The private equity industry should expect increased scrutiny by the Securities and Exchange Commission (SEC), particularly with respect to insider trading and how firms address conflicts of interest, according to recent speeches by representatives of the SEC Division of Enforcement’s new Asset Management Unit. Moreover, The Wall Street Journal has reported that the SEC has “launched a wide-ranging inquiry into the private equity industry.” 
The Enforcement Division’s increasing attention to private equity corresponds with the implementation of new rules under the Dodd-Frank Act that will significantly increase the number of private equity firms subject to SEC regulation as “investment advisers.” The Asset Management Unit, one of a number of specialized enforcement units formed by the Division of Enforcement in 2010 to focus on “priority areas,”  is staffed with 65 professionals, including private equity experts.
Once registered as investment advisers, private equity firms must appoint a chief compliance officer and maintain written policies and procedures reasonably designed to prevent violation of the federal securities laws, including laws prohibiting insider trading. According to the SEC Staff, these policies and procedures should also promote compliance with firms’ fiduciary duties and regulatory obligations, including identifying and addressing conflicts of interest.
In the case of insider trading, Robert Kaplan, the co-chief of the Asset Management Unit warned that “we’ve been looking at private equity broadly for a long time. . . . There will be more private equity cases coming from the Division of Enforcement in coming years than there have been previously.”  In addition, the Director of the SEC’s Office of Compliance Inspections and Examinations, Carlo di Florio, has also stated that “[o]nce the new registration requirements take effect, our examiners will be on the lookout for registrants that are not diligent about having effective policies and procedures in this important area.” 
Opportunities for insider trading identified by the SEC Staff include advance knowledge of going-private transactions or investments in public companies by private equity firms or information learned by a fund manager serving on the board of a portfolio company about public companies that the portfolio company does business with. Private equity firms’ insider trading policies should address these areas of possible abuse and should be “reasonably designed to the scale and level of complexity of the funds they advise for preventing the misuse of material nonpublic information,” according to Mr. di Florio. 
The SEC staff has identified potential conflicts creating the greatest risk for investors and has categorized these conflicts by the stage of a private equity fund’s life cycle. These potential conflicts include:
- Does a firm use consistent and comparable valuation methods and disclose pricing methodologies? Is the valuation methodology documented?
- Is the firm a party to side letters with certain limited partners, giving them preferential treatment regarding expenses, services provided by related parties or access to co-investments? Are the terms of these side letters fully and fairly disclosed to other limited partners?
- Is the firm seeking to raise more funds than it can effectively deploy in an effort to maximize management fees?
- How does the firm allocate investment opportunities between funds? Is co-investing allowed on a deal-by-deal basis, creating a risk that private equity professionals will cherry pick deals with the best prospects for the co-investment vehicle at the expense of the fund?
- Do investors receive accurate reports regarding fund performance? Does the firm selectively highlight only the most successful portfolio companies while ignoring or underweighting portfolio companies that underperform?
- Are fees charged to portfolio companies (transactional, monitoring, consulting, directors) fairly determined, adequately disclosed and consistent with what investors agreed to at the outset of the partnership?
- Has there been an effort on behalf of fund managers not to divest portfolio companies to extend mature funds beyond their normal lives?
- How are conflicts handled when portfolio companies are sold by a fund to an affiliated fund?
Given the SEC’s keen attention to this subject matter, private equity firms should plan to have their insider trading and other compliance policies– including policies designed to mitigate risks created by potential conflicts of interest–fully implemented at the time their registrations become effective.
 Gregory Zuckerman, SEC Launches Inquiry Aimed at Private Equity, Wall Street Journal, Feb. 11, 2012.
 Bruce Karpati, Robert Kaplan, et al., Remarks at News Conference Announcing New SEC Leaders in Enforcement Division, SEC Tracker Daily, Jan. 13, 2010.
 Pete Brush, SEC’s Kaplan Details Plan to Target Private Equity, Law 360, Jan. 27, 2012, http://www.law360.com/articles/304069/sec-s-kaplan-details-plan-to-target-private-equity.
 Carlo V. di Florio, Speech by SEC Staff: Private Equity International’s Private Fund Compliance, May 3, 2011, http://www.sec.gov/news/speech/2011/spch050311cvd.htm.