As a member of the Guild of the Wooden Flute (but not a founding member, a latecomer), I can share some of the background. Not too much, or I'll be excommunicated from the Guild...
The NWC developers added the flute partially because they thought that gamers were incredible pack rats, and would carry around a useless object forever, just in case they might need it.
They were right
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Plus, it gave that harper the opportunity to get snarky with you for not knowing the difference between a flute and a harp.
Some folks, however, decided to have some fun with it and started the legends of the flute and its uses.
Some of them combined the legend of the flute with other legends like Vori and the White Goblin.
Some of them got really, really elaborate, inspiring people to think that if there was that much detail, it *must* be true. It wasn't.
All that said, the folks at NWC were gamers, after all, and when they saw the impact that these legends were having on the game, they decided to add some things in there.
That led to the cheese quests in MM8, along with the various storyline pieces that refer to Vori.
It also led to the resurgence of the Holy Flute. If you haven't seen it, go to Lord Brinne's tomb in... Ravenshore, if my memory serves.
Lord Brinne was a gamer who was active in the NWC community among others and when he died, the decision was made by a number of gaming companies to raise tributes to him in upcoming games. That's why his Tomb is there in MM8.
All the NPCs around the casket are members of the 3DO community, and some of them you still see around the various boards. They are indestructible... for the most part
If you approach Lord Brinne's casket and click on it, you will receive the Holy Flute. Use it on your character, and its sweet tones will once again sound out upon the land.
*B*
Minister of Flute Flagellation
Guild of the Wooden Flute
*edit* Hot dog! I looked through that GWF site in the first post, and the members list is still up!
http://www.angelfire.com/ns/flute/members.html
Eight of those folks are around Lord Brinne's casket...