The latest bit of FUD spreading around about Android is that you can't ever sell your old Android phone without giving away all your data, secrets, and possibly the recipe for KFC.
Like many things you'll read elsewhere on the Internet, there's a lot of crap attached and presented as fact that is just wrong. Someone needs to explain what exactly is going on here. Allow me to try my best. Hit the break for a read.
Part one -- The FAT file system
Any device -- be it a smartphone, an SDcard, or your computer hard drive -- that's formatted with a FAT file system doesn't really erase data when it says it has erased it. Instead, it tells the system "Hey, go ahead and stick something else on top of that if you need to." But it doesn't actually "erase" anything immediately. Someone with the right computer forensic tools (not just some random dude from Craigslist or eBay) can recover data easily from these types of devices. Ever use one of those programs to recover pictures from an SD card you "erased" before you meant to? We're in the same ballpark here.
In fact, any writable storage will give up its secrets if enough pressure and know-how is applied, but FAT formatting just happens to be easy. That's what is being targeted in this round of scare-mongering, but it just looks better if the word Android is used.
FAT file systems are useful because just about every operating system can read and write to them. Format your SD card with it, and you can swap it to just about any computer or device that it will fit into. Just mount the drive and drag and drop files. This is why SD cards in mobile devices are formatted this way, and why the internal storage in older Android phones is formatted that way as well.
Yes it's true that an enterprising and intelligent person can find "erased" data from them. Since Honeycomb, Android has tended to stop using FAT partitioning and with Ice Cream Sandwich devices can be built with the entire internal storage partitioned without it. The offset is that you'll need to use MTP to access the storage. It's a little trickier (especially if you're not using Windows), but not overly difficult. But keep in mind that most devices that ship with an SDcard slot will expect that card to be formatted as FAT, so this isn't ever going away.
By now you're likely asking "what can we do to fix this?" That's easy to answer -- securely wipe your SDcard or internal storage with a free app. Two minutes of searching the Google Play store found these three, and they should do the job just fine.
Just know that when you tap and use any app like this, there's no turning back. Your data is gone for good, unless you're a very skilled worker in a very expensive forensics lab.
The same thing applies for your Windows computer. If you're using FAT (the default prior to Windows 7 and still in use by some OEMs) you need to wipe things clean before you pass them on to others. The selection of programs that do this for Windows is huge, and a quick Google search will find you exactly what you need.
Part two -- system partitions
We've covered FAT devices, but what about other partitioning systems like the ones used in Windows 7 or iOS or the Android system partitions? Chances are you don't know anybody who could retrieve data that's been erased from the internal system partitions -- even on an older Android phone. But contrary to the stories floating around today, data recovery is certainly possible with just about every device. The issue is that very few folks have the means, or will spend the money, to do it.
Part three -- encryption
While this isn't quite the same as securely wiping your phone clean, it's as good a time as any to talk about encryption. Since Android 2.2, device policy management has existed in Android, and Honeycomb brought a native encryption method. You'll find it in the settings, but be warned it's a one-way street if you want to play with it.
Encryption is what you want to be using if you lose your phone and don't want anyone to access it. It's not really relevant to this discussion except that you could sell an encrypted device and the only thing the buyer can do is erase the whole thing and start fresh. If you choose this route, be sure to tell the buyer that it's encrypted and he or she will have to wipe it all and start over, or just wipe it all yourself.
We don't want to stick our heads in the sand and pretend that this type of data collection and theft isn't possible. We just want to clear up some of the confusion, and point you towards some tools that help fight the FUD.