There seem to be a few glitches in the Arrange/sort model.
You can actually Arrange by and Sort By separately. You can get to the Sort options by holding down the Option key while selecting the Arrangement button.
However, there aren't any sort options when you Arrange by Name. And it doesn't change the sort by option when you switch to Arrange by Name.
Try setting the Arrange by to None. Then, hold down the option key and press the Arrange button. What is it sorted by?