I LOL'd when I saw this. Seriously.
Considering that when a kid goes to the beach they see far worse than this (I'll just let your mind go wandering on THAT for a little while...), I am surprised that they boggled so much at Katy.
I wouldn't be surprised if a big chunk of complaining parents don't know what their kid is doing behind their back. Like Kyle's mom in the South Park movie, they're so busy fighting a single pair of boobies that they don't see their kid in the kitchen playing with the kitchen knives.
What cracks me up is that no one on Sesame-side said "Y'know, we may want to try a different outfit because we have some uptight parents that might cry foul". Or after the fact, that Katy wasn't given the opportunity to just reshoot in another outfit..paid or not would probably be up to deliberation depending on how "responsible" Sesame would have been to know if the parents watching would object to her outfit.
Katy's response...I guess it depends on how funny you think it is
She definitely won't be dancin' with Elmo again, that is for sure..unless they have a serious sense of humor about the whole situation.