I think my only issue is framing it the way you did: "You can't be his friend and mine." I remember hearing that sort of thing in elementary school.
It doesn't sound like the wife or the kids did anything disloyal. If you don't feel you want to remain in contact, I'd just explain it nicely--that you don't want to hear anything about his life and don't want him hearing anything about yours, and that under the circumstances, maintaining a friendship with them is too difficult right now.
The way you put it just kind of makes it sound like you're BLAMING her for her husband's continued contact with him. And I don't know that he has many options, either, in terms of being in contact with your ex (and even being pleasant to him), but if you believe he is "reporting" then that's reason enough not to allow him to be in a position where he can do that.
I don't know, maybe you didn't put it in those exact terms to her. And I know you didn't ask anyone's opinion about it, either. But as long as you posted, that's my two cents.