With the cross site scripting reference, I wonder if they are referring to HTML escaped strings passed in via urls? like http://site.name.here/%2E%2E/%2E%2E/%2E%2E/etc/passwd or the like attempting to get past a filter looking at the URL for extra dots in the url. This could be checked and passed along and then get evaluated to a path with ../../../ in the middle of it.

This is the only thing I can think of offhand which would have % in the context of security and cross site scripting. The shell escape character also might be seen to have a similar purpose.