I found the bug.

It is NOT the file SYSDM.CPL 4.90.0.3001.
In order for USB drivers to silently install you need these keys, and they do NOT work on the Win98 version of SYSDM.CPL
1. HKLM,System\CurrentControlSet\Services\Class\USB,"SilentInstall",,"1"
2. HKLM,System\CurrentControlSet\Services\Class\USB,"SilentInstallNotify",,"1"
but wait, registry key (2) is the culprit. When that key is removed, the icon bug disappear, but wait, when that key is removed the icon bug is gone and everything installs silently and you don't get the New Hardware Found box that shows the USB drivers installing because everything installs in the background. This only happens when updating the .SYS drivers. USB flash drives devices shows the New Hardware Found box. This is not a bug since the whole purpose is to let drivers detect silently without the users input. If users are using NUSB 3.6, just remove key (2) up above, remove all drivers in safemode.