I have been having an associated problem.
I am working on migrating an existing Joomla 1.0 site to 1.5 and am using:
Joomla 1.5.6 with Breezing Forms 1.5.1, ARTIO JoomSEF 3.2.0, and Joomfish 2.0RC
When the SEF is switched on, I get either the custom 404 error, or the system 404 error.
So far I have not noticed any problems with the images though. So I suspect it might be another issue.
If I have Joomfish 2.0beta installed, it works fine. The people at Joomfish took a look at it (there was another problem with BreezingForms which they sorted out) say that the problem is with JoomSEF.
By the way, many thanks for the great component. I will update to the paid version, once I have the site working on its final URL.