After stumbling on this while shooting a few months ago I contacted Nikon support to ask about it. I really thought that it was a bug in the camera operating system. Most often, I shoot in Aperture Priority using available light. I had assumed that Auto ISO would be further down the chain of automatic adjustments in getting proper exposure if I had my flash active - but not so. Auto ISO jacks the ISO up to the max setting in an attempt to get the exposure correct and then the flash will still fire. This is not what I wanted at all. Nikon support said that the camera was acting properly. So, I learned to set the ISO manually whenever I want to use flash - which is not very often.
I am very happy with my D7000's low-light performance and use Auto ISO much of the time. My wife and I shoot horse shows in covered or indoor arenas. Shutter speeds have to be fast enough to capture the action. Flash is not allowed so higher ISO settings are needed. It is possible for me to use Auto ISO with a max usually set at 3200 and expect to get good, properly-exposed, and usable action shots. This is great!