I tested by disabling the network (unchecking "Enable networking" on the
network manager applet in GNOME).  I've also done it by simply
unplugging the network cable.

I used 'su - $USER', using a gnome-terminal session while logged in to
the GNOME desktop.

One incorrect, then one correct, allowed me to log in (using cached 
credentials).
Two incorrect, then one correct, allowed me to log in (again, using cached 
credentials).

Three incorrect, then one correct, did not allow me to log in, giving
the above error.

'sudo -i' gave similar results, although it prompted multiple times for
the password at one invocation rather than simply reporting
'Authentication failure' at the first failed attempt on each invocation.

In both cases, a correct password on the fourth or greater attempt will
display the error.

-- 
likewise-open: allows lockout while disconnected
https://bugs.launchpad.net/bugs/314623
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