This week’s revelation that Lumber Liquidators (NYSE: LL) allegedly sold flooring from a Chinese vendor that it knew contained carcinogenic material should be a wake-up call for every manufacturer in the United States that outsources production of its products to countries that are unable to enforce standards that directly affect the integrity of its products.

This episode also illustrates the degree of non-systematic risk in owning stock in companies that rely heavily on overseas contractors for its manufacturing process.

It’s one thing to outsource your call center to another part of the world, where perhaps the worst thing that could happen is customer frustration over difficulty communicating; but it is something else altogether for a company to either trust a dishonest or incompetent party to comply with its manufacturing protocols, are even worse, intentionally select a vendor that will knowingly violate those protocols under the blind eye of its sponsor.

The story broke wide open after a scathing “60 Minutes” segment that aired last Sunday, which revealed high levels of formaldehyde in Lumber Liquidators flooring products. Of the more than two dozen pieces of material sampled by 60 Minutes, all but one contained excessive levels of formaldehyde. The company is disputing those findings, arguing that the methodology used by 60 Minutes to sample those pieces was flawed.

In the short run it doesn’t really matter who is right, as the stock price of Lumber Liquidators dropped from a closing price of $51.86 last Friday to $38.83 by the end of trading on Monday. That’s a decline of 25% in one day, after having already fallen more than 50% from its all-time high price of $119 reached in November of 2013. It’s bad enough that a flooring company like Lumber Liquidators is subject to the vagaries of the economically sensitive housing market, but adding the additional layer of risk associated with an off-shore vendor only magnifies its potential volatility.

Of course, the class-action lawsuits are already being filed in the states where Lumber Liquidators does business, but whatever remediation comes about as a result will be of very little consolation to the homeowners who now know they most likely are occupying a dwelling containing carcinogenic material. If you have young children living in your house do you remain in it, knowing they may be exposed to high levels of a known cancer-causing material, or do you incur the cost of quickly moving into temporary quarters until the tainted flooring can be replaced?

For shareholders of Lumber Liquidators stock the question is equally problematic: Do you hang on to the stock hoping it will bounce back if/when the company can prove that the allegations are unfounded, or do you sell it now and realize a big loss but avoid the possibility of the stock eventually going to zero? That doomsday scenario doesn’t happen very often, but it does happen occasionally and this situation has the potential to result in the complete financial collapse of the company if the worst-case scenario unfolds.

The legal ramifications are almost limitless. If company management knew their product violated federal or state safety requirements before being sold to customers then this may take on the dimensions of the Enron debacle, bringing down an entire company and subjecting its principals to civil and criminal prosecution. But even if they did not know about it at all, that degree of negligence in exercising quality control over their supply chain will still result in substantial penalties.

I can’t think of many episodes similar to this one, but I do recall in my early days as a stockbroker in December of 1984 when a subsidiary company of Union Carbide was involved in a gas leak at a pesticide plant in Bhopal, India resulting in more than 500,000 local residents being exposed to toxic chemicals, killing more than 2,000 people right away and an undetermined amount later on.

Union Carbide’s stock price plunged in the days that followed, similar to what is currently happening to Lumber Liquidators. In this case the critical question was exactly who would be financially responsible for compensating victims for their losses, which ultimately was settled by Union Carbide at a cost of $470 million five years later. In 2001 Union Carbide was acquired by Dow Chemical, thus putting to rest what at one time had been a great American company.

Although there are some strong similarities between that situation and this one, there are also significant differences. In the case of Union Carbide the plant in question was located outside of the U.S., falling under the regulatory jurisdiction of the government whose citizens suffered the damages. Also, it was managed as a partnership between Union Carbide and a consortium of Indian corporate and government entities, making it difficult to pinpoint exactly which entity failed to perform its contractual duties.

For those reasons I actually bought stock in Union Carbide after it bottomed out, reasoning that its legal liability was much less than originally feared, and I turned out to be right about that. Its stock price recovered after it became apparent that the company most likely was not guilty of gross negligence (or worse) and would be able to settle for a tolerable sum of money.

But in the case of Lumber Liquidators there is no doubt which entity will be responsible for any damages incurred here in the United States, and it is highly unlikely that there will be much opportunity for remediation from the foreign supplier in U.S. courts.

The takeaway from all of this as investors is that we need to be aware of the potential for non-systematic risk from a wide range of sources, including owning stock in companies that have become too dependent on overseas vendors.

I expect in the weeks to come that many companies will publicly disclose exactly where their supply chains are located, along with a detailed explanation of their quality control processes. Those that don’t do so, especially product manufacturers heavily reliant on facilities in China, will see a run-off in shareholders who no longer feel comfortable being exposed to an unquantifiable level of risk.