It could easily be "zrozumiałem" as well. "Nie rozumiałem" sounds like "I wasn't understanding", which suggests that he was talking either in a very complicated way (difficult topic, perhaps?) or perhaps that he was simply mumbling. "Nie zrozumiałem" sounds more like "I didn't understand his message, what he meant".
Not necessarily. Perfective/imperfective in Polish doesn't directly translate to simple past tense vs. past continuous in English. The understanding is based on context, not A to A translation.
English doesn't use perfective/imperfective aspect verbs, and Polish doesn't use past continuous, past perfect, pluperfect, etc.
But the interpunction is not considered by the system when accepting answers. The thing is that "what was he saying" is wrong in English in this context. If it was a question of its own, it would of course be the only right answer. But in "I did not understand, what... you need to get back to the declarative word order, "I did not know what he was saying."