Image Watermark is relatively new plugin. It was released right after WP 3.5 showed up which introduced a significant change in media management. That’s why IW is not compatible with WP 3.4 and earlier WordPress versions.
There are to solutions for you:
1. Upgrade your WordPress install (strongly recommended)
2. Modify that part of IW that is resposible for watermark image selection. If you change that, watermarking and all the options should work properly