As of Patch 22, showing up soon on the test server for the game, the team has decided that "it would be best for the longetivity of the game" to completely reset all server and character data. They also say that there are certain items in game that make it unbalanceable, and so they're just starting over from scratch. There are a few other big fixes coming in the patch, but as they say, this will definitely be the "most talked about" change.
And players are taking it surprisingly well. Over on the forums, most players seem happy that developers are taking major steps to fix the game. The servers will apparently use the Vorringia mapset, and lots of players are happy about that, as it's a popular choice. A few players are unhappy that they're losing everything, but the general consensus seems to be that making the game balanced is more important than keeping individual player data.
Interesting. It's hard to imagine a more major game flipping a reset switch like this and surviving, but maybe Shadowbane will prove it's possible to reboot and keep a core audience that loves the game more than their own assets.