I can tell you, the first thing I would do is FREAK OUT!!!!! In private of course, and only for a moment.
After that, I would take my son aside and gently explain to him that it is TOTALLY inappropriate for him to play without his clothes on, and that it is inappropriate for him to EVER touch another person's private parts, or to have someone else touch his--which would just be a STRONG restatement of things that I have already told him. Of course in the future I would have to modify that statement in later discussions with him, but at his age, IT IS inappropriate for him to be touched or touching someone else. I would probably also brief my husband on the situation and get him to have the "sex" chat with the boy, if he hadn't already. Good luck, and I would do the exact same if it was a girl...
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