidatingReader

I am developing a library (VS 2010, assembly targeted for AnyCPU) and I am getting the following error while stepping over the constructor of XmlValidationReader(..). The parameter for this constructor is an instance of XmlReader(), and the specific XML is syntactically correct, and validates with third party tool.

Error: Catastrophic failure (Exception from HRESULT: 0x8000FFFF (E_UNEXPECTED))

Exception object: System.Runtime.InteropServices.COMException

Stack trace:

System.Security.Policy.PEFileEvidenceFactory.GetLocationEvidence(SafePEFileHandle peFile, SecurityZone& zone, StringHandleOnStack retUrl) at System.Security.Policy.PEFileEvidenceFactory.GenerateLocationEvidence() at System.Security.Policy.PEFileEvidenceFactory.GenerateEvidence(Type evidenceType) at System.Security.Policy.AssemblyEvidenceFactory.GenerateEvidence(Type evidenceType) at System.Security.Policy.Evidence.GetHostEvidenceNoLock(Type type) at System.Security.Policy.Evidence.GetHostEvidence(Type type, Boolean markDelayEvaluatedEvidenceUsed) at System.Security.Policy.AppDomainEvidenceFactory.GenerateEvidence(Type evidenceType) at System.Security.Policy.Evidence.GetHostEvidenceNoLock(Type type) at System.Security.Policy.Evidence.RawEvidenceEnumerator.MoveNext() at System.Security.Policy.Evidence.EvidenceEnumerator.MoveNext() at System.Configuration.ClientConfigPaths.GetEvidenceInfo(AppDomain appDomain, String exePath, String& typeName) at System.Configuration.ClientConfigPaths.GetTypeAndHashSuffix(AppDomain appDomain, String exePath) at System.Configuration.ClientConfigPaths..ctor(String exePath, Boolean includeUserConfig) at System.Configuration.ClientConfigPaths.GetPaths(String exePath, Boolean includeUserConfig) at System.Configuration.ClientConfigurationHost.RequireCompleteInit(IInternalConfigRecord record) at System.Configuration.BaseConfigurationRecord.GetSectionRecursive(String configKey, Boolean getLkg, Boolean checkPermission, Boolean getRuntimeObject, Boolean requestIsHere, Object& result, Object& resultRuntimeObject) at System.Configuration.BaseConfigurationRecord.GetSection(String configKey) at System.Configuration.ConfigurationManager.GetSection(String sectionName) at System.Xml.Schema.XmlSchemaCollection..ctor(XmlNameTable nametable)
at System.Xml.XmlValidatingReaderImpl..ctor(XmlReader reader) at System.Xml.XmlValidatingReader..ctor(XmlReader reader)

I have not changed any security configuration in the system. The specific account under which the assembly is loaded has administrative privileges. Any idea of what could cause this issue? I have run through the web extensively, but in vain.