I've spent some more time understanding the problem and solution now.
The Turtle Beach Santa Cruz has Left and Right and Front and Back "mixers" within its driver software.
The "default" setting focuses the Speaker Output on the "Rear" as if your sitting in a room and wanted to hear only the sound coming from the rear of you. It has sliders for "shifting" this in 4 speaker mode from Left to Right and Back to Front. When pushed to the extreme range of Back in 4 speaker mode. the ATI AIW USB2.0 goes silent.. and as your doing it... it "fades" out.
But when you push the control slider to the Front.. the sound "fades" back in.
The Speaker Modes basically manipulate with a two speaker system this same 4 speaker "grid space". Defaulting to this "Speakers Rear" only and hence it does not playback the ATI AIW USB2.0 sound at all. Setting speaker mode to "Speaker Front" snaps it back on.
Setting Speaker mode to 4 speaker, in addition to a L/R slider control, pops up a new B/F slider control on screen.. and you can fade it out and back in again by pushing the slider to the extremes.
I don't know synthetic 3D sound apetures.. but I do know this was invented for Gamers to simulate a 3D experience. It seems its a "feature" that was put in on purpose.
So its not "incompatible" its an unfortunate "interaction" with the video capture device and its output.
The output of the video capture device is "mixed" and the output is filtering sound input from the "front" and the "back" sources. It defaults to sources is "deems Rear" and filters out sources it thinks are in the "front" by default.
Figuring this out.. simplest guideline is leave it in 4 Speaker Mode and keep the mix in the "center" of the B/F slider and it mixes a little from the Front and Rear "sources" so the ATI doesn't completely go "silent".
The Sound Card mixer also has a "Reset to defaults" button.. doing that flips it back to "Speaker Rear" or "only display (allow sound) from rear sources to make it into the Output".
Its starting to "make sense" if annoying in the extreme.
Turtle Beach "should have" made the default [Speaker Mode: 4 Speaker] not [Speaker Mode: Headphones Rear (only)] that blocks all source sounds it thinks are coming from the front.. even if they are a synthetic source from a playback.
I know this doesn't happen with all video capture devices.. someplace, probably the registry there is a way of "hinting" or designating the new usb audio playback device as a "Rear" sound source to the sound card 3D mixer.. but I don't know how.. its something to investigate.. if possible. It might be a query to the device driver itself.. and if it doesn't answer.. the sound card may assume its a front sound source and filter it out by default.
Regarding the CDROM ISO images, yes I have both the -100 and the -200, from recent experience I knew which one to use with XP SP3 and it worked without error.. except the sound was silent. It isn't silent anymore.
I now understand its a filtering "feature" of the 3D experience the sound card is capable of synthesizing.
Update:
Also found by watching when I switch between [Headphones Rear] and [Headphones Front] it changes the diagram of the back of the card.
Headphones Rear : moves the "word" Headphones down to the "Black 3/4" jack.. if I plug my speakers or heaphones into that.. the sound "reappears".. its not a problem.
Headphones Front: moves the "word" Headphones up to the "Red 1/2" jack.. if I plug my speakers or headphones into that.. the sound "reappears".. its not a problem.
In these modes the opposite jack without the "word" Headphones.. the AIW ATI USB2.0 sound is gone.
Update2:
Performed a test capture with the "Headphones Rear" setting and it captured sound, no problem.
I assume it will do the same with the "Headphones Front" setting.
I no longer think this is a barrier to capturing sound, but
VirtualDub has no menu options for manipulating the playback sound card mixer settings.. so moving your headphones or speakers so you can listen is the only choice.. or using the sound card mixer and setting it so that its running in 4 speaker mode and B/F is centered so that neither is filtered out of the actual playback.
In my case with the Turtle Beach Santa Cruz.. I just have to be aware that I should always plug my headphones or default speaker set into the "Black" jack so that "when" the card defaults to "Speakers Rear" will produce sound from the ATI AIW USB2.0 by default.
I now feel silly and stupid because "if" this were better documented it would have been intuitive and obvious.. but I missed understanding what a "default" cabling of the sound card should be setup for.
But I still feel they should have defaulted to 4 Speaker mode, for stupid people like me.