Wellllll... when you request a reference, I think you get what you get. It sounds as though she didn't technically lie, and she also was clear that she would not be giving him a reference. Etiquette wise, I'm inclined to think that it was a bit tacky and the polite response should be have been to tell them that she wasn't able to give them a reference as she had never even met him in person.
I suppose it might depend on who the reference was for?
In a counter example, my mom has a story where a dangerously unstable ex-boyfriend used her as a reference to the Armed Forces (US). This "gentleman" had attempted to hit her with his car, which of course prompted the break up. So quite some time later when she receives this request, she felt obligated to tell them that she thought he was unstable, as it seemed pertinent given his chosen profession. She didn't tell the story to them, but she was honest and left it at that. She used this as her example to us growing up that one should generally always give a good reference when asked, but she did think at times it would be unethical to lie about it.