Hey Josh,
I think the problem is the Allow Simple Password option. I think you'll need to turn that off. Our settings are like this:
Require password is on
Allow simple password is on
Number of failed attempts allowed is set to 4
Minimum password length is set to 4
Time without user input before password must be re-entered is set to 60 minutes
Everything else is unchecked. (This is in the Default ActiveSync Policy Properties > Password tab.)
We originally were using long alphanumeric passwords. The problem was that users hated the qwerty keyboard that the iPhone used to enter these and the iPhone didn't honor the setting to require a alphanumeric password. This meant that lots of users had a long, bad password (e.g., qqqqqq). Version 2.1 of the firmware introduced the ability to wipe the phone after too many failed attempts. We decided that we'd take advantage of that (it was already on for other Windows Mobile PDAs), reduce it to only four attempts and switch to a numeric four digit password. Since a four digit password means that the iPhone will use the 12-key dial pad, we felt that users were now more likely to have a good, albeit short, password.
The only downside is that the iPhone doesn't have a mechanism like the BlackBerry for avoiding the kid problem: if you - or a two year old!- type the password wrong four times, the phone gets wiped. It's been a small downside though.
I believe that firmware 2.2 introduced the ability to have long numeric passwords that still use the 12-key dial pad. However, we decided to stick with the four digit password for now.
Let me know if you've got any other questions. We've got over 1000 iPhones connected to Exchange, so we're fairly familiar with their quirks.
Regards,
fh