In my experience, if you want to use the iSeries server for password authentication then you set the security exit flag to 1 and you do NOT enter any password information in the OnDemand Admin client. The other thing to be careful with regarding password authentication to the iSeries is that if it uses mixed case passwords, then you must hit the checkbox for mixed case passwords on the OnDemand Admin Client Server Parameters, otherwise you will get errors with logon.
I hope this helps.
Joe