Hi Jim
yes the PCB has FPGA(Actel) and MCU(AVR) on it, the 1 second blink is generated with the MCU.
the "issue" appeared when i was debugging an FPGA internal signal, I connected that signal to IO (LED2) LED2 indicated that my FPGA was not working properly (it was that big code that takes 99% of that FPGA).
then i connected 1 second blink generated by the Atmel to LED2.
and then i did observe the behaviour as described in the original posting.
and yes, when I finally found the issue, i changed 1 bit in the AVR firmware and then LEDs did work as they are supposed to work, that is signal driving LED2 was no longer have influence on LED1.
Antti