I'm having a similar sort of problem, however I am running Apache 2.0.59 as my webserver on Windows 2000.
All information I've found on how to properly configure a .htaccess and .htpasswd set has assumed I was running under Linux. How would I have to set this up in order to make it work properly? The password required dialog box pops up, but it acts as though it cannot find the .htpasswd file.
My current .htaccess looks like this: