I thought that was supposed to be the goal of every teacher of anything: for their students to eventually surpass them. Same with parents - it's a sentiment I've heard my dad express more than once when one of his kids did something well.
"And should I ever reach a point where I can no longer push the envelope of my own development I will step aside and pass the torch on."
How does a person 'pass the torch on' other than by teaching?
Of course one would hope teachers would keep developing as students as well, but it's hardly a failure as a teacher to be a better teacher than you are a student.
The only dilemma I see here is whether or not the teacher is giving ranks he isn't qualified to give. But if he doesn't belong to an organisation with rules about how ranks are given, then it's sort of up to him to do what he thinks is best. Maybe he thinks this student is better than him and this is his way of handling it. Without knowing the personal motives and details it's hard for an outsider to judge if it's right or wrong.
In any case I can't really see what it has to do with the poster, who isn't even a student there. It kind of gives the impression that he has a bad history with this guy and is looking for excuses to think badly of the guy or even to spread bad feeling among his current students. My advice would be to move on and stop thinking about what's going on in this dojo - it serves no positive purpose. Find another dojo if possible but in any case, don't keep looking back at this one.