To quote IGN:
"The version for the Apple devices seems to be a very, very rushed conversion of the open source emulator that's been made available to the public domain. The controls use a virtual D-pad that appears anywhere the player rests his thumb, with action buttons firmly located on the left side of the screen."
http://wireless.ign.com/articles/980/980678p1.html
Now that wording is pretty unclear, and I can't seem to find anything else about it, but it sounds to me like it very well could have been released to the public in a similar way to how id makes a habit of releasing their source code to the public several years after the games cease to be profitable. I'm not sure, as I can't find any definitive and clearly worded evidence either way.
EDIT: ok, so on a little more digging, it appears that you are both partially right. According to the Wikipedia entry to the developer (Manomio LLC), the app is just a port of an open source engine that will run flashback called REminiscence. As such, the initial app download is just over a meg. However, when you first launch the app, it then downloads about 3 megs of game data that is not in the public domain, and is essentially being pirated. Hence, it snuck into the app store because the app itself is not illegal, and apple probably didnt examine it too closely, but in my opinion it is much worse than simply downloading an 18 year old game by a now defunct company, because all Manomio did was port the code for an emulator and start charging for it. BOOOOOOOO!