I was on a (creative) server building a house when I found this out.
If you place a sugarcane on a block 1 deep and the surrounding blocks are 2 deep it can be placed.
(Pretty confusing.)

The images provide a better description.
If you are to replicate:

1.Minecraft 1.6.2
2. make a 3x3 square in the ground. 1 block deep.
3.Then dig 1 more block deep but leave the middle block.
4. Fill it up with water.
5.Place the sugarcane in the middle.