Thanks for the info, however the problem is a little different from the solutions that were mentioned.
I did call Sony Support and they said they never heard of such a problem. After 20+ minutes of the Sony gurus debating it, they came up with the most likely cause. They say it’s probably some sort of conflict in the registry that interferes with the storage of Smart Capture images, and trying to pin it down would take just about forever. They logged it as something to work on when they come out with a newer version (>1.2). There only current fix was to do a complete recovery of the hard drive, which is what another TR World member came up with. If anybody wants to talk to Sony about this problem in the future, mention Event Number: E25944914.
Since I have a recovery DVD, I uninstalled and reinstalled both Network Smart Capture and Smart Capture Library without success.
Ok, now I finally gave in and did the complete hard drive recovery. Yes it worked, only cost me more hours then I care to admit too just to get a little program working. :?