The following template call results in all HTML being stripped from the
result.  Is this normal?

<td><div class="topic_topic"><xsl:value-of select="$TOPIC"/></div></td>

Xsl:value-of copies the stringified value of the selected data
to the output, which flattens it if it was an XML tree, thereby
also stripping everything you think of as "tag".
Use <xsl:copy-of select="$TOPIC"/> instead.