As everyone who operates in the real world knows, choices are rarely so clear. Take business and investing. For every in-your-face fraud like Enron, there are a thousand situations where executives may cross the line occasionally to get things done. They’re no angels, but neither are they devils incarnate. They’re just people going about the business of business.

Shades of gray, however, hardly sell newsprint or attract eyeballs to computer screens and television sets. Rather, it’s all about the scandal--i.e., some bad guy or guys sticking to the rest of us. If the story is told in the right way, the result will be a groundswell of public outrage, which will further enlarge the story.

In some cases, such stories can indeed serve the public interest, forcing long overdue action on a problem. Often, however, they’re simply used by various factions--including but not restricted to ambitious politicians--to move things in a favorable direction for them. And there’s no time like an election year for a politician to jump on a story and ride it as far as he or she can.

For companies on the wrong side of such a big story, the results can be disastrous. First off, the market hates uncertainty, so the targeted company’s stock and bond prices will come under pressure, creating the image of crisis. Second, no matter what the actual merits of the case, much of the public will have already made up its mind before even hearing the company’s point of view. And the worse things get in the media, the more politicians are going to run away and hide.

In some cases, a media crisis can be the absolute best time to buy a particular company or sector. Many investors, for example, have made a mint buying ALTRIA (NYSE: MO), formerly Phillip Morris, every time the US government has gotten its dander up about the risks of smoking. As long as the story lasts, however, there are going to be plenty of scary times for investors. And though real Manville-like situations are few and far between, there’s always that risk of total meltdown in the face of litigation and government action as befell that once-prosperous maker of asbestos.

Consequently, it usually makes sense for investors to avoid situations where there’s a serious risk of being caught on the wrong side of some sort of media event. Every company faces litigation.

Most pay their executives a lot more than you or I would. And the larger and more successful a company becomes, the more criticism it’s bound to attract, and the more likely some ambitious litigant is going to try to shake the money tree. Small companies, meanwhile, are often less transparent and therefore constantly at risk to fraud or something happening to key personnel.

As a result, the only way to be really certain to avoid litigation risk is to keep your money in a safe deposit box. There are ways, however, for an informed investor to stay ahead of the game and generally limit risk.

The saving grace of America’s court system is it moves slowly, particularly when it comes to civil action against companies. It’s not uncommon for a high profile, high stakes case to take years to make it through the court system before all appeals have been exhausted. Litigation, for example, continues in the case of the Exxon Valdez wreck, which occurred during the administration of the previous President Bush.

The long lives of cases and resulting uncertainty are good reasons why many companies prefer to reach settlements--generally some financial remuneration in return for not admitting wrongdoing and ending the litigation--instead of seeing them through to the uncertain end. The good news is there’s generally plenty of time to read about the history of any major cases in the company’s 10-K

(annual) and 10-Q (quarterly) reports, filed with the Securities and Exchange Commission. And if there is a sudden action, it’s generally in the company’s favor.

CHANGING TIMES

Tort reform was one of President Bush’s key legislative goals as he assumed office in 2001. Essentially, the idea was to make it more difficult for companies to be sued, with the idea of reducing litigation uncertainty.

The fiasco with Social Security reform, the Katrina wipeout and continuing fallout, the unraveling of Iraq and now threat of war in Iran have probably ended the chances of this happening in any real way in national legislation. But the past five years have nonetheless seen a reduction in litigation risk for most industries.

The main reason is the federal government has soft pedaled various cases, for example the Clinton administration Environmental Protection Agency’s case against a dozen coal-burning utilities in the late 1990s. The Bush administration has also appointed judges that are likely to take a much tougher line on litigation than their predecessors.

It’s still a long way to November 7, and plenty of time for the current electoral trend to reverse. Even in a worst case on this issue, the president will still be in office through 2008 and a great many Democrats also support the principle of limiting litigation.

On the other hand, however, odds are growing that American politics are about to change in a way that will result in more corporate litigation. For one thing, many Republicans in Congress and around the country are taking on the president, supporting measures that could potentially lead to more litigation.

One good example is the growing chorus of anti-oil industry rhetoric in Congress, particularly in the US Senate. Super oils like EXXONMOBIL (NYSE: XOM) are now being accused in diatribe after diatribe of manipulating oil price for their benefit, funneling billions to executives and shareholders rather than using it to increase production, manipulating politicians and a hundred other unforgivable sins. Some advocate banning future industry mergers and even breaking up companies, on the grounds that super oils are using their size to squeeze the consumer.

Lost in the discussion are, of course, the shades of gray. Super oils like ExxonMobil are in business to make money, not to provide gasoline at the cheapest possible price for American consumers.

They’re going to act in their self-interest and that means not producing when it doesn’t make economic sense. And ExxonMobil’s board did pay its retiring boss Lee Raymond an awful lot of money that in my view should have gone elsewhere.

On the other hand, however, ExxonMobil is also confronted with its most daunting challenges in history, and a conservative production policy is not a bad idea. For one thing, production costs are soaring as never before, as oil service rigs and other equipment is in record demand. Several super oils, for example, have actually postponed major projects for lack of available equipment.

Most important, as America has grown more dependent on oil to function, so has the pool of available reserves contracted out of American super oils’ hands. Many of the major projects ExxonMobil, CHEVRON (NYSE: CVX) and others are counting on for growth are in the former Soviet Union. And, as the week’s events in the Central African country of Chad show once again, events in even the most obscure of oil producers threaten the world’s tightly stretched supply/demand balance.

No politicians--at least outside Houston--cried when oil prices were low and super oil profits were scraping bottom in the late 1990s.

And it shouldn’t surprise anyone that the rhetoric level is rising now, particularly with many Republicans running scared of losing in a tsunami like the one that swept them into power in November 1994.

Even in a worst case, it’s very unclear just what exactly Congress could do to the big oils, even a Congress with big Democratic majorities in both houses. Some have proposed a windfall profits tax on oil producer profits, but with so much of these companies outside the US it would likely fall hardest on domestic producers who need every bit of today’s high prices to stay in business.

What’s clear is that as long as oil prices remain high, the industry will remain in the public eye. And whether or not you believe the conspiracy theorists that super oils are sitting on breakthrough energy technologies and/or are pushing up prices in concert with Arab countries, litigation risk is going to be elevated, perhaps more so after the November elections.

ENERGY’S WELL

The good news is oil sector litigation risk is extremely minor, compared to the explosive profits companies will earn as the energy bull market unfolds. And until there’s a lot more conservation, use of alternatives, at least one new major conventional reserve find and very likely a recession--the factors that ended the energy bull market of the 1970s--this bull market will continue to run. That means ups and downs but over time higher oil and gas prices and fatter profits for well-placed producers.

Ironically, the best plays on energy for most investors are precisely those super oils many of us love to hate. Chevron in particular remains very cheap, as is CONOCOPHILLIPS (NYSE: COP). The latter recently completed the purchase of gas producer Burlington Resources at a price many considered far too high. As a result, its shares have been punished just as Chevron’s were last year and early this year in the wake of its Unocal buy.

As the bull market unfolds, these reserve pickups will come to be viewed as extremely prescient, even as they fuel production growth for both companies. NOW IS A GREAT TIME TO PICK UP EITHER CHEVRON OR CONOCOPHILLIPS IF YOU HAVEN’T ALREADY DONE SO.

Power generation is another industry that appears at risk to growing litigation risk in coming years. The key issues here are air and water pollution, and emerging concerns about global warming.

Under the Bush administration and a Republican-controlled Congress, little action has been taken on any of these issues, with the exception of emerging standards on mercury pollution. In fact, the Environmental Protection Agency (EPA) has back-pedaled on a number of fronts, such as the former litigation against a dozen coal-burning utilities. That’s left the action to the states, where a number of cases continue.

The principal risk to coal utes here is on the state level.

According to veteran pollster Charlie Cook, there are now 14 Republican-held statehouses at risk of changing hands to six Democrat-held states similarly situated. Moreover, in Michigan, Illinois and Pennsylvania, Republicans have been all too eager to exploit populist issues against Democratic incumbents.

As a result, despite the EPA’s pro-industry stance, we could see a great deal of action on the state level for new regulation as well as in the US Congress, starting in 2007. The good news for utility investors is exposure is most certainly not uniform.

First of all, the industry has made a major capital spending push to clean up its act. Second, in still-regulated states, companies are able to push the cost of reducing sulfur oxides (SOX) and nitrogen oxides (NOX) into their rates. In fact, some are allowed to recover the costs as they spend.

That’s the case for SOUTHERN COMPANY (NYSE: SO) in Georgia, where its emissions have been blamed for smog in the rapidly growing Atlanta area. As a result, the cleanup is actually increasing rate base and therefore earnings. Even in deregulated Ohio, AMERICAN ELECTRIC POWER (NYSE: AEP) has been allowed to recover pre-construction costs for a planned integrated gasification combined cycle (IGCC) power plant.

There’s no better example of how well-managed utilities are getting ahead of the game than the plea by DUKE ENERGY (NYSE: DUK) and others for Congress and the administration to lay down hard targets for reducing greenhouse gases that cause global warming. Carbon emission controls have been enacted by every other developed nation in the world. The Bush administration, however, still officially maintains global warming is a myth and has taken no action and set no targets.

By acting now, the Duke coalition may or may not be taking a stand on the science. And there is some self-interest on the part of some, particularly utes producing primarily from nuclear power like EXELON (NYSE: EXC). But these companies are definitely making a bet on politics. Basically, with post-2007 uncertainty growing, they’d rather have a hard target set by generally pro-business Republicans, rather than one set by the other side.

A number of utilities have already begun taking steps to curtail their greenhouse gases. Vermont-based GREEN MOUNTAIN POWER (NYSE:GMP), for example, has a voluntary end-year 2006 target of reducing its CO2 emissions by 4 percent from 1998-2001 average levels.

Ultimately, the key to how tightened environmental regulations will affect utilities lies in the states. If state regulators allow pass through of the necessary costs into rates, the utilities will remain financially healthy. In fact, they’re likely to increase rate base and shareholder returns. If pass through is not allowed, the results may not be catastrophic, but it’s certain to hit share prices and possibly bond ratings and dividends.

Again, the best way to get a handle on the exposure of the utilities you own is to use the current round of 10-K reports filed with the SEC to give your power companies an environmental assessment. That’s a focus for the upcoming May issue of Utility Forecaster, available for subscribers online beginning Saturday, April 29.

Unfortunately, we won’t have a clear idea of how regulation is going to shape up state-by-state for some months. But by eliminating the more vulnerable and focusing on companies like Duke Energy that stand to be winners, you can enjoy the benefits of owning utilities while avoiding what’s still a largely unrecognized risk.

MARKET WATCH

This week, the benchmark 10-year Treasury note yield moved over 5 percent for the first time in several years. Surprisingly, the overall reaction in the market was extremely muted. And while there was some weakening in traditional income investments like REITs and utilities, it was nothing on the scale of the selloffs that occurred in summer 2003, spring 2004 and spring 2005. REITs, for example, remain very close to all-time highs, as do many Canadian trusts.

This is a pretty clear sign that income-generating investments have more room to fall.

I continue to believe neither the US economy nor the stock market can support much higher rates, and that ultimately the result will be another big drop. Consequently, except for the most leveraged investments like 30-year Treasury bonds, the best idea is to stick with what you’ve got, provided the underlying business is strong enough to keep paying and hopefully increasing the dividend stream.

In addition, if you’ve been following my advice in recent months, you’re no doubt happy to have a fair supply of cash on hand. That will come in very handy when we do see the bottom. In the meantime, it’s a good idea to make a wish list of stocks, preferred shares and bonds that you’d like to own but which have been very expensive for a long time.

By the time this is over, a lot of things are likely to be a lot cheaper than they are even now. And remember: Quality income investments may lose ground in the face of rising interest rates but they always make it up down the road. Only income investments backed by businesses in decline really get socked in selloffs.