Hiring someone based on whether or not they know a particular algorithm that may or may not have any business relevance to their work, speaks to the process. Obviously the candidate was in the wrong here, but I question what this sort of teaser question actually buys you.

Experience and depth are varied. If you happen to ask a niche question where someone has a lot of depth, then you've identified perhaps deep knowledge on that narrow topic, but what about general problem solving and programming skills?