In System Settings I have selected - Disable convert lead action for converted leads. When I go to a lead and select Convert Lead it takes me to the page and gives me a warning but the action is not disabled. It that the way it is supposed to work?
No.
The disable convert lead action for Converted Lead will remove the ‘Convert Lead’ option for CONVERTED leads. If you have not converted the lead yet, there should be no restriction and it should allow you to convert.