Hmm, it doesn't work for me in r2610 when the server host is an observer.
$ cat ~/.megaglest/lastCustomGamSettings.mgg
Description=Cliff Way
MapFilterIndex=8
Map=cliff_way
Tileset=jungle
TechTree=megapack
DefaultUnits=1
DefaultResources=1
DefaultVictoryConditions=1
FogOfWar=0
AdvancedIndex=1
AllowObservers=1
FlagTypes1=3
EnableObserverModeAtEndGame=1
AiAcceptSwitchTeamPercentChance=100
PathFinderType=0
EnableServerControlledAI=1
NetworkFramePeriod=20
NetworkPauseGameForLaggedClients=1
FactionThisFactionIndex=0
FactionCount=8
FactionControlForIndex0=7
ResourceMultiplierIndex0=5
FactionTeamForIndex0=6
FactionStartLocationForIndex0=0
FactionTypeNameForIndex0=*Observer*
FactionPlayerNameForIndex0=tomreyn
FactionControlForIndex1=4
ResourceMultiplierIndex1=25
FactionTeamForIndex1=0
FactionStartLocationForIndex1=1
FactionTypeNameForIndex1=*Random*
FactionPlayerNameForIndex1=AI1
FactionControlForIndex2=5
ResourceMultiplierIndex2=5
FactionTeamForIndex2=8
FactionStartLocationForIndex2=2
FactionTypeNameForIndex2=*Observer*
FactionPlayerNameForIndex2=tomreyn
FactionControlForIndex3=4
ResourceMultiplierIndex3=25
FactionTeamForIndex3=1
FactionStartLocationForIndex3=3
FactionTypeNameForIndex3=*Random*
FactionPlayerNameForIndex3=AI2
FactionControlForIndex4=4
ResourceMultiplierIndex4=25
FactionTeamForIndex4=2
FactionStartLocationForIndex4=4
FactionTypeNameForIndex4=*Random*
FactionPlayerNameForIndex4=AI3
FactionControlForIndex5=4
ResourceMultiplierIndex5=25
FactionTeamForIndex5=3
FactionStartLocationForIndex5=5
FactionTypeNameForIndex5=*Random*
FactionPlayerNameForIndex5=AI4
FactionControlForIndex6=4
ResourceMultiplierIndex6=25
FactionTeamForIndex6=4
FactionStartLocationForIndex6=6
FactionTypeNameForIndex6=*Random*
FactionPlayerNameForIndex6=AI5
FactionControlForIndex7=4
ResourceMultiplierIndex7=25
FactionTeamForIndex7=5
FactionStartLocationForIndex7=7
FactionTypeNameForIndex7=*Random*
FactionPlayerNameForIndex7=AI6