LT has to use the "Require e-mail verification when a visitor creates an account" setting from core to make it's decisions, because it leverages the core login block. however, core's idea of email verification and LT's idea of email validation are pretty much polar opposites, which makes this setting very confusing to configure correctly for LT to function properly.
currently, we mirror the setting as 'Set password' in the LT settings, and flip it's display from the core setting, which makes a lot more sense for the way LT works. This however still leaves the core setting at admin/user/settings displayed, which still results in confusion.
all that to say that i think it would be a good idea if we did some form_alter magic at admin/user/settings to remove that checkbox, replace it with a static form value for the setting, and display something like "Control for user set passwords at registration has been moved to the Logintoboggan settings page as the 'Set password' option"