I've been playing with wpmu 1.2.5a, and just download 1.3rc3, and I'm having the same problem with both:
1) I add a new blog, say NEWS
2) I go to Site Admin -> Blogs and choose to edit NEWS
3) I set USERS CAN REGISTER to 1
Now when I go to mydomain.com/blog/news and click on register it will ask for username and password, so I enter a new username and a new password, and hit enter, but I get ERROR: WRONG USERNAME.
Am I missing something? Please help!