Reference - Laws of Duplicate Bridge 2007
In a tournament the correct procedure is to summon The Director (Law 9B):
After Attention Is Drawn to an Irregularity
- (a) The Director should be summoned at once when attention is drawn to an irregularity.
(b) Any player, including dummy, may summon the Director after
attention has been drawn to an irregularity.
(c) Summoning the Director does not cause a player to forfeit any
rights to which he might otherwise be entitled.
(d) The fact that a player draws attention to an irregularity
committed by his side does not affect the rights of the opponents.
- No player shall take any action until the Director has explained all matters in regard to rectification.
The Director (rather than the players) take the appropriate steps to rectify the situation. Laws 61-64 cover revokes (failure to follow suit) and the steps The Director may take to rectify the situation.
If you're playing informally, you'll have to sort the situation out yourselves. I'd suggest following Laws 61-64. In the situation you described the following would happen:
East withdraws his card (if East is defending it becomes a Major Penalty Card), East now plays a legal card.
You (South) may withdraw your card and play a different (legal) card.
Penalty cards are covered under Law 50. There are various restrictions imposed on you (and potentially your partner) when you have a penalty card.