He probably meant Pious Augustus by the main character, seeing as he IS the only character that persists throughout the timeline. But, I think the main character is obviously Alexandra Roivas. It's a cult classic game which only came out on gamecube, but still... didn't sell enough due to poor advertising.
I think the idea is cool, though obviously unlikely. Here is a list of the sanity effects.
http://www.gamefaqs.com/console/gamecube/file/913957/17705
You'll notice that most of those sanity effects aren't exactly Smash Bros material, unless they start liking the whole "Whoops, I decapitated myself bloodily" kind of humor. Also, many of the really cool sanity effects are to the effect of something crazy happening that couldn't happen in normal gameplay, and then things going back in time... which would just disrupt game speed.
So, in short, cool idea. Impractical and unlikely, though.
But, for the sake of tossing random, never-going-to-happen ideas around... what item would be used to initiate effects? A zombie head? If a redead pops up and attacks someone? The higher damage percentage the higher chance of an occurence?