Media coverage of northern Inuit clubbing baby seals was enough to charge emotions and virtually close down Canada’s fur trade in the 1980s. Images of white police officers clubbing blacks in SowetoTownship outside Johannesburg sent international investors and multinationals packing in apartheid-era South Africa a decade earlier.

Can reports of Chinese recently jailed on the strength of Yahoo-supplied information start a divestment trend against U.S. companies collaborating with dictatorships? Will investors bolt over Yahoo, Google, and MSN filtering out information critical of Beijing, as happens now? The current consensus on both questions is a resounding “no way.”

But what if there were a Yahoo-inspired roundup of 50 or 100 dissidents—would that have investors running for the hills? Almost anything could spark it: China is a web of fractious communities. “Social disturbances,” as Beijing calls riots often involving thousands, have increased alarmingly. The authorities are on edge.

Google, Yahoo, Microsoft, Cisco, and other American companies are caught in a deepening dilemma that could tatter their reputations, shrink stock valuations, and reshape business plans. The issue is dead simple: How can they conduct business in repressive countries without appearing as collaborators of the regimes ruling them?

Days of Glory

It’s been just over six months since Baidu.com—the Google of China—scored a 354 percent pop on its first day of trading on the Nasdaq, an event that sparked an explosion of excitement about the potential for profit for U.S. companies entering China’s fast-growing online search market—especially for Google, Yahoo, and MSN. For months, it appeared that Wall Street buy-siders were competing to see who could make the most optimistic prediction for Google’s stock. $350? $400? $500? $2,000?

As it turned out, shares in the company that pledged to “don't be evil” touched an all-time high of $475 by January 11. They tumbled to $337 by the time the U.S. House of Representatives held hearings February 15 on how American companies are helping the Chinese government suppress dissidents by censoring Internet search results, turning over email records, shutting down blogs, or providing web-filtering gear.

Much of the decline stemmed from concerns that the rapid growth of search advertising might not last forever, but the ethical crisis chained an anchor to the struggling stocks.

Certainly, the days of innocence are over. On some web sites, the word gulag has already been recast as “Goolag”—faithfully rendered in Google’s jolly colors. Blogs are filling up with angry comments about how the search engine king, Yahoo, and MSN agreed to filter information so that only the politically acceptable bits slip through.

That doesn’t amount to much in countries like China where only one political party is allowed. Do a search on Taiwan or Tibet independence and you’ll come up empty in China.

Apart from blog enthusiasts, Yahoo’s jailed users, and their family and friends—given China’s whimsical sense of transparency, we’ll never know how many Yahoo users have been imprisoned—Americans seem more fussed about the issue than Chinese themselves. Even if China’s bright sparks could express an unvarnished opinion without being charged with breaching some law or another, the number of protesters would probably be few. Chinese in large measure don’t care because, for the 8.5 percent of the population plugged into the Internet, the arrival of Yahoo and Google has inundated China with information it never had before.

Internet users now number 111 million, a staggering climb from only 22.5 million in 2000. But what Chinese think is beside the point. It’s what investors think that matters—and what regulators bent on overturning business plans think. It’s how risk is perceived that matters. And if holding shares in a company becomes risky from a business standpoint, or as socially redeeming as sashaying around in a blood-stained baby sealskin coat—or being an accomplice to informers—letting go becomes pretty easy.

Gang of Four

The editor’s blog at Chinaeconomicreview.com in Shanghai notes that even retired bureaucrats have joined in the debate. “The discussion over control of information in China’s media has developed surprisingly fast, both internationally and domestically,” a recent post asserts.

“The Gang of Four—Google, Yahoo, Microsoft, and Cisco—are under pressure in the U.S. for filtering information to meet Chinese government requirements, and senior retired Chinese officials are publicly criticizing the government in a letter for its info control-freak ways.”

Though the two issues weren’t linked, the open letter showed Chinese could rise to the wider debate. The letter, dated February 2, concerned Beijing’s closure of the often provocative Freezing Point and was signed by, among others, an ex-editor of China’s preeminent mouthpiece, People’s Daily, and a retired deputy chief of Xinhua news agency.

Turning to the Internet issue, the blog observes, “it was Bill Gates who proposed the neatest solution. ‘The U.S. government should pass a law covering the activities of the tech companies abroad (i.e. in China), giving them the opportunity to say to Beijing: ‘Can’t do that, we will get arrested in Washington.’ Very smart.”

That puts things a mite simplistically. Mr. Gates, in fact, sounded more hopeful than prescriptive when he told Financial Times correspondent Richard Winters that the U.S. Foreign Corrupt Practices Act might be a model for new legislation. He called the FCPA “a resounding success in terms of very clearly outlining what companies can’t do and other rich countries largely went along with that,” adding, “[it] may be that idea [will] come along.”

It’s possible, of course, that emotions will calm and activists in the West will focus on some new, more pressing issue. But what if sentiment spikes, or becomes just another reason to dump stock?

As it is, legislation reining in U.S. companies in nondemocratic countries could be in the offing. After participating in the mid-February hearings in Washington, D.C., Google, Yahoo, Microsoft, and Cisco appeared ready to work together on a formula for doing business in China—but the gesture was met by lawmakers threatening to draft legislation making some of their activities in China illegal.

Too Enticing

For Google, Yahoo, and Microsoft, it amounted to a turnaround after a season of deadpan statements saying how they were just complying with Chinese law, just following orders, so to speak. But to U.S. Representative Tom Lantos (D-California), it wasn’t so simple. He called their behavior “abhorrent.”

That behavior included shutting down offending blogs, as Microsoft had done; turning over email records to authorities that landed people in jail, as Yahoo did more than once; agreeing to filter search results on the just-launched Google.cn site, as Google had done; and selling networking equipment used to filter information, as Cisco continues to do.

But China was just too big a market to leave to competitors, all the Internet companies as much as said—though Google and Yahoo had already hedged their bets anyway, the former taking a stake in Baidu, the latter partnering with commerce-turned-search site Alibaba.com in a joint venture valued at $4 billion.

Though the companies’ representatives vigorously defended their businesses in China against a bipartisan attack from the House International Relations Committee, nobody actually came out in support of censorship. “This was not something that we did enthusiastically and not something that we’re proud of at all,” said Google’s representative at the hearing, Elliot Schrage, the Mountain View, California-based company’s vice president of global communications and public affairs.

Google has drawn fire for releasing a localized version of its search engine that complies with Chinese restrictions. It was in a conundrum: In order to catch up with the local competition, it had to deliver the goods faster. But Google couldn’t do that because the authorities would do the filtering or page blocking for them, sometimes being painfully slow about it. Google.cn overcomes the speed problem but makes Google the censor.

The competition, Baidu, last year owned 46 percent of the search market share, compared to Google’s 30 percent, according to ChinaInternetNetworkInformationCenter figures cited by Google. A sometimes-welcome alternative is Google.hk in Hong Kong, which doesn’t filter results but can be difficult for mainlanders to access for just that reason. Indeed, Hong Kong business travelers constantly complain that they can’t access things—be that newspapers or Google results—they read routinely at home when they go on the road on the Chinese mainland.

Since many of the firms he slams have their headquarters only a short drive from his own district, you might expect Mr. Lantos to be a staunch defender of the local heroes. But he seems more embarrassed by them than anything else. “Your abhorrent activities in China are a disgrace,” he said at the recent hearings. “I do not understand how your corporate leadership sleeps at night.”

Eyes of Congress

It’s unclear what will unclog China’s Internet pipes—aside from Beijing suddenly declaring an end to censorship, which is highly unlikely. But U.S. Representative Chris Smith (R-New Jersey) is out to do something. A draft version of his Global Online Freedom Act of 2006 would make it illegal for U.S. companies to host content, alter search results, or give identifying information to officials in China, Iran, Vietnam, and possibly other countries.

Mr. Smith’s roster of possible additions covers the gamut: Belarus, Burma, Cuba, Libya, the Maldives, Nepal, North Korea, Saudi Arabia, Syria, Tunisia, Turkmenistan, and Uzbekistan. It’s not all about China—except in one critical detail.

As Rebecca MacKinnon of HarvardUniversity’s BerkmanCenter for Internet and Society says, “The difference is, China is the one authoritarian country whose market is so impossible to ignore.”

Thus far, suggested strategies for avoiding censorship have been mostly technical: locating email servers outside of countries with repressive governments, establishing export controls on technologies used to restrict free speech, or putting funding into development of “anti-jamming” strategies to evade broadcasting restrictions. A 2003 proposed anti-jamming bill co-sponsored by Mr. Lantos has received renewed attention. The U.S. State Department recently formed a task force to consider the foreign policy aspects of Internet repression.

Mr. Smith’s bill, in addition to stipulated technical measures, would be the first to regulate the business of censorship, allowing foreign citizens to bring lawsuits in the United States for damages of up to $2 million and imprisonment of up to five years. It would make Google’s localized search and Yahoo’s email turnovers illegal. Microsoft’s MSN Spaces blogs—hosted outside China—would be beyond the purview of the proposed law.

The bill doesn’t go so far as to order companies out of China. But even activist groups and anti-China hawks are willing to be pragmatic. “There will be plenty of others around the world that will be willing to participate in the market if our companies don’t,” says economist Don Straszheim of Straszheim Global Advisors. “Easily the best way to effect change in China is to be involved.”

While most everyone doubts that Mr. Smith’s bill will survive intact when the House reconvenes in March, Jonathan Zittrain, a professor at OxfordUniversity’s Internet Institute and co-founder of Harvard’s BerkmanCenter, says he’s glad to see all the options on the table. He describes the bill as “the kitchen sink approach.”

Going Too Far

At least one critic, and undoubtedly anyone in the Chinese politburo who read the draft, could certainly see some risky overreaching: One section requires hosting services to check with the U.S. Department of Justice before turning over any records to foreign officials. “The Internet user in China says this is insane,” notes Hong Kong blogger Roland Soong, who sees authorities shutting off access to Google completely with a law like that on anyone’s books. “You’re doing this for freedom and democracy, but now I’ve just lost a useful resource.”

A Nasdaq official told Red Herring that the exchange was watching events but did not specify any plans to address them.

Recent news has driven investors who pride themselves on social responsibility to, if not dump shares, at least learn more about the intricacies of anti-jamming, according to Julie Gortie, vice president and chief social investment strategist at Bethesda, Maryland-based Calvert. Calvert’s Social Index Fund includes Google, Yahoo, Microsoft, and Cisco.

Even if business rips along nicely now for U.S. tech’s China traders, Dawn Wolfe, a social research and advocacy analyst at Boston Common Asset Management, sees risks ahead. Ms. Wolfe has helped lead freedom-of-expression campaigns, including one involving Cisco shareholders. “Any action [Cisco takes] to reduce Internet traffic clearly decreases their long-term viability,” she says. “It’s very clear to us that there’s a short-term/long-term trade-off happening.” Cisco insists that it sells the same equipment to all of its customers.

While public criticism may dent the companies’ stock prices, Ms. Gortie doesn’t see investors mobilizing—not yet, anyway. “While we’re concerned about this issue, it’s more a matter of public policy,” she says. “What am I going to tell you as an investor—to pull out of a huge market, or to break the law?”

Neither one, Ms. Gortie answers, adding that she, like others, doesn’t see a movement galvanizing around divestiture. Oxford’s Mr. Zittrain agrees: “I don’t think this is a shareholder ‘save the whales’ kind of issue—it’s too detailed.”

In China, the U.S. Congressional hearings were followed with some interest, a measure of how open the country has become. In fact, many Chinese think American concern is overblown. “This seems to be a peculiarly American affair,” says Mr. Soong.

China’s elite have little trouble using proxy servers and other techniques to circumvent barriers, though Ms. MacKinnon asserts that “the majority of Chinese Internet users are very much only seeing the reality that the government wants you to see.”

Many would undoubtedly say the majority isn’t trying hard enough—and probably because they don’t care. Much is made of China’s much-publicized, 30,000-strong Internet police force, which may seem like a large contingent, but not in the face of the billions of text messages and emails that crisscross China and the world month in and month out.

Control Technique

Besides, China has developed cleverer means of control than deploying police squadrons. Regulators tell the big players to abide by the rules or they will be thrown out of the game—a style that keeps operators fine-tuning their filters and behaving.

Shareholders in Nasdaq-listed Sina.com got a taste of this when in September 2004 the portal disclosed that it was caught breaking the rules by allowing porn to pass on wireless calls that some Sina subscribers were making through its gateway on the state-owned China Mobile network. It was cited for other offenses and a promising wireless business was temporarily suspended, the news immediately chopping 5 percent off Sina’s share price.

When Sohu.com was hit with a 12-month suspension weeks earlier, its stock sank 20 percent on the news. The lesson here is that China’s regulators can shed stock in a wink.

If the U.S. Congress pushes too far into areas China regards as its own sovereign business, investors could be in for a commotion in share prices. Beijing isn’t shy about deploying its regulators when push comes to shove—as both Sina and Sohu could attest to.

In China’s only official comment on the hullabaloo, Internet affairs official Liu Zhengrong said Chinese censorship was in accordance with international practice. While that may be a generous interpretation, it’s certainly true that other governments besides China’s—including Uncle Sam—restrict use of the Internet and insist on access to usage records.

Pointing to the U.S. Department of Justice’s subpoenas for data from Google, Yahoo, Microsoft, and other companies, attorney David Frazee of Greenberg Traurig in East Palo Alto, California, quips, “Maybe the legislation should require that the servers be set up outside the United States as well.”

As Mr. Frazee puts it, “We all want to believe that Google is something more than a company.”

Mr. Lantos obviously has higher expectations, too: “I think very highly of the companies themselves—they are among the gems of the American industry,” he says. “They’re bringing information globally to hundreds of millions of people and I passionately believe this is a very good thing.”

That noble calling seemed to make their contribution to last month’s hearings all the worse, or “worse than dismal,” as he puts it. “They were unprepared to admit to any mistake, to any shame, to any responsibilities for what their behavior had brought.”

He had asked a simple question of the Yahoo counsel. Had the company reached out to the families of people “who as we speak are in prison” because of their actions?