There is no section 3.2.1 in html-spec.txt.  I suppose it's:
Undeclared Markup Error Handling
To facilitate experimentation and  interoperability  between
implementations  of  various versions of HTML, the installed
base of HTML user agents supports a superset of the HTML 2.0
language  by reducing it to HTML 2.0:  markup in the form of
a start-tag or  end-tag  whose  generic  identifier  is  not
declared  is  mapped  to nothing during tokenization.  Unde-
clared  attributes  are  treated  similarly.    The   entire
attribute  specification  of an unknown attribute (i.e., the
unknown attribute and its value, if any) should be  ignored.
On  the other hand, references to undeclared entities should
be treated as data characters.
This says nothing about numeric charrefs nor should it.  As we have
already discussed, numeric charrefs that are not in the document 
character set are simply invalid, and with ordinary SGML tools that 
respect the document character set, they're not found in the output
of the parse. 
|   On the other hand, references to undeclared entities
| + and numeric character references which cannot be resolved
| + (e.g., are out of range)
|   should be treated as data characters.
| 
| The +ed lines are added words, no deletions.
And are not what we want to say here.  The language about 
numeric charrefs has been carefully crafted.  It will be
revised in the next version of HTML that appears after an
internationalization proposal is agreed upon (Gavin, time to
get a move on).  At that point we can discuss what "out of
range" might mean.  I strongly urge we stay with the 
present language here, much as I feel your pain.
-- Terry Allen (terry@ora.com) O'Reilly & Associates, Inc. Editor, Digital Media Group 101 Morris St. Sebastopol, Calif., 95472 occasional column at: http://gnn.com/meta/imedia/webworks/allen/A Davenport Group sponsor. For information on the Davenport Group see ftp://ftp.ora.com/pub/davenport/README.html or http://www.ora.com/davenport/README.html