To anyone that comes across this forum post, the explanation of the problem:
In versions 1.0.8.1 and prior (roughly since 1.0.7), in a subdirectory install, the plugin expects two .htaccess files.
For example, if WordPress is installed in public_html/wordpress and is accessed via example.com instead of example.com/wordpress/, the two files expected are:
public_html/.htaccess
public_html/wordpress/.htaccess
So the error message was correct in this case. The second .htaccess file was not there. However, the error message was not very clear, so I will update the error message in the next update.
EDIT: After discussion with jkeegan, instead of adding an error message for if the subdirectory .htaccess file exists, I will just write to the document root .htaccess file. This change will be done for the next version.