Sounds like the option is working correctly. Links in the Favorites
drop-down menu that you haven't used in awhile will be hidden and can be
accessed via the little arrows at the bottom of the menu.
From that options description on IE's Internet Options Advanced tab -
available by right clicking on that entry:
"Keeps your Favorites list clean by hiding links that you haven't used
recently, while still keeping other links easily accessible. You can view
hidden links by clicking the down arrow at the bottom of the Favorites
menu."
If no joy, then delete your Favorites folder - after backing up/exporting
your Favorites first, of course - reboot and it will be recreated as empty,
then import your backed up Favorites file. You'll have to log in with
another Admin. account to delete the Favorites folder.
http://inetexplorer.mvps.org/archive/answers3.htm#favorites