Yes they do overbook (constantly, like airlines, its how they make some extra cash) - though they are generous if you are overbooked. This is how the platinum over-ride works for example (i.e. the guaranteed availability with 48hours notice). Marriott.com always seems to offer more rooms than the hotel's front desk is ever willing to let you book as well. So there could certainly be scenarios where marriott.com is saying "I can sell/overbook another 2 rooms" and the FDC is looking and seeing "I have 40 rooms available and 43 reservations" - the point is that the marriott.com is a complex booking system which makes 'bets' on the number of expected cancellations and no-shows, whereas the front desk just don't want to have to walk a guest.

Don't forget that an upgrade to a suite is never a published benefit or a right, and so those rooms weren't really available for upgrade (of course some properties do upgrade to suites etc). Whether this is or isn't the case in your particular scenario is of course a different question - personally if I was checking for an upgrade at 11.30pm I might wonder about whether I should have just paid for the better room - its one of those things for me, I'm sure that it happens all the time!

Edit in my own view I think the fdc probably fibbed as most room bookings are likely to be for basic rooms so the overbooking wouldn't really come into it, but it could be the case, its unfair to always distrust people!