Odd, I just tried with a hidden field mapped to Merchant Reference and it succeeded. Did you set a value on the hidden field? Was it a calculated field or otherwise dynamically populated?
Regarding the transaction declined message, do you get the same error if you put your dev account details into the User ID / User Key fields and try? By test credit card details, I presume you mean something like 4111111111111111 as the credit card number (which is what you need to use in the sandbox). If you do all of that, and still get that error, then you'll need to discuss with DPS.
If it works with your dev account details but not when Sandbox is selected and your dev details in Test ID / Test Key, then let me know because it might be a bug. It works for me, and for Andrew (sponsor), however.
Regarding the notifications, I'm not seeing that here. Can you please export your GF form as XML (under Forms>Import/Export>Export Forms) and email to me? (see my contact page)