Can you try setting it to a common drive letter? (H:\Documents) instead of the UNC?

I think there may have been a problem with using a UNC on that dialog, but It's been a while since I've played with it.

You could also use the Policy template (off97nt4.ADM) from the Office Resource Kit.
http://www.microsoft.com/office/ork/download/SetupPol.exe

I have used the above policy and it works well.