I had the same thing happen to me; I had a paid first class ticket and wanted to go standby, but the gate agent upgraded a coach passenger and then offered me a coach seat. I refused.

AA's customer service gave me some compensation for that and apologized. I don't think that what happened to me was the correct procedure (and I think that AA admitted that it was not correct when it offered compensation to me).

There is another thread on FT about this situation (late November) and I believe that some posters said that the agent is using an incorrect PALL code or something if s/he processes upgrades for coach passengers before clearing FC standbys.