That's a great question. We are required by MLS to change the status of a listing within 24 hours of accepting an offer. There are 2 ways a status can be changed. The first is to go to Under Agreement right off the bat. Most listing agents do not use that option to protect the seller.
The 2nd, and most common, status change is Accpeted offer, accepting back ups.
That notifies everyone that an offer has been accepted (signed by all parties) and the buyer is protected with that contract. Because most offers come with contingencies that can include, but are not limited to, home inspection and financing, there are many reasons the accepted offer does not stay together.
As previously stated, some buyers use the home inspecition as an opportunity to renegotiate the price with the seller. Some homes have so many problems that the buyer makes a decision to withdraw the offer after the inspection. It's also a possibility that the buyer was unable to secure financing to purchase the house.
Until the purchase and sale contract is signed the buyer can get out of the contract fairly easily without penalty. And then, there is "cold feet" as stated by Donna.
The benefit of accepting "back up" offers, is that the back up buyer is in the queue, so to speak, so that if anything does happen to the original offer that it falls apart, they are in line to negotiate a new offer on the property. So, instead of a buyer's agent telling the listing agent, "If anything happens to the deal, let me know. I have an intersted buyer", and maybe getting that call, a firm offer is in place to begin negotiating.
The flip side is that often times the lsiting agent, doing their duty for their client, the seller, will use the back up offer as a way to put pressure on the existing buyer to move forward with the transaction.
So, to answer your questions for this scenario, if the explanation you received is accurate:
1- Yes, it's legit
2- There is nothing being done that is not within the law
3- The reason your offer would be used as a pawn in the exisitng offer is not to neccesarily drive the price up, but to let the existing buyer know that if they do not move forward there is another offer on the table the seller will negotiate with if the buyer backs out. The "take away" is often enough motivation for the buyer to keep moving forward and remove unreasonable demands of the seller.
I am a firm believer that when it's meant to be it will happen. So if that house does not work out for you, there must be a better home waiting for you to come along!
I hope that helps.
Good luck in your search.