Brian,

>What would be passed to the function?  The containing li?  a jQuery object
>containing the containing li?  The HTML text?

The source is available here:
http://dev.jquery.com/browser/trunk/plugins/autocomplete/jquery.autocomplete
.js

581         function dataToDom() {
582             var num = limitNumberOfItems(data.length);
583             for (var i=0; i < num; i++) {
584                 if (!data[i])
585                     continue;
586                 function highlight(value) {
587                     return value.replace(new RegExp("(" + term + ")",
"gi"), "<strong>$1</strong>");
588                 }
589                 jQuery("<li>").html( options.formatItem 
590                         ? highlight(options.formatItem(data[i].data,
i+1, num))
591                         : highlight(data[i].value) ).appendTo(list);
592             }
593             listItems = list.find("li");
594             if ( options.selectFirst ) {
595                 listItems.eq(0).addClass(CLASSES.ACTIVE);
596                 active = 0;
597             }
598         }

At the moment it runs against li.innerHTML.

-Dan

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