It sounds like the other boy either has been molested or (hopefully, if one of these is right) he's reenacting something he saw on TV or something his parents did. He sounds ashamed of what he did based on his reaction when you tried to talk about it, and his apology, and he wasn't laughing at your son or anything. So it seems like he thought this behavior was okay and then quickly learned that it wasn't.
It concerns me that the other mom accuses you of overreacting, and makes me think she might know something she's not telling you, because if my son did something like this to another kid I'd not only have a very strong reaction myself but would also be 100% supportive of the other mom's reaction. This is not something that should be casually dismissed.
So, what to do? First off, I would talk to all caregivers-- not just the mom-- about this incident. Father, stepfather, mom's boyfriend, super-involved grandparents, etc. I'd also talk to the boy directly and ask if anything has been done to him. He might not tell you depending on how close you are but maybe he will. I'd also not let my son and that kid hang out alone anymore--- only supervised, if at all. Finally, I'd let my own son know that while it's great he said no initially, if someone ignores his no and tries to make him do things like that he should not hesitate to call-- to SCREAM-- for help. Good luck and I'm so sorry this happened!