Using Joomla 2.5
VM 2.6
Template Transform

Zoom effect work properly; however all thumbnails are grossly distorted. They appear to be correct in the resize folder.

hmm, that sounds weird.

Within our Flexible Zoom Effect pictures are taken from VM image folder without re-sizing them. Maybe another CSS rule (that comes from your Joomla Template) is forcing thumbnails to have a fixed size? I can't be sure.

Provide me URL where i can see it, and then let me see the source codes. Without seeing, i can't provide you any solution about it.

regards.
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