Distribution lists are not persisted for smart groups. On Lion, if you search Address Book help for "distribution list", you will see a page called "Select addresses for group members". Below step 2 is this piece of bad news: "You can't choose smart groups."
Some versions of OS X show smart groups in the Edit Distribution List window, but as of Lion, this is simply the user interface being misleading.
Speaking of Lion, users who use iCloud for contacts will see the Edit Distribution List menu item disabled, because this feature is not yet available with iCloud.
Without some sort of mailing list software, I'm not sure you'll really get the functionality you want.
As a workaround I would try setting up a custom tag, using an existing unused field, or something in Notes, and then creating a Smart Ground around that.
For example, all the contacts you want in your group, put 'mailing list' into their notes. Then create a SmartGroup to show those contacts.
Send the contacts to your friend, and they can import and merge the data. If they setup the same smart group, you should have the same contacts, with the same info, in that group.
The other option would be to stop her importing anything, and just use a Shared Addressbook, and maintain everything there. Google, Exchange, LDAP etc will let you use a remote address book, that isn't automatically synced to your local address book, but all contacts are accessibly, so you can both use that. In the groups page of the address book you'll see your local contacts, and remote contacts as distinct lists. Then, you'll just know to send to everyone in that shared address book.
Best Answer
Send to yourself - some mailers won't send if there's no 'To' recipient
Mail.app actually will, so you could optionally leave the To field blank - though I'd test that your ISP allows it through as well, before relying on that.
Then send to the group as BCC
BCC stands for Blind Carbon Copy, as opposed to CC which is just Carbon Copy
i.e. the recipients are hidden from each other.
Show/hide the BCC field from the View menu, or Cmd ⌘ Opt ⌥ B
Then enter your Group name in the Bcc field; click the drop-menu or hit Enter once it's recognised.
The pref you mentioned - "when sending to a group, show all member addresses" - switches between showing the field as "my Group" or "Fred, Barney, Wilma" etc