Maybe someone else around here has a better answer, but as I understand this, I don't think there is a concise definition of what constitutes a bad neighborhood because that would be proprietary information. So the "how" aspect of your question can't really be answered.
Answer: Google does not know and does not care. They will occasionally wipe some link exchanges out, the rest stands and counts.
Like with anything on Google's webmaster guidelines it's rather random what will lead to penalization and what not.
Use at your own risk.
I think it may be the appearance of the page. For example:
200 links on one page, no real content, links on page go to some junk websites
200 links with 10 on each page (20 pages total), broken down by category, real content on pages, links are to related sites that are quality, not junk
I'd think that Google could tell the difference between the two. Everyone's goal is to be more like Website 2, rather than Website 1.
I think a FFA is manually determined following complaints to Google and it is probably one where there is zero editorial control over what goes in it.
DarkFriend said something interesting..."broken down by category." That seems to be significant along with the part about number of links on a page and content. Which is all good common sense anyway regardless if you are a FFA.
>I am fortunate to have many directories in my industry. I can submit to them, they review the site, and I'm listed with them.<
It is my belief, from reading the posts here, that as long as you are not giving a reciprocal link you should be fine. As many have pointed out in various threads it would be to easy to have your competition penalized by submitting their sites.
I have seen a lot of SEO's start creating directories, solely for the purpose of placing their clients in them.
They can have up to 3 or 4 directories in some cases, all linked together.
Is this a new trend among SEO's? Create Directories so you can have control of that ever elusive PR?
I'm guessing these go in the same category as mentioned by anallawalla, its up to the poor guys at the other end of the spam report form :)
For certain types of entertainment websites, link sites (directory style) are a popular way to generate traffic and promote your product stream. However, if you run a site (like I do) that has 5000+ sites sorted by category, with descriptions, it is sometimes hard to avoid "bad neighborhoods", mostly because it is somewhere between hard and impossible to review all 5000 sites on a regular basis. I do use bots to check for 404s, redirects, dropped domains, etc... but there is no easy way to check PR on all of those sites to avoid bad neighborhoods...
I am not sure that using this as an SEO tool is good for anything except maybe getting googlebot to see new sites...
Google can probably tell the difference between an FFA and a directory that people actually use. In most cases I think they can.
If they cannot, then their technology is not as good as they think it is, or claim it to be.