The fact that it works for CD suggests that the DC-1 input is OK but that it may not be getting the signals it needs from the other sources. What does BYPASS do? The downloadable manual doesn't say.
A two channel DAC will NOT decode a multichannel signal, which is in a different format.
The data stream from your player is in the two channel CD format for CDs, and other codecs for other types of disc.
You would need a receiver with digital inputs (which can recognize and decode those non-two channel codecs)
OR, a BluRay or DVD player which will change the multi channel coding into the two channel code and THEN output it to the two channel DAC. (My Technics DVD-A10 player does this via a menu in the player)
Since you are apparently only using a stereo signal Elizabeth is correct. If your going to use the coaxial or Toslink inputs on the Lex, you need to set the Bluray player to mix down the hi res signal to PCM stereo. You will probably get better sound out of the RCA outs though because the Toslink connector will not pass hi res audio and the analog outs will or a least your player will decode the hi res signal and output them through the RCA outs.
OK going back to "bypass" I would then bet the 'bypass' is for music, allowing all the video stuff etc to be bypassed. Well, I then guess 'bypass' is two channel, and for only stereo in your unit? Then it also probably only allows a PCM (two channel) digital input signal. Probably you need to NOT use the bypass! to allow the multichannel signal to be processed. It is most likely a design in the Lexicon logic system Lexicon does not want to/can't fix.
I would think they feel if you want multichannel, you would not use the bypass (which was probably designed for a pure two channel use?)
This is all conjecture, as I do not know your Lexicon device. But from what has been said, and other products with bypass features.. this is what it seems to be.
As I said, the TOSlink input is working and should be able to handle DD, dts and regular PCM/stereo. Since it is not, I would suspect that the sources are not set up properly. If they have HDMI outputs, they probably default to sending the audio to HDMI and not to the digital coax/TOSlink outputs. Check the setups for the BR player audio and the cable box.