I had my Intellimouse do this for a couple of reasons:
1. A screen printed mousepad, i.e. one that has a printed picture on it, especially if it's printed on plastic, not cloth. Also, a textured mousepad, i.e. the 3M precise mousing surface, WILL NOT WORK. Also some finely textured cloth does not work.
2. There was the slightest amount of fuzz in the LED hole. Use a camera blower to blow it away.