Okay, first off, the article has a follow-up posted at the top of it saying they made a mistake and were corrected. But for the interest of people who would rather read comments than articles, here's what I've been telling everyone on Facebook who keeps passing around this foolishness:
First off, the claim that Facebook is allowing 3rd party advertisers to use people's photos isn't quite the case. In fact, Facebook Terms of Service (http://www.facebook.com/terms.php) state (section 10.2) "We do not give your content to advertisers."
Yes, Facebook may pair up your name and profile photo with an ad that gets sent to your friends, and yes, that can be blocked with the option mentioned in the message going around (Settings->Privacy->"News Feed and Wall"->"Facebook Ads" and select "No One" - or this link might work to get you there faster, since I'm feeling useful http://www.facebook.com/privacy/?view=feeds&tab=ads
This is not, however, 3rd party advertisers using your photo. Section 15 of the advertising guidelines for Facebook (http://www.facebook.com/ad_guidelines.php) state that an ad won't even be accepted if the advertiser is using photos for which they don't own copyright.
Now for the useful:
A Facebook application that has not been authorized by you or a friend cannot access any information about you other than what's in your public search listing. This means, though, that if you have a public search listing displaying your photo, an unscrupulous advertiser could get your profile photo.
Any application your friends have authorized may be able to access any information about you (on behalf of your friend) that your friend can access. To limit what the applications can see, go to Settings->Privacy->Applications and go to the Settings tab (or have another link http://www.facebook.com/privacy/?view=platform&tab=other
pointed out what more likely happened and downloadsquad corrected their position.
And apparently, as jdigital noted already, even the official facebook blog says that's what happened. So yeah, if you've posted stuff online, somebody may take it and abuse it.. but no, it wasn't Facebook's doing in this case. RTF....Retraction?