Well, it's a done deal, we have spoken to both ds and the "friend". We spoke with ds last night, after she was here, after she said she would take our ds as her "brother". DS seemed unpreturbed and kind of oblivious (he is not a demostrative, or emotional kid by nature). We told him what we felt was inappropriate and asked him how he felt. He said the attention didn't really bother him, but had no objections to our limiting his contact with her. We said he might need to "defriend" her on fb and he said fine. Then he started talking about something else. He seemed completely relaxed.
Dh and I decided that even though these encounters do not appear to have led to anything serious yet, it still needs to be nipped in the bud. As long as we treat her as we always have we are in a way approving of her acting this way toward ds, and we just won't allow it, even having spoken with ds about it. I decided to confront her, but did not know when. For better or worse she could tell I was not acting right and asked me what was wrong. I let her have it and it was just awful. She said she had no inappropriate feelings for ds, but wanted to be someone he could confide in. She said she thought she was being a friend to him. She was very apologetic and remorseful, and acknowledged the inappropriatness of their contacts. I think it especially hit home for her when I asked her how she'd feel if I did the same stuff to her son.
She has removed ds from her friends list and has agreed to only supervised contact. She also displayed a lot of self-pity, which I can't deal with right now. Her dh was not present, how she works this out with him is their business. My regret is how this may effect her kids, and certainly their relationship with mine.
Thank you to everyone that posted here offering me support and advice. I am grateful for all opinions, as I really needed the time to gain some clarity on this issue before acting. I think we did the right thing, even with the necessary losses involved. My mama-bear claws have retracted, but the hurt is deep.

I'm just glad my son is safe.