He shouldn't do - my example shows two null characters been embedded in
a line read with a single call of ReadLine.

Could you give an example of this, bearing mind my earlier example?
Here's another example using the OP's sample data - again, it doesn't
show StreamReader failing with null characters:

using System;
using System.IO;
using System.Text;

class Test
{
   static void Main(string[] args)
   {
       // A B
       byte[] data = { 65, 66, 0x0d, 0x0a, 0,
               0x0c, 0x0d, 0x0a, 67, 68};
       
       using (MemoryStream stream = new MemoryStream(data))
       using (StreamReader reader = new StreamReader(stream))
       {
           string line;
           while ((line=reader.ReadLine()) != null)
           {
               Console.WriteLine ("Next line:");
               for (int i=0; i < line.Length; i++)
               {
                   Console.WriteLine("{0}: {1}", i,
                                     line[i]=='\0'
                                     ? "NUL"
                                     : line[i].ToString());
               }
           }
       }
   }
}

It also means that *you* need to worry about all the nasty issues of
text handling rather than getting the framework to do it.