Symptoms

Nested groups were not resolving. 

Diagnoses

'Resolve Nested Groups' setting not set in WorkSpace 

Resolution 

Set the 'Resolve Nested Groups' option in workspace and restarted the K2 service.

http://help.k2.com/onlinehelp/k2blackpearl/userguide/4.6.5/webframe.html#k2_um_settings.html