Is Baidu Bad to the Bone?

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With Baidu.com's (Nasdaq: BIDU) integrity at stake, it'd better know how to answer.

Shares of China's leading search engine fell 25% yesterday, after an expose on China Central Television took the company to task for its paid-search practices.

According to the report, Baidu's paid-search listings include unlicensed pharmaceutical companies among its top bidders for medical keywords. Alone, that wouldn't be enough to shave more than $1 billion off of the dot-com's market cap. Policing advertisers is a common concern for Google (Nasdaq: GOOG) and Yahoo! (Nasdaq: YHOO) here in the United States.

Unfortunately for Baidu, the report's allegations go deeper. The expose claims that Baidu hasn't booted the unlicensed advertisers, and that unauthorized merchants are even outranking legitimate pharmaceutical companies. Baidu reportedly responded yesterday by booting out the baddies, but the damage is already done.

These allegations are heavy stuff. If users and clients believe its organic search results are compromised, will Baidu remain China's top search engine? Won't enlightened consumers simply switch over to distant rivals like Google.cn or Sohu's (Nasdaq: SOHU) Sogou? That's the real danger here.

Baidu has been doing pretty much the opposite of Google's "do no evil" mantra, judging by some of its recent stumbles. Even before this morning's wrinkle, Baidu had been slammed by music piracy lawsuits and allegations that it helped suppress news during this summer's tainted milk powder scandal.

Baidu needs to respond, because its entire model is at stake. It can't ignore being publicly raked over the coals. China Central Television ran an expose on real-world ad giant Focus Media's (Nasdaq: FMCN) business practices earlier this year, and the stock has yet to bounce back.

Baidu has cashed in on its pole position in search in the world's most populous nation. Whether it's running a popular online community or launching a consumer-to-consumer marketplace, the company has taken advantage of its popular search engine to roll out sticky sites.

Beware, Baidu -- that online infrastructure can all crumble the same way it started.

I don't have the evidence to convict or defend Baidu. My only point is this: If you're clean, stay clean. If you're dirty, clean up. Either way, the sooner you are armed with the ammo to silence the critics, the fewer defectors you'll have to win back.

I'm still a major bull on Baidu. I've been a believer since I recommended the stock to Motley Fool Rule Breakers, thankfully at lower prices than today. Now that the company's integrity is being questioned, I hope it's ready to answer. There's just too much at stake -- starting with this morning's $1 billion haircut.

Other recent Baidu headlines:

• Baidu has been in a bit of hot water lately.
• Revenue and earnings were on a growth tear at the company last month.
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