This is a huge headache that only recently became one.
Two enforcement actions by Google create most of the problems. By addressing their "link issue," Google has been eliminating the PR push from link structures known to be for sale. This one affects you if you bought links and the seller's links became worthless. You might slide in the ranks, but no problem, really.
But additionally, Google tries to identify "bad neighborhoods" and either supporting one, or being seen as part of one will create a hole in your ranks. If you have lots of those pointing home, your ranks may be nonexistent.
So you've got to assign someone to periodically vet the inbounds. You can download your list from Webmaster Tools and run them through a tool like: bad neighborhoods link checker
A lot of previously uncorrupted web space has become toxic due to enforcement protocols that require sites to avoid certain industries. We all know the bad stuff - porn, gambling, Viagra - but what you don't realize is that WITHIN these markets, a different standard exists. A porn/casino site is not toxic to another porn/casino site, and their search for link structures is in direct conflict with the censor mentality at Google. So a directory that permits a couple of porn/casino sites in will eventually become completely toxic as other sites discover the link platform. Removal is the only responsible, preemptive action.
There are 3 new requirements on link purchases.
-1- They must be vetted for bad neighborhood association BEFORE the links get posted.
-2- They must be REMOVABLE.
-3- They must NEVER point to the homepage.
Being penalized for bad inbounds is a reality for everyone, even if you have no paid links, but especially if you do. We have encountered too many sites with huge numbers of bad links pointing to the index page - and every one of them must be removed before the site is free from either the penalty, or the vulnerability to one. What we find is that most of the identified bad links are probably NOT the trigger - it's usually a small number relative the total. But ALL must be removed. This is because we don't know the real culprits. But there's another, more compelling reason to be thorough. The sites that are toxic to us are themselves looking for linking platforms, and many doors are closing on them because of this issue. So any directory that permits them to post links will quickly be found by other porn sites and that link structure will eventually become toxic. So get out now.
We need to repeat #3 above, because it's the most important rule in the new world of link gathering, no matter how you obtain them. This is a tip that can save your enterprise. Never point links home unless you have total control over them (very rare). Bad links pointing home have to be removed by contacting the source and requesting or paying for removal. If the trigger of your penalty is a bad inbound, the site will not come back until that link is removed at the source. This can mean the effective loss of a domain for ranking purposes if it's impossible (can't contact sources), or the cost of repair is prohibitive.
It's also smarter seo to point links at landing pages that share exactly matching nomenclature - any traffic from them will convert at a much higher rate. And it can save the enterprise from disaster - to remove toxic inbounds, you just change the filename. Then use a custom 404 as a new sitemap to acknowledge the change to those who were linked/bookmarked to the old page, and provide the alternative via link. Much preferable to frantically emailing and calling, then realizing the removals are very likely not going to happen.
NEW 22 July 2008 - This technique has enabled us to find toxic structures among huge numbers of inbound links that have been flagged by other tools.
This is a brand new strategy addressing a trademark suppression, triggered by bad inbound links. There are 2 ways a trademark suppression can be applied.
#1 - The most painful is when your web trademark (domain minus the extension) does NOT rank #1. All other ranks are suppressed as well, usually 30-50 positions back.
#2 - The other is when the web trademark ranks #1, but all the other terms associated with your trademark do not (eg. 'trademark ______' (where blank is a product))
There are so many sites compromised by previous link purchases, that we have been working to develop techniques to recover from them. We've found that bad inbound links are easy to identify using a bad neighborhoods tool, but this only points to suspects, and does not finger the culprit.
If you were smart/lucky enough to point all your links to landing pages, then you can remove the link liability by simply changing the filename of the landing pages.
But most sites have these links pointing to the homepage, and in this case, you must get these links removed before your site can recover from the penalty. This can be a daunting task.
And it can be very unproductive, since the vast majority of links identified as bad neighborhoods are not the trigger (but should be removed anyway, preemptively).
After a lot of experimentation, we devised a method to evaluate inbound links for toxic structures that let you rule out the non triggers.
Here's the logic: If a site is a toxic structure, your link will not be the only one causing a penalty to be passed. We're assuming that any link sharing the structure with your link will reveal a penalized site. Test the other links sharing the space with your link for the same trademark issue your site is experiencing.
That's easy for the trademarks that don't rank #1. If you're site is penalized with #2 above, you'll have to look at the products/services offered and test with the trademark plus the product. So if the domain in question sells widgets, search for 'domainname widgets' - a legitimate trademark/product term should be #1.
When you find a link structure in which other sites with similar links to them are all penalized with the same penalty as you're experiencing, you found one of the very likely triggers. You still need to test them all, but this technique enables you to focus your effort on real triggers.
Of course identifying and removing are 2 different tasks, and the latter may be much more difficult. But once you know with some certainty that a site is toxic, you can focus your resources on contacting the owners with some confidence that it's not a wasted effort. Use whatever means necessary - whois, ip lookup, hosting company - even post comments on groups.google.com to see if anyone else has been successful.
We haven't used this information yet in a reconsideration request, but that will happen for the first time this week, so we'll know in a bit whether revealing this information to Google will help sites that have been unable to remove those links, but have identified the structure.
UPDATE 23 July 2008
It is possible that links on a toxic structure have just been placed there. If this is the case, they won't show positive for a trademark suppression, yet. So when you're checking these structures, and if you find multiple, penalized sites among the links, set that domain aside as a likely culprit, and get your links removed.
The chances of finding multiple, penalized sites on these structures is very unlikely if the structure is ok. So even if not all are suppressed, treat the structure as if it were very questionable. This is not a world where you should assume innocence first. In fact on these links, it's safer to drop any that are even suspect.