The Sandman

[Anderas]

Let them enjoy their win, and walk away with a good feeling... afterwards they may realize they battled the winter successfully and it is summer now, but the next winter is coming.
Like in the north, with Thor and Odin and the Ice Giants. Every year the same story.

[Big Bene]

If it is german tradition or not...

Not German, but Germanic. Don't want to sound teachy here, but I didn't want to give the impression that the sandman legend is German. "Germanic" describes a group of people of a certain type of language, which historically of course also has connections in culture and ethnography. It includes the continental German speaking people, but also Neterlands, English and Skandinavia.
The sandman legend is common to all those people, only some of them have given him a proper name (to be precise, I only know of the Danes).

[TMU]

In Finnish Sandman is Nukkumatti, wich is basically "Sleepmatt" Matti is like a finnish version of Matt

[Daedalus]

I'll leave the story/fluff in more capable hands. My comments are about some mechanics mentioned in the OP.

Special - Hallucinate:
Heroes must roll one red die for each Mind Point and must roll
a 6 on at least 2 dice to break or resist this spell. If the
spell is not broken or resisted, the effected hero will view
his companions as the most abundant enemy currently in view, and
will last until it is broken. The effected hero will not be able
to see his companions as they really are, nor will he be able to
hear anything they say - their voices will be heard as nothing
more than growls and screams. If no enemies are in view when the
spell is cast, it will have no effect.

How does a Hero choose what to attack while under the effects of this spell? If the Heroes match the the most abundant enemy in view, what is to prevent the Hero from simply choosing one of the true, abundant monsters to attack? After all abundant monsters are killed and the spell is still in effect, he can then choose to attack the party tank rather than the most vulnerable Hero. I'd say the Hero must attack another Hero. I'd make it the closest Hero or else randomize.

Special - Dream:
If a hero is asleep, Sandman can cause him to dream any dream
he wishes. The hero must roll one red die for each Mind Point,
and must roll 6 on at least 3 dice to break the spell.
If the Evil Wizard wishes, this dream can be drawn out into full
quests. If not, simply treat as a combat - Sandman and Hero roll
combat dice equal to their respective mind points, though any
damage that would be caused reduces the heroes actual body points.
The hero does not roll attacks against Sandman.

I think the full Quest part of the spell is better seperated and simply inserted into Quests. Who wants to create a Quest that can be nullified by rolling a die? The Mind Point contest looks like the playable Spell Card here.

[Big Bene]

How does a Hero choose what to attack while under the effects of this spell?

When playing a roleplaying-heavy Heroquest with experienced players, you may just tell the hero under effect that he sees his comrades as monsters and expect him to act accordingly.
When playing Heroquest more close to the original, the spell card should specify what he has to do. Thinking of smething like this:
As long he is affected by the hallucination, the hero must always attack the nearest "monster", including the other heroes. If the "monster" has more health points or more attack dice than he has, he may decide not to attack, but he cannot choose to attack another monster instead. For the other heroes, health and attack dice are counted as if they were the monsters the affected hero sees.

Perhaps, there should be two versions of the spell for the EWP to choose.

[torilen]

Daedalus - both very good points. I would/will probably go with Bene's solution,
and add in the extra direction to ensure that the idea plays out the way it is supposed to.
As he said, when playing a full role-playing game, a GM would simply tell the players how
the effects work and they would play it out properly. With HQ, this might not happen.

As for making a quest that can be nullified with a die roll? I typically don't have a problem
with that. As a GM with a full rpg background, one kind of expects that some plans will just
go unused, or that they may have to be rewritten just a bit and recycled for a future plot.

Making HQ quests are fairly easy, though, especially if you make use of HeroScribe. I can't
imagine an Evil Wizard getting all that upset that a quest goes unused in the present. Again,
it can be recycled for the future, perhaps.

Besides this - every quest created can be used by someone at some point, if it is posted here,
and the creative juices that flow always yield good ideas for Evil Wizards and players alike.
I quite enjoy creating just for the sake of creation. I understand not everyone does, and that is
okay.

[Big Bene]

I have worked the descirption a bit:
Special - Hallucinate:
Heroes must roll one red die for each Mind Point every turn and must roll a 6 on at least 2 dice to break or resist this spell. Until the spell is broken or resisted, the effected hero will view his companions as the most abundant enemy currently in view. He will not be able to see his companions as they really are, nor will he be able to hear anything they say - their voices will be heard as nothing more than growls and screams. If no enemies are in view when the spell is cast, it will have no effect.
As long he hallucinates, the hero must always attack the nearest "monster", including the other heroes. This may mean he has to walk to this moster before attacking. The spell only affects the sensual impressions of the hero, it doesn't make him sucidal, so if the nearest "monster" has more health points or more attack dice than he has, he may decide not to attack - but he cannot choose to attack another monster instead. The other heroes' health and attack dice are counted as if they were the monsters the affected hero sees.

Would just barely fit on a spell card with 9pt font size...