There's a long standing post on Tink's blog about the lack of support for OSX by Flash Media Encoder (FME). While I initially had little luck getting FME to recognize any connected camera in Parallels I have since noticed (in a proper DOH moment) that USB devices often need enabling separately under Parallels.
The quick and easy fix to get FME running under Parallels is therefore to simply click the little USB icon (see image) and choose the camera you wish to use (for example 'Built-in iSight). Once you've done that you can use your iSight or other chosen camera under Parallels with FME.

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