A default installation of openssh-server-2.3.0p1-4 will not allow sftp 
connections due to an error in the sftd_config file. The following is the 
default:

# Uncomment if you want to enable sftp
Subsystem       sftp    /usr/libexec/openssh/openssh/sftp-server

It should read:

# Uncomment if you want to enable sftp
Subsystem       sftp    /usr/libexec/openssh/sftp-server

(Without the Redundant openssh in the path)

Once corrected and a /etc/rc.d/init.d/sshd restart issued, sftp connection 
work fine.