openssh3.7 and above have different behavior with respect to pam when connecting from an ssh-2 or ssh-1 client. When connection comes from ssh-2 client, the server calls the appropriate pam modules and authenticates fine. When a connection comes from ssh-1 client, it does not. (auth failed). This worked in 3.6.1p1 for what it's worth (no difference in behavior)
Created attachment 428 [details] ssh-1 client connect - fails auth (same user)
Created attachment 429 [details] ssh2 client connect - pam session works (debug3)
Could you send a "ssh -1v" trace from the client?
The debugging for the SSHv1 shows it only trying password authentication when it should be using ChallengeResponse (aka TIS). Can you try with "PasswordAuthentication=no" in sshd_config (as well as attaching the ssh -1v trace djm asked for)?
4 months no reply == closed bug.
Mass change of RESOLVED bugs to CLOSED