Looks like the zetacoin-qt.exe ignores the -datadir argument. No matter what folder is provided, the data directory always defaults to the %AppData% folder.
If an invalid folder is provided the client will throw an error as expected, but if a valid folder is provided for the data directory argument, it is ignored.
On my system all data except for debug.log is in directory shown by -datadir.
Weird....
After investigating this further I found that once I created the zetacoin.conf file in the specified data directory, the data directory is being used as expected. However I am still experiencing the issue with the debug.log file being placed in %AppData% folder all alone. Not sure why the zetacoin.conf file makes the difference but it does.