It took 3 days of work and a cram course in Cruise-O-Matic design but I am pretty sure I found the problem. The Ford shop manual and Bob Mannel's analysis of Ford and Transgo shift kits were my main source materials. http://www.fordsmallblock.com/PDF/289-HiPo-C4.pdf
History: Engine came out in January for +20 overhaul. C4 overhauled at the same time with shift kit added. Both back in car in May but didn't get engine started until 9 July. With everything else in the world to do there are only 118 miles on the car since then.
Two weeks after the first start we had enough parts back on to take her on public roads: a trip to visit a friend 13 miles away mostly on high speed arterials and I-40. At the higher speeds nothing was noted to be really wrong but then, as with any major work, our attention was likely focused elsewhere. We were happy it was again drivable.
We live in a hilly neighborhood, 6-8 percent grades, so my 'local' testing of a few miles at a time is at low speed and up/down considerable slopes. This indicated something truly not right. Most low throttle shifts from 2-3 were as if a sledge hammer hit the driveshaft. More than crisp: BANG.
At 40-50 MPH streets and then later on 25 MPH city streets I noticed that the 2-3 shifts with more throttle were actually two 'shifts' and not one. The direct clutch would engage but then the engine struggled slightly and then something would later 'release' (the intermediate band) and the engine recovered somewhat. Even at other times it almost seemed that something was dragging in the C4. The engine never had a problem overcoming it but it just didn't seem right.
Tuesday I drained and removed the C4 pan. Fluid a little dark but murky and smelled half burnt. Enough friction material detritus in the pan to think I had driven 20k miles not 100. This confirmed something truly wrong. I have done maybe 5 C4s and the only thing really different this time was the shift kit. Not knowing where else to start I removed the 4 shift kit springs leaving an 'anti-balloning' plug in a converter passageway and the single valve body plate hole that was now .067" instead of .047. Removing the shift kit springs is easy; no reason to take the valve body apart except for the 3 valves with the changed springs. After spring removal it was only a 2 pound hammer hitting the driveshaft on 2-3. Better, but certain to destroy the U-joints eventually if nothing else.
By now I was convinced something dire was causing the intermediate band to not disengage - but what? It may have even been dragging while driving about not just at shift time. Bad servo? Was the oversized shift kit hole causing some of this? Yesterday I pulled the pan and valve body again. Performed air pressure checks on all the clutches, bands, governor, etc. I had done those before assembly and all checked out good then and still did. The intermediate band was free to move. It had to be the something in the valve body! The valve body came apart and I searched for problems. Did I put it together wrong? I analyzed the passageways (not easy) and determined that the hole I drilled is shown in the '66 shop manual on page 7-21. Near the center of the page, just to the left of the words "Throttle Modulator Valve" there is a narrowed portion drawn in one of the vertical passageways. That narrowing is the small hole in the plate that Transgo has you drill. It restricts flow between the Manual Valve (gear shift position) and the 2-3 Shift Valve. This will only make it shift sooner and has nothing to do with what happens AFTER it decides to shift. So, good, it has NOTHING to do with the shift kit.