Wow Sabett.. seriously.
There is no phallus on the pokemon. There's a tuft of hair. If that makes you think it's meant to be a phallus, then you're the one mentally adding the "inappropriate" part. That goes to everyone. If a kid looks at the card and sees a wiener, the kid clearly knows what a wiener is and nothing is inflicted upon his/her psyche. If they're not aware of genitalia, they aren't suddenly going to be scarred by what they see as hair.
Beyond that, the SHAPE you keep screaming about is not anywhere close to a representation of male genitalia. It's a curved triangle. You mentally have to make a big jump to say that it looks like a ding-dong. The LOCATION is sensible, it's a natural transition for a furred animal, as the coat of hair curves around and under the torso. It's not really an anatomically likely place for a reproductive organ, compared to mammals in general. Again, you're only seeing what YOU want to see there.
As far as a lawsuit, that's so ridiculous it's not worth considering. Nintendo isn't pushing sexual themes into the minds of innocent children. At worst, kids are projecting so called "inappropriate" themes onto the Pokemon! There is absolutely no grounds for a lawsuit. Sure, someone could go crazy and try, but hell, anyone can attempt a law suit about anything. "The yellow fill in the text of the Pokemon logo reminds me of the jacket that a childhood bully wore! I'm suing!" That's really not any more ridiculous of a claim, and yet I can't imagine anyone actually suggesting they change the color of the text.
Finally, I repeated your experiment, and took the pictures of both pokemon to my local league. I showed players, parents, kids and adults the pictures and simply asked "What do you think of the new pokemon?" I received tons of responses along the lines of "COOL!" "I WANT THAT ONE!" and "HE LOOKS STRONG!". One player pointed out the palkia-esque designs. Most of the parents simply nodded and smiled, expressing almost no interest at all. The few who are into the franchise asked questions about when the pokemon would come out or what their powers could be.
One mother asked "This hasn't come out yet, right?" to which I replied "No, not till next year". She breathed a sigh of relief and said "Thank God there's time!" after which she pulled out her cell phone and dialed a number. I'm not sure who she was talking to, but I heard "Charles, listen, Nintendo is gearing up to poison the minds of our children with unacceptable sexual imagery! Yes.. uh-huh. Right, if we start the litigation right away, we might be able to stop them! Or alt least make a few million." She hung up the phone, and then shouted "You're all under arrest, the police will be here soon to confiscate this filfth that you call a game!".
Wait, that didn't happen. That whole paragraph was made up. In reality, not a single person mentioned the spot of hair. Not one.
Now, I'll agree with you that the designs in general look a little uninspired, and don't particularly feel like "pokemon" to me. Then again, my idea of a Pokemon is a coconut tree with feet and smiling faces on each of the coconuts, so the "optimally designed super-fighter" pokemon never really were my cup of tea.