I honestly have never heard of that supposed bug in the game- i don't believe it to be true.
The Sea Dragon is located between Lyp and Shikk, and you have to use Zig's
boat to get to him. Go northeast out of Lyp(wait for a SW wind). When you pass the cove (it is on an island and has a lake with a big rock and a ship coming out of it), you should see lighter blue water with an L-shaped rock formation next to it. Search(use triangle) near the bottom of the L and you will wind up on an island. This is where the dragon is.