I originally logged an LJ support request here.
There are other "similar" requests pending here and here. Although they may be different types of phones.
After further investigation, it appears to be a problem with the way fotobilder processes the images.
Using scrapbook to rotate an image generates the following message
"error instantiating image from scalarref: Exception 425: Corrupt JPEG data: 158 extraneous bytes before marker 0xd9"
I'm guessing that the same image processing objects are reused in vaious parts of the system - generating thumbnails, scaled views and the like, and that because of the unexpected data the code doesn't work.
A sample of one such image is http://pics.livejournal.com/loom/pic/000093z5/