Re: No 404, Just Shows
Pierce2-
Yes, that is true. A bogus url should trigger the 404.php file in your theme directory.
I think jjj is correct in thinking that this has something to do with the subdirectory install.
From the link that you PMed me, it appears that for your production site, you will be doing a root-level, and not a subdirectory WPMU install. If that is the case, this issue will not be relevant and is just taking time away from your development. You should be prototyping using the same directory structure in your dev environment as in your production environment.