I have disabled all filtering of users and it is still not working. Users are confirmed as friends with each other (my other system administrator). I even went and set all access levels to the plugins and software to public (which I was trying to get away from because this is a private community).

The only other thing I can this of its that I am using sh404sef for Search Engine Friendly URL's and that could be screwing with some of the mechanics of the chat software.