I have the same problem audriusme had, except that blogs.php is in the right place.
If I use Firebug to edit the <img/> tags to add “wp-content” to the @src attribute, then everything works just as it should.
I’m running on WPMU 2.9.1.1 and I just upgraded BP from 1.1.something to 1.2.1. In fact, since it wasn’t working, I also deactivated everything again and deleted BuddyPress altogether from the server and then did a manual install, just to be sure it wasn’t a problem with the upgrading process.
I’ve searched both the BuddyPress forums and the WordPress forums for hours and it seems that all the other references to group avatars is “almost” similar to my problem, but not quite the same… until I saw audriusme’s post above about the missing “wp-content” in his <img/> tags. That’s exactly my problem.
