^The options aren't that advanced. If you happen to have all the files in sub folders then for some reason it can't read them.
The music files have to be in the MUSIC folder that appears on the first folder options screen that you get when you click on the screen (through My Computer route). If you go into the PSP folder and put them in the music folder in there, they won't be read.
Also make sure the volume for the Custom soundtrack is turned up.
I hope that helps, but I'm sure its been discussed elsewhere.