Well my this issue is resolved, tnx to redhat knowledgebase article FAQ_81_2471.shtm.html.
However, there is a small problem now. If i do not check "My server requires authentication" in Outgoing mail server , in OE, I can still send a mail and the sendmail server dosen't tell OE user that "authentication" needs to be checked. But if i check this option then everything works fine i.e. user cannot send mail with wrong password.