How would you handle this situation in a fantasy football league?

It sounds like you're the commisioner so as the commissioner, you have an obligation to make sure that everyone is playing fair. I think you did the right thing by blocking the trade and locking the guy's roster. We made it clear to our league in the beginning that we had the right to veto any trades that seemed unfair. The other thing that you can do going forward is open your league up to a voting system for all trades.