UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-K

                (X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934.
                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
                                       OR
          ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                        SECURITIES EXCHANGE ACT OF 1934.
                 FOR THE TRANSITION PERIOD FROM        TO
                                                ------    ------

                         Commission File Number 33-35938
                       PAINEWEBBER R&D PARTNERS III, L.P.
             (Exact name of registrant as specified in its charter)


               DELAWARE                                   13-3437420
   (State or other jurisdiction of                     (I.R.S. Employer
    incorporation or organization)                    Identification No.)

1285 AVENUE OF THE AMERICAS, NEW YORK, NEW YORK                10019
(Address of principal executive offices)                     (Zip code)

Registrant's telephone number, including area code:  (212) 713-2000


SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:


                                                Name of each exchange on
        Title of each class                         which registered
        -------------------                         ----------------
              None                                        None


SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

                            Limited Partnership Units

     No voting  stock has been  issued by the  Registrant.  Neither a public nor
other  market  exists for the Units,  and no such market is expected to develop,
therefore there was no quoted market price for the 50,000 Units.

     Indicate  by check mark  whether the  Registrant  (1) has filed all reports
required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
1934  during  the  preceding  12 months  (or for such  shorter  period  that the
registrant was required to file such reports),  and (2) has been subject to such
filing requirements for the past 90 days.  Yes   X    No
                                               -----     -----

                          ---------------------------

     Indicate by check mark if disclosure of delinquent  filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best  of  the  Registrant's   knowledge,  in  definitive  proxy  or  information
statements  incorporated  by  reference  in Part  III of this  Form  10-K or any
amendment to this Form 10-K (X).



<PAGE>



                             SPECIAL NOTE REGARDING
                           FORWARD LOOKING STATEMENTS


     The  Private  Securities  Litigation  Reform  Act of 1995  provides a "safe
harbor" for forward-looking  statements.  Except for the historical  information
contained herein, the matters discussed herein are  forward-looking  statements.
Such forward-looking  statements involve known and unknown risks,  uncertainties
and other factors that may cause the actual results, performance or achievements
of  PaineWebber  R&D Partners  III,  L.P. or industry  results to be  materially
different  from any future  results,  performance or  achievements  expressed or
implied by such forward-looking  statements. Such factors include, among others,
the following:  general  economic and business  conditions;  fluctuations in the
value of  securities  for which only a limited,  or no,  public  market  exists;
dependence  on  the  development  of  new  technologies;  dependence  on  timely
development and introduction of new and competitively priced products;  the need
for regulatory  approvals;  the Sponsor Companies  (hereinafter  defined) having
insufficient  funds to commercialize  products to their maximum  potential;  the
restructuring of Sponsor  Companies;  the dependence of PaineWebber R&D Partners
III, L.P. on the skills of certain scientific  personnel;  and the dependence of
the Partnership on the General Partner (hereinafter defined).





<PAGE>



                                     PART I



ITEM 1.     BUSINESS.

     PaineWebber R&D Partners III, L.P. (the "Partnership" or "Registrant") is a
Delaware limited  partnership that commenced  operations on June 3, 1991, with a
total of $43.1  million  available  for  investment.  Paine  Webber  Development
Corporation ("PWDC" or "General Partner"), an indirect,  wholly-owned subsidiary
of Paine Webber Group Inc.  ("PWG"),  is the general  partner and manager of the
Partnership.  The principal objective of the Partnership is to provide long-term
capital  appreciation  to investors  through  investing in the  development  and
commercialization  of new products (the  "Projects")  with technology  companies
("Sponsor  Companies"),   which  are  expected  to  address  significant  market
opportunities.  The Partnership will terminate on December 15, 2015,  unless its
term is extended or reduced by the General Partner.

     The  Partnership  has  completed  the  funding of its seven  Projects at an
aggregate  investment  since  inception  of $32.5  million.  (See Exhibit B, the
Annual Letter to the Limited Partners,  for a detailed discussion of the current
status of the  Partnership's  Projects.)  In  addition  to the  Projects,  as of
December 31,  1996,  the  Partnership  owned  equity  investments,  warrants and
marketable  securities  as  described  in  Notes  3 and 5 of the  "Notes  to the
Financial Statements" included in this filing on Form 10-K.

     At a meeting of the Board of Directors of PWDC in January  1997,  the Board
adopted the Policy Regarding Requests for Partner Lists attached as Exhibit C.


PARTNERSHIP MANAGEMENT

     The  Partnership  has contracted  with the General  Partner,  pursuant to a
management agreement (the "Management Contract"),  responsibility for management
and administrative services necessary for the operation of the Partnership.  The
General Partner meets  periodically  with an Advisory Board that acts as special
advisor to the General Partner in the management of the  Partnership's  Projects
(see Exhibit A for a brief  biography of the Advisory Board  Members).  All fees
and expenses of the Advisory Board are paid for by the General Partner.

     Under the Management  Contract,  the General Partner is entitled to receive
an annual management fee for management and administrative  services provided to
the  Partnership.  The  management  fee is  equal to 2% of the  aggregate  gross
proceeds  received  by the  Partnership,  reduced by the  Partnership's  capital
commitments  in Projects  that have been  concluded,  and the final  proceeds of
which, if any, have been distributed to the General Partner and limited partners
(the "Limited Partners",  with the General Partner, the "Partners").  Commencing
in January 1995 the General Partner began eliminating the management fee charged
with respect to certain Projects. As of January 1, 1997, the General Partner has
elected to discontinue charging a management fee to the Partnership.



<PAGE>



(ITEM 1 CONTINUED)



DISTRIBUTIONS


All  distributions  to the Partners from the Partnership have been made pro rata
in accordance with their respective capital  contributions.  The following table
sets forth the  proportion  of each  distribution  to be received by the Limited
Partners and the General Partner, respectively:

<TABLE>
<CAPTION>
                                                                       Limited     General
                                                                       Partners    Partner
                                                                       --------    -------
<S>                                                                       <C>        <C>
I.     Until the value of the aggregate distributions for each            99%        1%
       limited partnership unit ("Unit") equals $1,000 plus
       simple interest on such amount accrued at 5% per
       annum ("Contribution Payout")

II.    After Contribution Payout and until the value of the               80%        20%
       aggregate distributions for each Unit equals $5,000
       ("Final Payout")

III.   After Final Payout                                                 75%        25%
</TABLE>



At December 31, 1996, the Partnership has made cash and security  distributions,
as valued on the date of distribution, since inception of $593 and $98 per Unit,
respectively.


OTHER

     At December 31, 1996,  the  Partnership  had no  employees,  and PWDC,  the
General  Partner,  had no employees other than its executive  officers (see Item
10.  Directors and Executive  Officers of the  Registrant).  The  Partnership is
engaged in one primary  business  segment,  the  management  of  investments  in
technology products and companies.


ITEM 2.     PROPERTIES.

     The  Partnership  does  not  own or  lease  any  office,  manufacturing  or
laboratory facilities.


ITEM 3.     LEGAL PROCEEDINGS.

IN RE:  PAINEWEBBER LIMITED PARTNERSHIP LITIGATION

     As previously  disclosed on the Partnership's  Form 10-K for the year ended
December 31, 1995, PWDC, the General Partner of the Partnership,  was named as a
defendant in a class action lawsuit against PaineWebber Incorporated ("PWI") and
a number  of its  affiliates  relating  to PWI's  sale of 70  direct  investment
offerings,  including the offering of interests in the  Partnership.  In January
1996, PWI signed a memorandum of understanding  with the plaintiffs in the class
action  outlining the terms under which the parties agreed to settle the case. A
definitive  settlement  agreement and plan of allocation was signed in July 1996
and submitted to the United States  District Court for the Southern  District of
New York (the "Court") for its approval.  Under that  settlement,  PWI agreed to
pay the class $125 million (which had  previously  been deposited in escrow with
the  Court  when  the  memorandum  of  understanding  was  signed)  and  certain
additional consideration. The additional consideration included the assignment


<PAGE>


(ITEM 3 CONTINUED)


of fees and income  attributable  to the  general  partnership  interest  in the
Partnership as well as guarantees of certain  minimum  returns to class members.
In March 1997, the Court approved the settlement as fair and reasonable.

     In February 1996,  approximately  150 plaintiffs  filed an action  entitled
ABBATE V. PAINEWEBBER INC. in Sacramento,  California Superior Court against PWI
and  various  affiliated   entities,   including  the  General  Partner  of  the
Partnership, concerning the plaintiffs' purchases of various limited partnership
interests.  The complaint alleges,  among other things, that PWI and its related
entities  committed fraud and  misrepresentation  and breached  fiduciary duties
allegedly  owed to the  plaintiffs by selling or promoting  limited  partnership
investments  that were  unsuitable for the  plaintiffs  and by  overstating  the
benefits,  understating the risks and failing to state material facts concerning
the investments.  The complaint seeks  compensatory  damages of $15 million plus
punitive  damages.  In June 1996,  additional  complaints  similar to the ABBATE
action, but involving fewer plaintiffs,  were filed in Sacramento, San Diego and
Arizona.  In September  1996,  the California  Superior Court  dismissed many of
ABBATE  plaintiffs'  claims as barred by the applicable  statutes of limitation.
Certain of the other  complaints were also dismissed with prejudice while others
remained  pending.  In  March  1997,  all of these  actions  were  settled.  The
settlement had no effect on the Partnership or the General Partner.


ITEM 4.     SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

None.








<PAGE>


                                    PART II


ITEM 5.     MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
            MATTERS.

     There is no  existing  public  market for the Units,  and no such market is
expected to develop.  Units are transferable  subject to certain restrictions as
set forth in the  Partnership  Agreement and applicable  securities  laws. As of
December 31, 1996, there were 4,786 Limited Partners.

     The  Partnership  distributes  to the  Partners,  when  available,  the net
proceeds from royalty  distributions,  interest payments on portfolio securities
and net proceeds from dispositions of portfolio securities and any other cash in
excess of amounts that are  necessary  for the  operation  of the  Partnership's
business. The Partnership made cash distributions to its Partners of $24,895,837
($493 per Unit;  $245,837 to the general  partnership  interest) and  $5,050,505
($100 per Unit; $50,505 to the general partnership interest) for the years ended
December 31, 1996 and 1995, respectively.  In addition, in 1995, the Partnership
distributed to its Partners 202,261 warrants of Alkermes,  Inc.  ("Alkermes") (4
warrants per Unit;  2,261  warrants to the general  partnership  interest).  The
warrants were valued at $303,392 ($6 per Unit; $3,392 to the general partnership
interest) on the date of distribution. During the year ended December 31, 1994,
the Partnership  distributed to its Partners 505,120 Cephalon, Inc. ("Cephalon")
warrants  (10  warrants  per Unit;  5,120  warrants to the  general  partnership
interest) valued at $3,121,642 ($62 per Unit; $31,642 to the general partnership
interest) on the date of distribution.


ITEM 6.     SELECTED FINANCIAL DATA.

     See the "Selected  Financial Data (Unaudited)" on Page F-2 included in this
filing on this Form 10-K.


ITEM 7.     MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
            RESULTS OF OPERATIONS.

LIQUIDITY AND CAPITAL RESOURCES

     Partners' capital of $32.4 million at December 31, 1996, increased by $14.6
million from $17.8 million at December 31, 1995. For the year ended December 31,
1996,  the  Partnership  recognized net income of $39.5 million (as discussed in
Results of Operations  below) which exceeded cash  distributions to the partners
in the amount of $24.9 million.

     The Partnership's funds are invested in marketable securities until cash is
needed to pay for the  ongoing  management  and  administrative  expenses of the
Partnership.  Liquid  assets at December  31,  1996,  totaled  $0.9  million,  a
decrease of $0.6  million from the balance of $1.5 million at December 31, 1995.
The decrease in liquid assets is primarily due to net proceeds received upon the
sale of various  investments  of $18.9  million and proceeds  from the sale of a
product  development  project of $6.0 million  offset by cash  distributions  to
Partners of $24.9 million and the payment of management fees and  administrative
expenses of $0.7 million. The balance of the liquid assets at December 31, 1996,
is to be used  primarily  for the  payment of  administrative  costs  related to
managing the Partnership's business.

     The Partnership adopted the provisions of Statement of Financial Accounting
Standards  No.  115,  "Accounting  for  Certain  Investments  in Debt and Equity
Securities"  ("Statement No. 115") for investments  held as of or acquired after
January 1, 1994. In accordance  with Statement No. 115,  prior period  financial
statements  have not been restated to reflect the change in  accounting  method.
There was no  financial  statement  impact  as of  January  1, 1994 of  adopting
Statement No. 115.



<PAGE>


(ITEM 7 CONTINUED)


RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 1996 COMPARED TO THE YEAR ENDED DECEMBER 31, 1995:

     Net income for the years ended December 31, 1996 and 1995 was $39.5 million
and $5.3 million, respectively. The favorable variance of $34.2 million resulted
from an increase in revenues of $25.9 million and a decrease in expenses of $8.3
million.

     Revenues  increased  from $14.9  million  in 1995 to $40.8  million in 1996
resulting primarily from increases in (i) unrealized appreciation of investments
of $17.4 million,  (ii) the gain from the sale of a product  development project
of $6.0  million,  and (iii) the gain on the sale of marketable  securities  and
investments of $3.0 million  offset by a decrease on the gain upon  distribution
of  warrants  of $0.3  million  (see  Results of  Operations  for the year ended
December  31, 1995  compared to the year ended  December 31,  1994).  Unrealized
appreciation  for the year ended December 31, 1996, was $27.2 million  resulting
from  the  Partnership's   investment  of  2,100,000  shares  of  Biocompatibles
International plc ("Biocompatibles").  In accordance with Statement No. 115, the
Partnership  recorded  this  investment  at its  market  value of $29.3  million
($13.94 per share) as of December 31, 1996, as compared to its carrying value of
$2.1 million ($1.00 per share) at December 31, 1995. For the year ended December
31, 1995, the  Partnership  recognized  unrealized  appreciation of $9.8 million
(see Results of  Operations  for the year ended  December  31, 1995  compared to
December 31, 1994). In 1996, the Partnership sold its rights, title and interest
in its callable warrant to purchase 500,000 shares of Athena Neurosciences, Inc.
("Athena") as well as its various product  program  agreements with Athena for a
purchase  price of $6.0  million and  recognized  a gain of this amount from the
sale.  The  Partnership  recognized a gain from the sale of  investments of $7.5
million  and $4.5  million  for the  years  ended  December  31,  1996 and 1995,
respectively.  During 1996, the Partnership  sold its investments of (i) 650,000
shares of  Biocompatibles  for proceeds of $5.3 million with a carrying value of
$4.8 million; (ii) 357,233 shares of GelTex Pharmaceuticals, Inc. ("GelTex") for
proceeds of $6.8 million  with a carrying  value of $4.4  million;  (iii) 23,839
shares of Alkermes for net  proceeds of $0.3  million  with a carrying  value of
$0.2 million;  and (iv) 295,600 shares of Elan Corporation,  plc for proceeds of
$8.3 million and a carrying value of $6.1 million. In addition,  the Partnership
sold its entitlement to Biocompatibles Rights for total proceeds of $2.2 million
and recognized a gain on the sale of this amount.

     Expenses  for the years ended  December 31, 1996 and 1995 were $1.3 million
and $9.6 million,  respectively. The decrease of $8.3 million resulted primarily
from  decreases  in (i)  expenditures  under  Projects  of  $5.6  million;  (ii)
write-down of an  investment of $2.3 million (see Results of Operations  for the
year  ended  December  31,  1995  compared  to  December  31,  1994);  and (iii)
management fees of $0.3 million. Expenditures under Projects for the years ended
December 31, 1996 and 1995 was $0.5 million and $6.1 million,  respectively.  In
1995, the Partnership accrued  expenditures under Projects in the amount of $3.2
million. Also, in 1995, the Partnership funded its final commitment to a Project
in the amount of $2.9 million.  Management fees were further reduced as a result
of the General Partner's decision to discontinue the management fee charged with
respect to certain Projects.


YEAR ENDED DECEMBER 31, 1995 COMPARED TO THE YEAR ENDED DECEMBER 31, 1994:

     Net income for the year ended December 31, 1995, was $5.3 million  compared
to a net  loss of $7.8  million  for the  year  ended  December  31,  1994.  The
favorable  variance of $13.1 million was due to an increase in revenues of $11.1
million and a decrease in expenditures of $2.0 million.


<PAGE>

(ITEM 7 CONTINUED)


     Revenues  for the year ended  December  31, 1995,  were $14.9  million,  an
increase of $11.1 million over revenues for the year ended December 31, 1994, of
$3.8 million.  The favorable  variance was due primarily to increases in 1995 in
unrealized appreciation of marketable securities and investments of $9.9 million
and in realized gains on the sale of marketable  securities  and  investments of
$4.5 million  off-set by declines in 1995 in interest income of $0.5 million and
realized gains on  distributions of warrants of $2.8 million from 1994. In 1995,
Biocompatibles  and GelTex completed initial public offerings  ("IPOs") of their
common stock.  In connection  with the IPOs,  the  Partnership's  investments of
convertible  preferred  stock of  Biocompatibles  and GelTex were  converted  to
common  shares.  At December 31, 1995, the  Partnership's  investment of 650,000
unrestricted shares of Biocompatibles had a market value of $4.8 million ($7.375
per share) as compared to a carrying  value of $0.65 million  ($1.00 per share).
The  Partnership's  investment of 357,233 shares of GelTex had a market value of
$4.4  million  ($12.25  per  share)  and  a  carrying  value  of  $1.0  million.
Accordingly,  the Partnership  recognized unrealized  appreciation on its equity
investments  in  Biocompatibles  and GelTex of $4.15  million and $3.4  million,
respectively.  Also, as of December 31, 1995, the Partnership  held  exercisable
warrants to purchase  common  shares of Athena and  Alkermes  whereby the market
value for each of the common shares as of this date exceeded the exercise prices
of the warrants.  The Partnership  recorded its investments in these warrants at
their intrinsic values (the excess of the market price over the exercise price),
and accordingly,  recognized unrealized appreciation of $2.1 million. In October
1995, the Partnership sold 750,000 shares of  Biocompatibles  common stock at an
aggregate  sales price of $3.5  million and  recognized  a gain upon the sale of
$2.8  million.  In  November  1995,  the  Partnership  exercised  its warrant to
purchase 113,330 shares of Cephalon common shares at an aggregate exercise price
of $1.5 million and  simultaneously  sold the shares at a selling  price of $3.1
million, net of commissions. Accordingly, the Partnership recognized a gain upon
sale of $1.6  million.  The  Partnership  distributed  to its  Partners  in 1995
warrants to purchase 202,261 shares of Alkermes common stock. The exercise price
of the warrants was $1.0 million ($5.00 per share)  compared to the market value
of the shares on the date of distribution of $1.3 million ($6.50 per share). The
Partnership  recognized a gain upon  distribution of $0.3 million.  In 1994, the
Partnership  distributed to its Partners  warrants to purchase 505,120 shares of
Cephalon  common stock  resulting in a realized gain upon  distribution  of $3.1
million.  The decline in interest  income of $0.5  million from 1994 to 1995 was
due to the decrease in marketable securities held by the Partnership. Marketable
securities were liquidated and the proceeds were used to pay the Project funding
commitments of the Partnership and to purchase an additional equity investment.

     Expenses  for the year  ended  December  31,  1995,  were $9.6  million  as
compared to $11.6 million for the year ended  December 31, 1994. The decrease of
$2.0  million  was due to a decrease  in  expenditures  under  Projects  of $4.1
million  and a  decrease  in  management  fees of  $0.2  million  offset  by the
write-down of an investment in 1995 of $2.3 million. Expenditures under Projects
for both years  consisted  of the payment of  commitments  to Alkermes  Clinical
Partners,  L.P.,  Cephalon Clinical Partners.  L.P., Repligen Clinical Partners,
L.P. and PharmaGenics, Inc. In addition, in 1994, the Partnership fully funded a
$4.0 million commitment for a new Project with Athena. The timing and the amount
of the  expenditures  are based on the terms of the agreements  with the Sponsor
Companies.  Management  fees  declined  as a  result  of the  General  Partner's
decision  to  discontinue  the  management  fee  charged  with  respect  to  two
additional  Projects.  In 1995, GenPharm  International,  Inc.  ("GenPharm") was
restructured resulting in a spin-off of its European subsidiary, Pharming BV. In
connection with the spin-off, the Partnership received 14,395 shares of Pharming
BV stock which the  General  Partner had valued at $1.2  million.  In  addition,
based on a review of the current and future financial prospects of GenPharm, the
General Partner has determined that the  Partnership's  investment in GenPharm's
convertible  preferred stock,  with a carrying value of $3.5 million,  should be
valued at zero. Accordingly,  the Partnership recognized a net write-down of its
GenPharm related investments in the amount of $2.3 million.

<PAGE>


ITEM 8.     FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

     The  information  in response to this item may be found under the following
captions included in this filing on Form 10-K:

          Report of Independent Auditors (Page  F-4)
          Statements of Financial Condition (Page F-5)
          Statements of Operations (Page F-6)
          Statements of Changes in Partners' Capital (Page F-6)
          Statements of Cash Flows (Page F-7)
          Notes to Financial Statements (Pages F-8 to F-16)


ITEM 9.    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
           FINANCIAL DISCLOSURE.

           None.



<PAGE>




                                    PART III



ITEM 10.        DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.



     The  Registrant has no directors or executive  officers.  The Registrant is
managed by PWDC, which is the General Partner of the Partnership.

     Pursuant to the Management Contract, the General Partner is responsible for
the management and  administrative  services  necessary for the operation of the
Partnership.  Based in part on discussions  with the Advisory Board, the General
Partner assesses and manages the Partnership's  Projects. As part of its ongoing
role in all Projects,  the General Partner  participates in a steering committee
or similar body with the Sponsor Companies with overall  responsibility for each
Project during the development  phase.  The General Partner makes regular visits
to facilities of Sponsor Companies in order to monitor the progress of Projects,
and its  representatives  take  part in  important  decisions  with  respect  to
development and commercial strategies.  During the commercialization  phase, the
General  Partner  continues  to review the Sponsor  Companies'  performance.  In
addition,  the General  Partner  monitors the  industries in which it undertakes
Projects by  attending  trade shows,  screening  trade  journals  and  reviewing
changes in legislative and regulatory conditions.

     The  following  table sets forth  certain  information  with respect to the
persons who are directors and  executive  officers of the General  Partner as of
December 31, 1996:



NAME                                AGE         POSITION AND DATE APPOINTED
----                                ---         ---------------------------
DIRECTORS
     Dhananjay M. Pai               34          Director since December 1996
     Gerald F. Goertz, Jr.          39          Director since April 1995
     Pierce R. Smith                53          Director since June 1993 (1)

EXECUTIVE OFFICERS
     Dhananjay M. Pai               34          President since December 1996
     Pierce R. Smith                53          Treasurer since August 1988 (1)
     Dorothy F. Haughey             72          Secretary since July 1985



     The directors have a one-year term of office. The officers are elected by a
majority of the directors and hold office until their  successors  are chosen by
the directors.

     (1) Mr. Smith resigned these positions in February 1997 and was replaced by
William J. Nolan. Mr. Nolan is a Managing  Director in the Treasury  Division of
PWI.


<PAGE>



(ITEM 10 CONTINUED)


DIRECTORS

     MR.  PAI is a  Managing  Director  of PWI.  Before  joining  the  Principal
Transactions  Group  of  PWI in  1990,  Mr.  Pai  was a  Vice  President  in the
Investment  Banking  Division of Drexel Burnham  Lambert from 1988 to 1990. From
1983 to 1988,  Mr. Pai held  various  positions  within the Finance  Division of
Drexel  Burnham  Lambert.  Mr. Pai is a Director and  President  of  PaineWebber
Capital,  an Advisory  Board Member of Rifkin  Acquisition  Partners  LLLP,  and
either a Director or Officer of certain  affiliates  of PWI. He holds a Bachelor
of Science  degree  form  Wharton  School of  Business  and a Master of Business
Administration from New York University.

     MR. GOERTZ is a Senior Vice  President and Director of Private  Investments
of PWI.  Prior to joining PWI in December  1990,  Mr.  Goertz was with CG Realty
Advisors  and the Freeman  Company.  He received  his Bachelor of Arts degree in
Business  Administration  in 1979  from  Vanderbilt  University  and  his  Juris
Doctorate and Master of Business Administration from Memphis State University in
1982.

     MR. SMITH was Treasurer of PWG and Executive  Vice  President and Treasurer
of PWI. Mr. Smith  joined PWG in 1987.  From 1982 to 1987,  Mr. Smith was Senior
Vice  President  and  Treasurer  for Norwest  Corporation,  a multibank  holding
company in  Minneapolis.  From 1980 to 1982, Mr. Smith was Vice President of the
Treasury Department for Mellon Bank in Pittsburgh and from 1973 to 1980 was Vice
President for various  subsidiaries  of  Commercial  Credit  Company.  Mr. Smith
received  a Bachelor  of  Science  degree in  Electrical  Engineering  from Yale
University  and a  Master's  degree in  Business  Administration  from  Stanford
University. He also served as a lieutenant in the United States Coast Guard.


EXECUTIVE OFFICERS

     MR. PAI, President, see "Directors" above.

     MR. SMITH, Treasurer, see "Directors" above.

     MS. HAUGHEY, Secretary, joined PWI in 1962.  She is Secretary of PWI.




<PAGE>



ITEM 11.    EXECUTIVE COMPENSATION.

     No  compensation  was paid  directly to  executive  officers of PWDC by the
Registrant. PWDC serves as General Partner for the Registrant, and pursuant to a
Management  Contract,  is  entitled  to  receive  an annual  management  fee for
management  and  administrative  services  provided  to the  Partnership.  As of
January 1, 1997, the General  Partner  elected to discontinue the management fee
charged  to  the   Partnership.   See  the  section   entitled   "Related  Party
Transactions"  under the caption  "Notes to Financial  Statements"  on pages F-8
through F-16 included in this filing on Form 10-K.


ITEM 12.    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

None.


ITEM 13.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

     Information  in response to this item may be found in the section  entitled
"Related Party Transactions"  under the caption "Notes to Financial  Statements"
on pages F-8 through F-16 included in this filing on Form 10-K.






<PAGE>


                                     PART IV


ITEM 14.    EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K.

     The following documents are filed as part of the filing on Form 10-K.

FINANCIAL STATEMENTS

     The  financial  statements,  together with the report of Ernst & Young LLP,
are  listed  in the  accompanying  index to  financial  statements  and notes to
financial statements appearing on page F-1.


     Report of Independent Auditors (Page F-4)
     Statements of Financial Condition (Page F-5)
     Statements of Operations (F-6)
     Statements of Changes in Partners' Capital (Page F-6)
     Statements of Cash Flows (Page F-7)
     Notes to Financial Statements (Pages F-8 to F-16)


REPORTS ON FORM 8-K

     On October  1, 1996,  the  Partnership  filed a current  report on Form 8-K
relating  to  the  election  of  the  President  of  Paine  Webber   Development
Corporation.






<PAGE>



                                   SIGNATURES



Pursuant to the  requirements of Section 13 or 15(d) of the Securities  Exchange
Act of 1934,  the  Registrant  has duly  caused  this report to be signed on its
behalf by the undersigned,  thereunto duly authorized, on this 31st day of March
1997.

     PAINEWEBBER R&D PARTNERS III, L.P.


         By:   PaineWebber Development Corporation
               (General Partner)


         By:   Dhananjay M. Pai/s/
               ------------------------------------------
               Dhananjay M. Pai
               President and Principal Executive Officer


         By:   William J. Nolan/s/
               ------------------------------------------
               William J. Nolan
               Principal Financial and Accounting Officer


Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following  persons on behalf of the  Registrant and
in the capacities indicated*,  each on this 31st day of March 1997.


Dhananjay M. Pai/s/
------------------------------------------
Dhananjay M. Pai
President (principal executive officer) and Director


William J. Nolan/s/
------------------------------------------
William J. Nolan
Principal Financial and Accounting Officer and Director


Gerald F. Goertz, Jr. /s/
------------------------------------------
Gerald F. Goertz, Jr.
Director





* The  capacities  listed are with respect to PWDC,  the General  Partner of the
Registrant.



<PAGE>


                       PAINEWEBBER R&D PARTNERS III, L.P.
                        (A DELAWARE LIMITED PARTNERSHIP)

                          INDEX TO FINANCIAL STATEMENTS


Description                                                        Page
-----------                                                        ----

Index to Financial Statements                                       F-1

Selected Financial Data                                             F-2

Quarterly Financial Information                                     F-3

Report of Independent Auditors                                      F-4

Statements of Financial Condition,
  at December 31, 1996 and 1995                                     F-5

Statements of Operations,
  for the years ended December 31, 1996, 1995 and 1994              F-6

Statements of Changes in Partners' Capital,
  for the years ended December 31, 1996, 1995 and 1994              F-6

Statements of Cash Flows,
  for the years ended December 31, 1996, 1995 and 1994              F-7

Notes to Financial Statements                                       F-8 to F-16





All schedules  are omitted  either  because they are not  applicable or the
information  required  to be  submitted  has  been  included  in  the  financial
statements or notes thereto.




                                      F-1


<PAGE>



PAINEWEBBER R&D PARTNERS III, L.P.
(A DELAWARE LIMITED PARTNERSHIP)


SELECTED FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------

Years ended December 31,                                 1996            1995            1994              1993            1992

------------------------------------------------------------------------------------------------------------------------------------
<S>                                                  <C>             <C>             <C>              <C>              <C>
Operating Results:

   Revenues                                          $ 40,810,648    $ 14,856,172    $  3,751,749     $  3,014,763     $  1,408,675
   Net income (loss)                                 $ 39,513,429    $  5,306,891    $ (7,819,966)    $ (6,338,119)    $ (5,649,083)

Net income (loss) per partnership unit:

   Limited partners (A)                              $     782.37    $     105.08    $    (154.84)    $    (125.49)    $    (111.85)
   General partner                                   $ 395,134.29    $  53,068.91    $ (78,199.66)    $ (63,381.19)    $ (56,490.83)


Financial Condition:

   Total assets                                      $ 32,633,103    $ 17,914,426    $ 19,508,779     $ 31,142,666     $ 36,800,119
   Partners' capital                                 $ 32,442,803    $ 17,825,211    $ 17,872,217     $ 28,813,825     $ 36,679,409

Distributions to partners:
   Cash                                              $ 24,895,837    $  5,050,505    $       --       $       --       $       --
   Alkermes, Inc. warrants
    (at intrinsic value) (B)                         $       --      $    303,392    $       --       $       --       $       --
  Cephalon, Inc. warrants
    (at intrinsic value) (B)                         $       --      $       --      $  3,121,642     $       --       $       --
   Gensia, Inc. warrants
    (at intrinsic value) (B)                         $       --      $       --      $       --       $  1,527,465     $       --
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>

(A) Based on 50,000 limited partnership units.
(B) The excess of market  value per share at the date of  distribution  over the
    exercise price per share.



                                      F-2

<PAGE>

PAINEWEBBER R&D PARTNERS III, L.P.
(A DELAWARE LIMITED PARTNERSHIP)


QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------
                                                                                       Net Income (Loss)
                                                       Net Income                  Per Partnership Unit (A)
                                Revenues                 (Loss)             Limited Partners     General Partner
------------------------------------------------------------------         --------------------------------------
<S>                          <C>                     <C>                      <C>                 <C>
Calendar 1996

4th Quarter                    14,014,291              13,844,845                 274.14              138,448.45

3rd Quarter                     2,874,006               2,702,018                  53.50               27,020.18

2nd Quarter                    17,562,388              17,134,012                 339.25              171,340.12

1st Quarter                     6,359,963               5,832,554                 115.48               58,325.54

-----------------------------------------------------------------------------------------------------------------

Calendar 1995

4th Quarter                  $  4,945,967            $   (428,166)            $    (8.47)         $    (4,281.66)

3rd Quarter (B)                 6,088,165               5,327,420                 105.48               53,274.20

2nd Quarter (C)                 3,594,170               1,933,280                  38.28               19,332.80

1st Quarter                       227,870              (1,525,643)                (30.21)             (15,256.43)

-----------------------------------------------------------------------------------------------------------------

Calendar 1994

4th Quarter                  $    137,335            $ (5,838,737)            $  (115.61)         $   (58,387.37)

3rd Quarter                       193,731              (1,874,856)                (37.12)             (18,748.56)

2nd Quarter                       267,594              (1,911,572)                (37.85)             (19,115.72)

1st Quarter                     3,153,089               1,805,199                  35.74               18,051.99

-----------------------------------------------------------------------------------------------------------------
</TABLE>

(A) Based on 50,000 partnership units and a 1% general partnership interest. (B)
Amounts have been restated from the amounts reported as of September 30,
    1995.
(C) Amounts have been restated from the amounts reported as of June 30, 1995.



                                      F-3

<PAGE>






Report of Independent Auditors


To the Partners of PaineWebber R&D Partners III, L.P.

We  have  audited  the  accompanying   statements  of  financial   condition  of
PaineWebber  R&D Partners  III,  L.P. as of December 31, 1996 and 1995,  and the
related statements of operations,  changes in partners' capital,  and cash flows
for each of the  three  years in the  period  ended  December  31,  1996.  These
financial statements are the responsibility of the Partnership's management. Our
responsibility  is to express an opinion on these financial  statements based on
our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion,  the financial  statements  referred to above present fairly, in
all material  respects,  the financial position of PaineWebber R&D Partners III,
L.P. at December 31, 1996 and 1995,  and the results of its  operations  and its
cash flows for each of the three years in the period ended December 31, 1996, in
conformity with generally accepted accounting principles.

Ernst & Young LLP/s/
-----------------------
Ernst & Young LLP

New York, New York
March 21, 1997






                                       F-4


<PAGE>

PAINEWEBBER R&D PARTNERS III, L.P.
(A DELAWARE LIMITED PARTNERSHIP)

STATEMENTS OF FINANCIAL CONDITION

<TABLE>
<CAPTION>
                                                            December 31,      December 31,
                                                                1996              1995
-----------------------------------------------------------------------------------------
<S>                                                         <C>               <C>
Assets:

       Cash                                                 $      --         $    56,903

       Marketable securities, at market value                   911,375         1,432,382

       Investments, at fair value                            31,423,754        15,514,892

       Interest receivable                                         --              37,739

       Organization costs, net of accumulated
        amortization of $125,724 at December 31, 1996
        and $115,104 at December 31, 1995                          --              10,620

       Advances to product development projects                 297,974           826,167

       Other assets                                                --              35,723

                                                            ===========       ===========
Total assets                                                $32,633,103       $17,914,426
                                                            ===========       ===========


Liabilities and partners' capital:

       Accrued liabilities                                  $    99,420       $    83,494

       Payable to Paine Webber Development Corp.                  3,613             5,721

       Other liability                                           87,267                 0

                                                            -----------       -----------
                                                                190,300            89,215

       Partners' capital                                     32,442,803        17,825,211

                                                            ===========       ===========
Total liabilities and partners' capital                     $32,633,103       $17,914,426
                                                            ===========       ===========


-----------------------------------------------------------------------------------------
</TABLE>

See notes to financial statements.




                                      F-5

<PAGE>

PAINEWEBBER R&D PARTNERS III, L.P.
(A DELAWARE LIMITED PARTNERSHIP)

STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>

For the years ended December 31,                                  1996             1995             1994
---------------------------------------------------------------------------------------------------------
<S>                                                       <C>              <C>              <C>
Revenues:
       Interest income                                    $    170,677     $    210,351     $    729,190
       Income from product development project                  19,500          146,208           18,750
       Unrealized appreciation (depreciation) of
        marketable securities and investments               27,169,770        9,733,309         (117,526)
       Realized gain from sale of product development
         project                                             6,000,000             --               --
       Realized gain on distribution of warrants                  --            303,392        3,121,642
       Net realized gain (loss) on sale of
        marketable securities and investments                7,450,701        4,462,912             (307)
                                                          ------------     ------------     ------------
                                                            40,810,648       14,856,172        3,751,749
                                                          ------------     ------------     ------------

Expenses:
       Expenditures under product development projects         528,193        6,074,149       10,210,247
       Management fee                                          569,334          857,658        1,040,047
       General and administrative costs                        189,072          242,330          296,277
       Amortization of organization costs                       10,620           25,144           25,144
       Write down of investment                                   --          2,350,000             --
                                                          ------------     ------------     ------------
                                                             1,297,219        9,549,281       11,571,715
                                                          ------------     ------------     ------------

Net income (loss)                                         $ 39,513,429     $  5,306,891     $ (7,819,966)
                                                          ============     ============     ============

Net income (loss) per partnership unit:
       Limited partners (based on 50,000 units)           $     782.37     $     105.08     $    (154.84)
       General partner                                    $ 395,134.29     $  53,068.91     $ (78,199.66)

---------------------------------------------------------------------------------------------------------
</TABLE>

<TABLE>
STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
                                                               Limited          General
For the years ended December 31, 1996, 1995 and 1994          Partners          Partner         Total
---------------------------------------------------------------------------------------------------------


<S>                                                       <C>              <C>              <C>
Balance at January 1, 1994                                $ 28,525,350     $    288,475     $ 28,813,825

Distribution of Cephalon, Inc. warrants                     (3,090,000)         (31,642)      (3,121,642)
Net loss                                                    (7,741,766)         (78,200)      (7,819,966)
                                                          ------------     ------------     ------------

Balance at December 31, 1994                                17,693,584          178,633       17,872,217

Distributions to partners:
       Cash                                                 (5,000,000)         (50,505)      (5,050,505)
       Alkermes, Inc. warrants                                (300,000)          (3,392)        (303,392)

Net income                                                   5,254,961           51,930        5,306,891
                                                          ------------     ------------     ------------

Balance at December 31, 1995                                17,648,545          176,666       17,825,211

Cash distribution to partners                              (24,650,000)        (245,837)     (24,895,837)
Net income                                                  39,118,295          395,134       39,513,429
                                                          ------------     ------------     ------------

Balance at December 31, 1996                              $ 32,116,840     $    325,963     $ 32,442,803
                                                          ============     ============     ============

---------------------------------------------------------------------------------------------------------
</TABLE>

See notes to financial statements.


                                       F-6

<PAGE>

PAINEWEBBER R&D PARTNERS III, L.P.
(A DELAWARE LIMITED PARTNERSHIP)

STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>

For the years ended December 31,                               1996             1995             1994
------------------------------------------------------------------------------------------------------
<S>                                                    <C>              <C>              <C>
Cash flows from operating activities:
Net income (loss)                                      $ 39,513,429     $  5,306,891     $ (7,819,966)
Adjustments to reconcile net income (loss) to
  cash provided by (used for) operating activities:
  Amortization of organization costs                         10,620           25,144           25,144
  Unrealized (appreciation) depreciation
   of marketable securities and investments             (27,169,770)      (9,733,309)         117,526
  Realized gain on distribution of warrants                    --           (303,392)      (3,121,642)
  Write down of investment                                     --          2,350,000             --

Decrease (increase) in operating assets:
  Marketable securities                                     517,023        9,578,818       11,942,414
  Investments                                            11,264,892         (250,000)        (500,000)
  Interest receivable                                        37,739           41,960          (17,853)
  Advances to product development projects                  528,193         (363,151)        (463,016)
  Other assets                                               35,723              750          (34,691)

(Decrease) increase in operating liabilities:
  Liabilities under product development projects               --         (1,456,326)        (717,470)
  Payable to PaineWebber Development Corporation             (2,108)           3,327           (5,299)
  Accrued liabilities                                        15,926          (94,348)          30,490
  Other liability                                            87,267             --               --
                                                       ------------     ------------     ------------
Cash provided by (used for) operating activities         24,838,934        5,106,364         (564,363)
                                                       ------------     ------------     ------------

Cash flows from financing activities:
  Distributions to partners                             (24,895,837)      (5,050,505)            --
                                                       ------------     ------------     ------------

(Decrease) increase in cash                                 (56,903)          55,859         (564,363)

Cash at beginning of period                                  56,903            1,044          565,407
                                                       ------------     ------------     ------------

Cash at end of period                                  $       --       $     56,903     $      1,044
                                                       ============     ============     ============

------------------------------------------------------------------------------------
</TABLE>

Supplemental disclosure of cash flow information:
The  Partnership  paid no cash for  interest  or taxes  during  the years  ended
December 31, 1996, 1995 and 1994.

Supplemental schedule of non-cash activities:

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------
For the years ended December 31,                               1996           1995            1994
------------------------------------------------------------------------------------------------------

<S>                                                    <C>              <C>              <C>
Distribution of investments to partners:
  Alkermes, Inc. warrants                              $       --       $    303,392     $       --
  Cephalon, Inc. warrants                                      --               --          3,121,642

------------------------------------------------------------------------------------------------------
</TABLE>

See notes to financial statements.



                                       F-7


<PAGE>


                       PAINEWEBBER R&D PARTNERS III, L.P.
                        (A DELAWARE LIMITED PARTNERSHIP)

                         NOTES TO FINANCIAL STATEMENTS


1.       ORGANIZATION AND BUSINESS

     PaineWebber R&D Partners III, L.P (the "Partnership") is a Delaware limited
partnership that commenced  operations on June 3, 1991. Paine Webber Development
Corporation  ("PWDC"  or  the  "General  Partner"),  an  indirect,  wholly-owned
subsidiary of Paine Webber Group Inc., is the general partner and manager of the
Partnership.  The  Partnership  will terminate on December 15, 2015,  unless its
term is extended or reduced by the General Partner.

     The principal  objective of the Partnership is to provide long-term capital
appreciation   to   investors   through   investing  in  the   development   and
commercialization   of  new  products  with   technology   companies   ("Sponsor
Companies"),  which are expected to address  significant  market  opportunities.
When the product  development  phase has been completed,  Sponsor Companies will
generally  have a license from the  Partnership  to  commercialize  the products
resulting  from  the  product  development  project,  and the  Partnership  will
generally  have  the  right  to  receive  payments  based  upon the sale of such
products.  Sponsor  Companies will generally have an option to purchase from the
Partnership  the products or  technology  developed for a  predetermined  price,
payable through a one-time  payment and/or a series of payments based on product
sales over a ten to twelve year period.  In connection with product  development
projects (the "Projects"), the Partnership sought to obtain warrants to purchase
the common stock of Sponsor  Companies.  These  warrants  have the  potential to
provide additional capital appreciation to the Partnership which is not directly
dependent  upon the  outcome  of the  Projects  (see Note 5). In  addition,  the
Partnership  invested  as a  limited  partner  in  product  development  limited
partnerships.  Such partnerships  were formed to develop specific,  new products
through contracts, similar to those described above, with Sponsor Companies. The
Sponsor  Companies  conduct the Projects and affiliates of the Sponsor Companies
serve as general  partners of the  partnerships.  As such,  the  Partnership  is
engaged  in  diverse   Projects   including   product   development   contracts,
participation  in other  partnerships  and  investments in securities of Sponsor
Companies.

     As of  December  31,  1996,  the  Partnership  has fully  funded  its seven
Projects at an aggregate  investment  of $32.5 million (see Note 5). In addition
to these  Projects,  the  Partnership  has invested in the securities of several
other Sponsor Companies (see Note 3).





                                       F-8
<PAGE>


                       PAINEWEBBER R&D PARTNERS III, L.P.
                        (A DELAWARE LIMITED PARTNERSHIP)

                         NOTES TO FINANCIAL STATEMENTS


(NOTE 1 CONTINUED)

     All  distributions  from the  Partnership  to the  General  Partner and the
limited partners of the Partnership (the "Limited Partners";  collectively,  the
"Partners") have been made pro rata in accordance with their respective  capital
contributions. The table below sets forth the proportion of each distribution to
be received by the Limited Partners and the General Partner, respectively:

<TABLE>
<CAPTION>
                                                                            LIMITED      GENERAL
                                                                            PARTNERS     PARTNER
                                                                            --------     -------

<S>                                                                         <C>          <C>
I.   Until the value of the aggregate distributions for each limited
     partnership Unit ("Unit") equals $1,000 plus simple interest on
     such amount accrued at 5% per annum ("Contribution Payout").........     99%           1%


II.  After Contribution Payout and until the value of the aggregate
     distributions for each Unit equals $5,000 ("Final Payout")..........     80%          20%

III. After Final Payout..................................................     75%          25%
</TABLE>


     For  the  year  ended  December  31,  1996,  the   Partnership   made  cash
distributions  totaling  $24,895,837  ($493 per Unit;  $245,837  to the  General
Partner).  At December  31,  1996,  the  Partnership  has made cash and security
distributions,  as valued on the date of  distribution,  since inception of $593
and $98 per Unit, respectively.

2.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     The financial statements are prepared in conformity with generally accepted
accounting  principles which require management to make certain estimates.  Such
estimates   include  the  carrying  value  of   non-marketable   securities  and
assumptions  that affect the amounts  reported in the financial  statements  and
accompanying notes. Actual results could differ from those estimates.

     In  accordance  with the  provisions  of Statement of Financial  Accounting
Standards  No.  115,  "Accounting  for  Certain  Investments  in Debt and Equity
Securities"  ("Statement No. 115"), the Partnership accounts for its investments
in restricted common stock (where the restriction  period expires in one year or
less) at  market  value  with  unrealized  gains  and  losses  reflected  in the
Statements of Operations  during the period in which the change in value occurs.
Investments in restricted common stock,  whereby the restriction  period exceeds
one year, is accounted for at the lower of cost or fair value.

     Marketable  securities  consist of readily  marketable  securities that are
valued  at  market  value.   Marketable   securities  are  not  considered  cash
equivalents for the Statements of Cash Flows.

     The  Partnership's  investments  in  convertible  preferred  stock  are not
publicly traded and,  therefore,  are subject to fluctuations in value dependent
on the underlying value of the issuing company.  Non-publicly  traded securities
are valued at cost,  except  when a decrease  is  required  based on the General
Partner's  evaluations  of the  project  technology  or Sponsor  Company.  These
evaluations  are  made  based on  currently  available  information  and may not
necessarily represent the amount, if any, which may ultimately be realized.  The
future value of these securities, if any, are dependent upon circumstances which
cannot reasonably be determined until the position is actually liquidated.




                                       F-9

<PAGE>


                       PAINEWEBBER R&D PARTNERS III, L.P.
                        (A DELAWARE LIMITED PARTNERSHIP)

                         NOTES TO FINANCIAL STATEMENTS



(NOTE 2 CONTINUED)

     Realized  and  unrealized  gains or losses  are  determined  on a  specific
identification  method and are reflected in the Statements of Operations  during
the period in which the change in value occurs.

     The General  Partner  incurred  offering  and  organizational  costs in the
amount of $1,813,138  and $125,724,  respectively,  that were  reimbursed at the
Partnership's  closings.  Offering  expenses have been charged against partners'
capital.  Organizational  costs incurred during the formation of the Partnership
were amortized over a period of 60 months from the date of the  commencement  of
operations.

     The  Partnership  invested in Projects,  as more fully described in Note 5,
through one of two vehicles:


     o     Product Development Contracts
           The  Partnership  paid  amounts to Sponsor  Companies  under  product
           development contracts.  Such amounts were expensed by the Partnership
           when  incurred  by the  Sponsor  Companies.  Income from  the Sponsor
           Companies is  reflected  in the  Statements  of  Operations  for  the
           period in which the income is earned.

     o     Product Development Limited Partnerships
           The  Partnership   participates  as  a  limited  partner  in  product
           development limited partnerships formed to develop specific products.
           Such  partnerships  expense product  development costs when incurred.

     The Partnership carries warrants at a zero value in cases where the Sponsor
Company's  stock is not  publicly  traded or the  exercise  period  has not been
attained.   To  the  extent  that  the  Partnership's   warrants  are  currently
exercisable and the Sponsor Company's stock is publicly traded, the warrants are
carried  at  intrinsic  value  (the  excess of market  price per share  over the
exercise price per share), which approximates fair value.


3.   MARKETABLE SECURITIES AND INVESTMENTS

     MARKETABLE SECURITIES:

     The Partnership held the following marketable securities at:

<TABLE>
<CAPTION>
                                        DECEMBER 31, 1996                   DECEMBER 31, 1995
                                 ------------------------------      -----------------------------
                                     MARKET             COST            MARKET             Cost
<S>                              <C>               <C>               <C>              <C>
U.S. Treasury obligations        $      -----      $      -----      $    603,544     $    599,560
Money market fund                     911,375           911,375           828,838          828,838
                                 ------------      ------------      ------------     ------------
                                 $    911,375      $    911,375      $  1,432,382     $  1,428,398
                                 ============      ============      ============     ============
</TABLE>




                                      F-10

<PAGE>


                       PAINEWEBBER R&D PARTNERS III, L.P.
                        (A DELAWARE LIMITED PARTNERSHIP)

                         NOTES TO FINANCIAL STATEMENTS



(NOTE 3 CONTINUED)

     INVESTMENTS:

     The  Partnership's  investments  in  convertible  preferred  stock  are not
publicly  traded  securities and are subject to  fluctuations in value dependent
upon the Sponsor  Companies'  underlying  value.  The Partnership  records these
non-public  investments  at the  lower  of cost or fair  value.  Fair  value  is
determined  by the  General  Partner,  in good faith,  based on all  appropriate
information  available at the time.  In accordance  with  Statement No. 115, the
Partnership records investments in restricted common stock (when the restriction
period  expires in one year or less) at market value with  unrealized  gains and
losses reflected in the Statements of Operations  during the period in which the
change in value occurs. Exercisable warrants held by the Partnership whereby the
market value of the  underlying  common shares exceeds the exercise price of the
warrant  are  recorded  at  their  intrinsic  value.  The  Partnership  held the
following investments at:

<TABLE>
<CAPTION>
                                                  DECEMBER 31, 1996                    DECEMBER 31, 1995
                                          -------------------------------       -------------------------------
                                          CARRYING VALUE          COST          CARRYING VALUE          COST
                                          --------------          ----          --------------          ----
<S>                                        <C>                <C>                <C>                <C>
Biocompatibles International plc:
   2,100,000 Restricted                    $29,273,754        $ 2,100,000        $ 2,100,000        $ 2,100,000
   Common Shares
   650,000 Unrestricted                           --                 --            4,793,750            650,000
   Common Shares
GenPharm International, Inc.                      --                 --                 --                 --
  1,000,000 Shares of Series E
   Convertible Preferred Stock
Pharming BV                                  1,150,000          3,500,000          1,150,000          3,500,000
   14,395 Shares of Class A Stock
GelTex Pharmaceuticals, Inc.                      --                 --            4,376,104          1,000,000
   357,233 Unrestricted Common Shares
PharmaGenics, Inc.                           1,000,000          1,000,000          1,000,000          1,000,000
   480,242 Shares of Series C
   Convertible Preferred Stock
Alkermes, Inc.                                    --                 --               70,038               --
  Warrant to purchase
   23,839 common shares
Athena Neurosciences, Inc.                        --                 --            2,025,000               --
  Core Warrant to purchase
  500,000 shares
                                           -----------        -----------        -----------        -----------
                                           $31,423,754        $ 6,600,000        $15,514,892        $ 8,250,000
                                           ===========        ===========        ===========        ===========
</TABLE>

     Biocompatibles  International plc ("Biocompatibles") is a development stage
company engaged in the research,  development and  commercialization of coatings
and new materials which reduce  compatibility  problems  associated with certain
medical devices. On April 13, 1995,  Biocompatibles  completed an initial public
offering  ("IPO") on the London Stock Exchange.  In connection with the IPO, the
Partnership's  350,000  shares  of Series C  Convertible  Preferred  Stock  were
converted to 350,000 common shares (140,000 shares of which were



                                      F-11

<PAGE>


                       PAINEWEBBER R&D PARTNERS III, L.P.
                        (A DELAWARE LIMITED PARTNERSHIP)

                         NOTES TO FINANCIAL STATEMENTS


(NOTE 3 CONTINUED)

unrestricted).  Concurrent  with the  IPO,  the  common  shares  split  10-for-1
resulting in a Partnership  investment of 3,500,000 common shares.  In 1995, the
Partnership  sold  750,000  unrestricted  shares  generating  proceeds,  net  of
commissions,  of  $3,537,782.  The  carrying  value of such  750,000  shares  at
December 31, 1994, was $750,000. The Partnership recognized a gain upon the sale
of  $2,787,782  which  has  been  included  in the  accompanying  Statements  of
Operations.  During 1996, the Partnership  sold 650,000  unrestricted  shares of
Biocompatibles at a price, net of commissions,  of $5,291,129 (average price per
share  of  $8.14).  The  carrying  value  of  the  shares  including  unrealized
appreciation  of $4,143,750  for the year ended December 31, 1995 was $4,793,750
($7.375 per share). Accordingly, the Partnership recognized a gain upon the sale
of $497,379 for the year ended December 31, 1996. The Partnership has agreed not
to sell,  assign,  transfer or otherwise dispose of its remaining  investment of
2,100,000  common  shares for a period to expire in April 1997.  At December 31,
1995, the Partnership  recorded these  restricted  shares at their cost basis of
$2,100,000.  In accordance with Statement No. 115, during the quarter ended June
30, 1996, the Partnership  commenced recording its investment in these shares at
their market  value.  At December 31, 1996,  the market value of the  restricted
shares was $29,273,754 ($13.94 per share). The Partnership recognized unrealized
appreciation  of $27,173,754 for the year ended December 31, 1996. In connection
with a Rights  Issue  by  Biocompatibles  in April  1996,  the  Partnership  was
entitled to purchase one Right for every six shares owned  (aggregating  458,333
Rights).  Each Right was comprised of one new common share of Biocompatibles and
one warrant.  In May 1996, the Partnership sold its entitlement to the Rights at
a price of (pound)1.25 per Right. The Partnership  received aggregate  proceeds,
net of commissions,  of $865,798  ((pound)571,484) and recognized a gain of this
amount from the sale for the year ended December 31, 1996. A second Rights Issue
by  Biocompatibles  in November 1996 entitled the  Partnership  to purchase four
Rights for every 23 shares owned (aggregating 365,217 Rights). In December 1996,
the Partnership sold its entitlement to the Rights at a price of (pound)2.20 per
Right   for   aggregate   proceeds,   net   of   commissions,    of   $1,339,815
((pound)803,477).  The Partnership recognized a gain of this amount for the year
ended December 31, 1996.

     GenPharm International,  Inc. ("GenPharm") is a biotechnology company which
is pursuing the research and  development  of  transgenic  technology  for human
medical applications. In 1995, GenPharm's restructuring resulted in the spin-off
of its European subsidiary,  Pharming BV. In connection with this spin-off,  the
Partnership  received  14,395  shares  of  Pharming  BV Class A stock  which the
General  Partner has valued at $1,150,000.  Based on a review of the current and
future financial prospects of GenPharm,  the General Partner determined that the
Partnership's  investment in GenPharm's  convertible  preferred  stock should be
valued at zero. Accordingly,  the Partnership recognized a net write-down of its
GenPharm related investments of $2,350,000 for the year ended December 31, 1995.

     GelTex Pharmaceuticals,  Inc. ("GelTex") is a company formed to develop and
commercialize  luminal  therapies,  which are based on the use of non-absorbable
therapeutic   polymers   to   selectively    eliminate   substances   from   the
gastrointestinal tract before they are absorbed. In connection with a GelTex IPO
in November 1995, the Partnership's shares of GelTex Convertible Preferred Stock
were  converted to 357,233  common shares.  In 1996,  the  Partnership  sold its
shares for  proceeds of  $6,805,351  (average  price per share of  $19.05).  The
Partnership  recorded the shares for the year ended  December 31, 1995, at their
market  value  of  $4,376,104   ($12.25  per  share)  with  related   unrealized
appreciation of $3,376,104.  Upon the sale the Partnership  recognized a gain of
$2,429,247 for the year ended December 31, 1996.

     PharmaGenics, Inc. ("PharmaGenics") is an integrated drug discovery company
engaged in the research and development of pharmaceuticals  for the treatment of
cancer as well as other human diseases.  In 1995, the Partnership made a loan to
PharmaGenics in the amount of $1,000,000 which was subsequently converted into


                                      F-12
<PAGE>


                       PAINEWEBBER R&D PARTNERS III, L.P.
                        (A DELAWARE LIMITED PARTNERSHIP)

                         NOTES TO FINANCIAL STATEMENTS


(NOTE 3 CONTINUED)

480,242  shares  of Series C  Convertible  Preferred  Stock.  In  addition,  the
Partnership's commitment to further fund research and development expenses under
its contract with PharmaGenics was reduced by $1,000,000.

     At December  31,  1995,  the  Partnership  held an  exercisable  warrant to
purchase 500,000 common shares of Athena Neurosciences, Inc. ("Athena") in which
the market value of the common shares of $12.25 per share  exceeded the exercise
price of $8.20 per share. Accordingly, for the year ended December 31, 1995, the
Partnership  recorded  this warrant at its  intrinsic  value of  $2,025,000  and
recognized  unrealized  appreciation  of this  amount.  As a result  of a merger
between Athena and Elan Corporation,  plc ("Elan"), the Partnership's warrant to
purchase  Athena  shares was converted  into a warrant to purchase  295,600 Elan
shares.  In 1996,  the  Partnership  exercised  its Elan warrant at an aggregate
exercise price of $4,099,972 ($13.87 per share) and subsequently sold the shares
for proceeds of $8,320,588 (average price per share of $28.15).  The Partnership
recognized a gain of  $2,195,616  upon the sale for the year ended  December 31,
1996.

     For the  year  ended  December  31,  1995,  the  Partnership  recorded  its
exercisable warrant to purchase 23,839 shares of Alkermes,  Inc. ("Alkermes") at
its intrinsic  value of $70,038 and recognized  unrealized  appreciation of this
amount.  In June 1996,  the  Partnership  exercised this warrant at an aggregate
price of  $119,195  ($5.00 per share) and sold the shares for  proceeds,  net of
commissions,  of $312,080.  The  Partnership  recognized a gain upon the sale of
$122,847 for the year ended December 31, 1996.


4.    RELATED PARTY TRANSACTIONS

     The General  Partner  received an annual  management fee for management and
administrative  services  provided to the  Partnership.  The  management fee was
payable  quarterly in advance and was adjusted annually on the first day of each
fiscal year in an amount proportionate to the increase for the prior year in the
Consumer  Price Index  published by the United States  Department  of Labor.  In
addition,  the  General  Partner  received  a project  fee for  formulating  and
implementing the business  strategy of the Partnership,  paid at each closing in
an  amount  equal  to 2%  of  the  aggregate  gross  proceeds  received  by  the
Partnership at such closing. The Partnership paid the General Partner $1,000,000
at closings in 1991. In connection  with the Partnership  offering,  PaineWebber
Incorporated  ("PWI"),  the sales agent,  an  affiliate of the General  Partner,
received  selling  commissions  of $3,966,210.  The management  fees paid by the
Partnership to the General  Partner were  $569,334,  $857,658 and $1,040,047 for
the years ended December 31, 1996,  1995 and 1994,  respectively.  Commencing in
July 1995 the General Partner eliminated the management fee charged with respect
to certain  Projects.  As of January 1, 1997, the General Partner has elected to
discontinue the management fee charged to the Partnership.

     The  Partnership's  portfolio  of  marketable  securities  was  managed  by
Mitchell Hutchins  Institutional  Investors ("MHII"),  an affiliate of PWDC. The
Partnership paid MHII a fee with respect to such money management services which
has been  included in general and  administrative  expenses in the  accompanying
Statements of Operations.  The fees for the years ended December 31, 1996,  1995
and 1994 were $3,088, $10,145 and $41,896, respectively.

     PWDC and PWI,  and its  affiliates,  have  acted in an  investment  banking
capacity  for  several  of the  Sponsor  Companies.  In  addition,  PWDC and its
affiliates have direct limited partnership interests in some of the same product
development limited partnerships as the Partnership.



                                      F-13
<PAGE>


                       PAINEWEBBER R&D PARTNERS III, L.P.
                        (A DELAWARE LIMITED PARTNERSHIP)

                         NOTES TO FINANCIAL STATEMENTS



5.   PRODUCT DEVELOPMENT PROJECTS

     The Partnership entered into three product  development  contracts and four
product development limited  partnerships which were fully funded as of December
31,  1995.  These  seven  Projects  consist of the  following:  The  Partnership
provided  $6.0 million to Alkermes  Clinical  Partners,  L.P.,  a $46.0  million
limited   partnership   formed  to  fund  the  development,   clinical  testing,
manufacturing and marketing of  Receptor-Mediated  Permeabilizers for use in the
treatment  of diseases of the brain and central  nervous  system by enabling the
delivery of drugs across the blood brain barrier.  The Partnership provided $4.0
million to Athena for a Project to fund the further  development  of  Diastat(R)
which is a gel-like  solution of diazepam  indicated  for the treatment of acute
repetitive  seizures  associated with epilepsy.  The  Partnership  provided $1.5
million to Cadre  Technologies,  Inc.  ("Cadre")  for a Project which funded the
development  of  software  development  tools  for  database  applications.  The
Partnership  provided $6.0 million to Cephalon Clinical Partners,  L.P., a $45.0
million limited  partnership  formed to fund the development,  clinical testing,
manufacturing  and  marketing  of  MyotrophinO  for  use  in  the  treatment  of
amyotrophic   lateral  sclerosis  and  certain  peripheral   neuropathies.   The
Partnership  provided $4.0 million to Gensia  Clinical  Partners,  L.P., a $26.2
million limited  partnership  formed to fund the development,  clinical testing,
manufacturing and marketing of the GenESAO System, a product designed to enhance
the  diagnosis  of heart  disease.  The  Partnership  provided  $5.0  million to
PharmaGenics for a Project using PharmaGenics'  screening technology to discover
novel  oligonucleotide  therapeutics.  The Partnership  provided $6.0 million to
Repligen Clinical Partners,  L.P. ("RCP"),  a $45.0 million limited  partnership
formed to fund the development, clinical testing, manufacturing and marketing of
recombinant  platelet  factor-4 for use in certain  cancer  applications  and to
reverse the effects of the anticoagulant heparin.

     On  April  18,  1996,  Repligen  Corporation  ("Repligen")  terminated  its
arrangements   with  RCP  regarding  the  development  and  marketing  of  RCP's
recombinant  platelet factor-4  ("rPF4")  program.  Repligen and RCP have agreed
that the rights to the rPF4  technologies  will  remain  with RCP.  The  general
partner of RCP is seeking third parties who may be willing to either purchase or
license the rPF4  technologies so that residual  proceeds or royalties,  if any,
may be distributed to the partners of RCP (including the Partnership).  However,
there  can be no  assurance  that  anyone  will  purchase  or  license  the rPF4
technologies or that there will be any residual proceeds or royalties  available
for distribution.

     On May 31, 1996, the Partnership sold, transferred and assigned its rights,
title and interest in the callable  warrant to purchase 500,000 shares of Athena
as  well  as  its  various  product  program  agreements  with  Athena  for  the
development  of Diastat(R)  for a purchase  price of $6,000,000 and recognized a
gain of this amount from the sale of this  product  development  project for the
year ended December 31, 1996.

     If the  Projects  produce  any  product for  commercial  sale,  the Sponsor
Companies have the option to license the Partnership's technology to manufacture
and market the products developed.  In addition,  the Sponsor Companies have the
option  to  purchase  the   Partnership's   interest  in  the   technology.   In
consideration for granting such purchase  options,  the Partnership has received
warrants to purchase shares of common stock of certain of the Sponsor Companies.
At December 31, 1996, the Partnership owned the following warrants:



                                      F-14

<PAGE>


                       PAINEWEBBER R&D PARTNERS III, L.P.
                        (A DELAWARE LIMITED PARTNERSHIP)

                         NOTES TO FINANCIAL STATEMENTS




(NOTE 5 CONTINUED)

<TABLE>
<CAPTION>
                                 NUMBER OF         EXERCISE                           12/31/96
                              SHARES THAT CAN       PRICE           EXERCISE        MARKET PRICE
                               BE PURCHASED       PER SHARE          PERIOD          PER SHARE*
                               ------------       ---------          ------          ----------
<S>                                <C>             <C>                      <C>        <C>
Cayenne Software Inc. (A)          35,512          $ 25.91       Current to 7/98       $3.813

Repligen Corporation (B)          133,000          $  2.50       Current to 3/01       $1.188
                                  252,700          $  3.50       Current to 3/01

PharmaGenics, Inc.              1,000,000          $  2.15       Current to 6/01         (C)
-----------------------------------------------------------------------------------------------
</TABLE>

* The share prices of these  technology  companies are generally highly volatile
  and the shares are often thinly  traded.  The market  prices  listed above may
  have changed significantly  subsequent to December 31, 1996, and/or may change
  significantly in the future.  The market prices above may not,  therefore,  be
  indicative  of the  ultimate  values,  if any,  that  may be  realized  by the
  Partnership.


     (A) On July 19, 1996, Cadre merged with Bachman Information Systems to form
         Cayenne  Software  Inc.  ("Cayenne").  As a result of the  merger,  the
         Partnership's  warrant  to  purchase  115,000  shares  of  Cadre  at an
         exercise price of $8.00 per share  converted into a warrant to purchase
         Cayenne shares.


     (B) During the first  quarter of 1995,  the  Partnership  was notified of a
         modification  offer  (the   "Modification")  by  Repligen   Corporation
         ("Repligen")  to modify the Exchange  Warrants.  The principal terms of
         the Modification were (i) the exercise price was reduced from $9.00 per
         share to $2.50  per share for  133,000  shares  and $3.50 per share for
         252,700  shares  but will  increase  to $8.00 per  share 90 days  after
         Repligen  notifies the Warrant  holders that the NASDAQ National Market
         closing price of Repligen's  common stock is equal to or exceeds $12.00
         per share for any 20 out of 30  consecutive  trading  days and (ii) the
         exercise period under the Exchange Warrants will terminate on March 31,
         2001 instead of March 31, 2000. In connection  with the foregoing,  the
         initial royalty rate on future product  revenues due to the Partnership
         from Repligen will not change under the Modification and will remain at
         9%.

     (C) At  December  31,  1996,  the common  shares of  PharmaGenics  were not
         publicly traded.


     In addition, the Partnership owns a warrant (with a carrying value of zero)
to purchase  666,667 shares of  PharmaGenics  at an exercise price of $2.15.  If
PharmaGenics elects to exercise the purchase option agreement,  the warrant will
be redeemed at zero value.

     On October 23, 1995, the Partnership  distributed to its Partners a warrant
to purchase  202,261 shares of Alkermes common stock. The intrinsic value of the
warrant  on the  date of  distribution  was  $303,392  ($1.50  per  share)  and,
accordingly, the Partnership recognized a gain of this amount. In November 1995,
the  Partnership  exercised its warrant to purchase  113,330 shares of Cephalon,
Inc. ("Cephalon") common stock at an aggregate exercise price of $1,536,128. The
shares were  subsequently  sold by the Partnership  for total  proceeds,  net of
commissions,  of $3,100,947  (average price per share of $27.362).  Accordingly,
the Partnership  recognized a gain of $1,564,819 for the year ended December 31,
1995.  Of  the  113,300  warrants  exercised,  6,930  warrants  represented  the
fractional portion allocable to the Limited Partners that was not distributed in
1994. The gain


                                      F-15

<PAGE>


                       PAINEWEBBER R&D PARTNERS III, L.P.
                        (A DELAWARE LIMITED PARTNERSHIP)

                         NOTES TO FINANCIAL STATEMENTS



(NOTE 5 CONTINUED)

attributable to the exercise of these warrants and the sale of the shares in the
amount of $113,856  has been  allocated  solely to the  Limited  Partners in the
accompanying Statements of Changes in Partners' Capital.

     In January 1994, the  Partnership  distributed to its Partners a warrant to
purchase  505,120 shares of Cephalon  common stock.  The intrinsic  value of the
warrant  to  purchase  Cephalon  common  stock on the date of  distribution  was
$3,121,642 ($6.18 per share) and, accordingly, the Partnership recognized a gain
of this amount.

6.    INCOME TAXES

     The  Partnership  is not subject to federal,  state or local income  taxes.
Accordingly,  the individual  partners are required to report their distributive
share of realized  income or loss on their  individual  federal and state income
tax returns.




                                      F-16
<PAGE>


EXHIBIT A
ADVISORY BOARD BIOGRAPHIES



ADMIRAL BOBBY R. INMAN U.S. NAVY (RET.)
Chairman, Executive Committee of Science Applications International Corporation;
former Chairman and Chief Executive  Officer,  Westmark  Systems,  Inc.;  former
Chairman,  President and Chief Executive  Officer,  Microelectronics  & Computer
Technology  Corporation;   Director,  Fluor  Corporation,  Science  Applications
International  Corporation,  Southwestern  Bell  Corporation,  Temple-Inland and
Xerox Corporation.

ALFRED J. COYLE
Advisory Director, PaineWebber Incorporated;  former Director, American DualVest
Fund, Cubic Corp.,  Leaseway  Transportation  Corp.,  Oilfield Services Corp. of
America and Radiation Dynamics.

RICHARD HODGSON
Co-founder  and  Director,  Intel  Corporation;  Director,  I-Stat  Corp.,  Ibis
Technology Inc., McCowan Associates and several private technology companies.

EUGENE KLEINER
Founding partner,  Kleiner,  Perkins,  Caufield & Byers;  Co-founder,  Fairchild
Semiconductor  Corporation;  Director,  Andros  Corporation,  Resound,  Inc. and
several private technology  companies;  Trustee,  Polytechnic  University in New
York.

ANTONIE T. KNOPPERS, M.D.
Former  President,  Chief  Operating  Officer  and Vice  Chairman,  Merck & Co.;
Director,  Centocor,  Inc; former Chairman,  U.S.  Council of the  International
Chamber of Commerce.

DR. GEORGE KOZMETSKY, D.C.S.
Executive  Associate for Economic  Affairs,  The University of Texas System;  IC
Senior Research Fellow; Chairman, IC Advisory Board.

JOSHUA LEDERBERG, PH.D.
Nobel  Laureate;   university   professor  and  former  President,   Rockefeller
University;  Director,  Chemical  Industry  Institute  for  Toxicology,  Dreyfus
Foundation and Council for Foreign Relations.



<PAGE>


EXHIBIT B

PAINEWEBBER R&D PARTNERS III, L.P.                            ANNUAL REPORT 1996
--------------------------------------------------------------------------------

LETTER TO LIMITED PARTNERS

To Our Limited Partners:

Two sponsor  companies in PaineWebber R&D Partners III, L.P. (the  "Partnership"
or "R&D Partners III") made significant  announcements  during the year.  First,
Elan  Corporation  plc ("Elan")  purchased  R&D Partners  III's rights to Athena
Neurosciences,  Inc.'s ("Athena")  Diastat  development  program.  Also, Bachman
Information Systems, Inc. completed its acquisition of Cadre Technologies,  Inc.
("Cadre") in July. The combined  companies have been renamed  Cayenne  Software,
Inc. ("Cayenne"). In addition, R&D Partners III made cash distributions totaling
$4,930 per $10,000 investment in the partnership during the year.

In June 1996,  Elan  purchased the exclusive  U.S.  market  license for Athena's
Diastat  product for $6.0 million from R&D Partners III. Also in June,  Elan and
Athena jointly  announced  that the  stockholders  of each company  approved the
merger  of Elan  and  Athena.  Under  the  merger  agreement,  Athena  became  a
wholly-owned  subsidiary of Elan, and Athena  stockholders  received 0.2956 Elan
American  Depository  Shares  ("ADSs") for each common share of Athena that they
owned  upon  completion  of the  merger.  Diastat  is a viscous  formulation  of
diazepam  which was tested  for its use in the  treatment  of a severe  epilepsy
condition  afflicting  children  and  young  adults  known as  acute  repetitive
seizures.  Athena  warrants  held by R&D Partners III were  converted  into Elan
warrants  under the merger  agreement  with an  exercise  price of  $13.87.  The
warrants were  exercised and cash was  distributed to investors in the amount of
$835.70 per $10,000 investment in R&D III.

R&D III distributed $16.7 million on December 13, 1996; the cash distribution to
investors was in the amount of $3,300 per $10,000 investment.  The major portion
of the distribution  ($6.8 million)  resulted from the sale of 357,233 shares of
GelTex  Pharmaceuticals,  Inc., at approximately  $19.80 per share. R&D Partners
III  sold  650,000   ordinary  shares  of   Biocompatibles   International   plc
("Biocompatibles")  resulting in distributed  proceeds of $5.2 million.  R&D III
purchased $3.5 million of Biocompatibles  convertible preferred stock at a price
of $1.00 per share in a private  placement in 1993.  R&D III retains 2.1 million
shares of  Biocompatibles  ordinary  shares  which are  subject to certain  sale
restrictions until April 1997. The balance of the distribution resulted from the
exercise  of 295,600  Elan  warrants  and sale of the common  shares  generating
proceeds of $4.2 million and from the exercise of 23,839 Alkermes, Inc. warrants
and sale of the common  shares  resulting  in proceeds  of  $312,080  with these
proceeds   being   distributed   to  investors  as  part  of  this  December  13
distribution.  On December 27, 1996 R&D III made a second cash distribution from
the  sale  of the  Biocompatibles  rights  of  approximately  $270  per  $10,000
investment.

R&D  III  was  formed  in  1991  and  invested  in a  portfolio  of six  product
development  programs as well as four equity investments in private  placements.
The  objective  of each  product  development  program  is to obtain  attractive
returns for investors by accelerating the development and  commercialization  of
new products. In addition to cash distributions derived from revenues of product
sales in each  program,  investors  may  benefit by the growth of the  companies
through the issuance of warrants to purchase the  companies'  common  stock.  In
each



<PAGE>




PAINEWEBBER R&D PARTNERS III, L.P.                            ANNUAL REPORT 1996
--------------------------------------------------------------------------------


program,  the  management  team of  PaineWebber  Development  Corporation  works
closely  with the  sponsor  companies  to monitor the  progress of each  product
development program.

In  addition  to the six  product  development  programs,  R&D III has made four
equity investments in privately-held companies. R&D III invested $3.5 million in
Biocompatibles  International  plc,  a  U.K.-based,  development  stage  company
engaged in the research,  development and  commercialization of coatings and new
materials which reduce  compatibility  problems  associated with certain medical
devices.  Biocompatibles  completed a $27.5 million  initial public  offering in
April 1995 of ordinary  shares on the London Stock Exchange.  Simultaneous  with
the offering , R&D's  convertible  preferred shares were converted into ordinary
shares and these shares then split ten-for-one. R&D III invested $3.5 million in
GenPharm  International,  Inc.,  ("GenPharm"),  a  privately-held  biotechnology
company  pursuing  the  development  of  transgenic  animals  for human  medical
applications.   In  1995,   GenPharm   completed  a  restructuring,   which  was
percipitated by Cell Genesys,  Inc.'s patent lawsuit against it, by spinning off
its European  subsidiary,  Pharming BV. The pending lawsuit against GenPharm has
been recently  dropped by Cell Genesys.  R&D III currently owns 14,395 shares of
Pharming BV Class A common  stock.  R&D III also invested $1.0 million in GelTex
Pharmaceuticals,  Inc.,  a  biopharmaceutical  company  formed  to  develop  and
commercialize  luminal therapies,  which are based on the use of non-absorbable,
therapeutic   polymers   to   selectively    eliminate   substances   from   the
gastrointestinal  tract before they are absorbed.  GelTex  completed its initial
public  offering in November  1995 at a price of $10.00 per share.  In addition,
R&D III made a $1.0  million  equity  investment  in 1995 and  received  480,242
shares of PharmaGenics,  Inc. ("PGI") Series C Convertible  Preferred Stock. PGI
is a drug  discovery  company in which R&D III has  committed  $5.0 million to a
product  development  program with the company (see Product Portfolio Status for
update).

In addition to potential  returns from product  development  programs and equity
investments,  investors have received warrants from R&D III, allowing  investors
to purchase  the common  stock of certain  sponsor  companies  at  predetermined
prices.  To date, R&D III has made three  distributions of warrants.  In October
1995,  investors  received a warrant to  purchase  40 shares of  Alkermes,  Inc.
("Alkermes")  common  stock per  $10,000  investment  in R&D III.  The  Alkermes
warrant is  exercisable at a price of $5.00 per share through March 31, 2000. In
January  1994,  investors  received a warrant to purchase 100 shares of Cephalon
common  stock  per  $10,000  investment  in R&D III.  The  Cephalon  warrant  is
exercisable  at a price of $11.32 per share  through  August  31,  1997 and at a
price of $13.82 per share from  September  1, 1997 through  August 31, 1999.  In
August 1993, investors received a warrant to purchase 60 shares of Gensia common
stock per $10,000  investment in R&D III. The Gensia warrant is exercisable at a
price of $19.47 per share from August 1, 1996  through July 1998.  In 1996,  the
total value of the  distributed  warrants  from R&D III ranged from $0 to $4,694
per  $10,000  investment.  The value of the  distributed  warrants  based on the
respective dates of distribution is $980 per $10,000 investment in R&D III.

Thank you for your continued interest in R&D III.


Sincerely,

Robin Stanley
Vice President
PaineWebber Development Corporation


<PAGE>


PAINEWEBBER R&D PARTNERS III, L.P.                            ANNUAL REPORT 1996
--------------------------------------------------------------------------------


PRODUCT PORTFOLIO STATUS

ALKERMES, INC.

COMPANY
Alkermes,   Inc.   ("Alkermes")  is  developing  innovative  products  based  on
sophisticated  drug delivery  techniques  for the  treatment of central  nervous
system   disorders   and   for   enhancing   the   effectiveness   of   existing
biopharmaceutical products. Alkermes lead products are ProLease(R),  Medisorb(R)
and RMP-7(TM)  which focus on two drug delivery  opportunities:  (i) controlled,
sustained release of injectable drugs lasting several days to several weeks; and
(ii) the delivery of drugs into the brain past the blood-brain barrier.

In December  1996,  Alkermes  announced the results of the two European Phase II
RMP-7  clinical  trials  designed to test the safety and efficacy of intravenous
RMP-7 and the chemotherapeutic  agent carboplatin for treatment of patients with
recurrent,  malignant brain tumors. The results showed that the drug combination
was well  tolerated  and  provided  positive  responses as measured by patients'
neurological impairment, performance status and tumor volume.

Alkermes announced a new collaboration with R.W. Johnson Pharmaceutical Research
Institute ("PRI") a division of Johnson & Johnson for ProLease.  Their objective
is to apply  ProLease to a  proprietary  PRI  compound  being  utilized  for the
treatment of hormone disorders,  enabling a single injection to last for several
weeks.  In addition  to the  collaboration  with PRI,  Alkermes  expanded  their
current  collaboration  with Genentech  Inc. for human growth  hormone  ("hGH").
Results from the Phase I clinical trial show that a single injection of ProLease
elevated hormone levels for as long as three to four weeks.

PROGRAM
R&D III committed $6.0 million to a $46.0 million limited  partnership formed to
complete  the  development  and  human  clinical  trials  of  receptor  mediated
permeabilizers  ("RMPs").  In clinical studies completed to date, RMP-7 has been
shown to be safe when  administered to volunteers and patients,  and to increase
temporarily the permeability of the blood-brain  barrier.  Alkermes is currently
conducting  Phase  II  clinical  trials  in  the  U.S.  of  RMP-7  delivered  in
combination  with  carboplatin  for the  treatment of glioma,  a type of primary
brain  tumor.  The Phase II studies  are  designed  to test the  efficacy of the
combination  of RMP-7 and  carboplatin  in treating  brain tumor.  U.S. Phase II
trials are expected to be completed in the first half of 1997.

WARRANT
R&D III distributed the Alkermes  warrant in August 1995.  Investors  received a
warrant to purchase 40 shares of Alkermes common stock per $10,000 investment in
R&D III with an exercise price of $5.00 per share through March 31, 2000.  Based
on the closing price of $6.50 per share on the date of  distribution,  a warrant
to purchase 40 shares of Alkermes common stock had a value of approximately  $60
per $10,000 unit. The available gain from the distributed  Alkermes  warrant has
ranged from $30 to $820 per $10,000 investment in R&D III.


ATHENA NEUROSCIENCES, INC.

COMPANY
Athena  Neurosciences,   Inc.  ("Athena")  and  Elan  Corporation  plc  ("Elan")
announced  in June 1996,  that the  stockholders  of each  company  approved the
merger  of Elan  and  Athena.  Under  the  merger  agreement,  Athena  became  a
wholly-owned subsidiary of Elan. Under the terms of the



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PAINEWEBBER R&D PARTNERS III, L.P.                            ANNUAL REPORT 1996
--------------------------------------------------------------------------------


agreement,  Athena stockholders  received 0.2956 Elan American Depository Shares
or ADSs for each  common  share of Athena  they  owned  upon  completion  of the
merger. Elan subsequently effected a 2-for-1 stock split on August 23, 1996.

In June 1996, Elan purchased R&D III's rights in the Diastat development program
for $6 million. A cash distribution was made to R&D III investors for $1,180 per
$10,000  investment  from the Diastat  program  acquisition.  Elan  announced in
December 1996,  that they received an approved  letter from the FDA for Diastat,
(diazepam solution for rectal  administration) the anti-convulsant,  to commence
marketing the product in the U.S.
market.

PROGRAM
R&D III committed $4.0 million to a product  development  program with Athena to
fund the further development of Diastat. Diastat is a treatment for young adults
and children with epilepsy who suffer from acute repetitive seizures.  The panel
found the data  submitted by Athena in the December 1995 NDA helped  support the
FDA approval.  Diastat will offer the convenience of at-home  administration  to
help control increased seizure activity,  thereby enabling patients and families
to avoid  visits to the  emergency  room and the economic  and  emotional  costs
related  to those  visits.  Diastat  is a new  proprietary  gel  formulation  of
diazepam and is now available for those who require intermittent use of diazepam
to control bouts of increased seizure activity.

WARRANT
The R&D III  callable  warrant to  purchase  an  additional  500,000  shares was
canceled  upon  exercise  of the  program  purchase  option by Elan on behalf of
Athena  in  June  1996.  R&D III  exercised  the  converted  Elan  warrants  and
simultaneously  sold  the  common  stock  resulting  in a cash  distribution  in
December  1996 of $835.70 per $10,000  investment  in R&D III.  This will be the
last Product  Portfolio  Status report on Athena,  since the consummation of the
merger and the complete exercise of the converted Elan warrants resulting in the
final cash payment to R&D III investors in this program.

CAYENNE SOFTWARE, INC.

COMPANY
Cayenne  Software,  Inc.  ("Cayenne") is a publicly traded  company,  NNM: CAYN,
which  supplies  modeling,   database  design  and  development   solutions  for
commercial and technical application and database  development.  The new company
Cayenne Software,  Inc. resulted from the July 1996 merger between the privately
held company Cadre Technologies  Inc.("Cadre") and Bachman Information  Systems,
Inc. ("Bachman").

PROGRAM
R&D III  committed  $1.5 million to Cadre's  product  development  program which
funded the generation of software  development tools for database  applications.
R&D III does not expect any returns from this program.

WARRANT
In July 1996,  Cadre  warrants  were  converted  into Cayenne  warrants with the
Partnership owning a warrant to purchase 35,512 Cayenne common shares at a price
of $25.91 per share. Warrants from this transaction have not been distributed to
investors.  The stock price of Cayenne closed on December 31, 1996 at a price of
$3.81.



<PAGE>


PAINEWEBBER R&D PARTNERS III, L.P.                            ANNUAL REPORT 1996
--------------------------------------------------------------------------------


CEPHALON, INC.

COMPANY
Cephalon,  Inc. ("Cephalon") discovers and develops  pharmaceutical products for
the  treatment  of  neurological  disorders.  The company  focuses  primarily on
neurodegenerative diseases, which are characterized by the death of neurons, the
specialized   conducting  cells  of  the  nervous  system.   Cephalon's  product
development  programs are directed  toward  promoting  neuronal  survival  using
neurotrophic factors and various classes of small molecules.

Cephalon   received   significant  news   specifically  in  the  development  of
Myotrophin(TM).  Myotrophin is a recombinant form of insulin-like growth factor,
a naturally  occurring  neurotrophic  factor which is believed to participate in
the nervous  system's  normal  attempt to recover from  injury.  The FDA granted
treament IND status for Myotrophin in June 1996. The panel based its decision on
the positive data from the U.S.  clinical trial. The treatment IND program makes
investigational  drugs available  where no comparable or satisfactory  therapies
exist.  Cephalon and U.S. partner Chiron Corporation said that all U.S. patients
diagnosed  with ALS are eligible to register for the  Myotrophin  treatment  IND
expanded access program. Recently, the two companies submitted an NDA to the FDA
for clearance to market the drug in the United States.  The agency has indicated
that it will give the NDA an expedited review.

PROGRAM
R&D III  committed  $6.0 million to Cephalon  Clinical  Partners,  L.P., a $45.0
million  limited  partnership  formed to fund the development and human clinical
trials of  Myotrophin  for use in the  treatment  of ALS and certain  peripheral
neuropathies. In clinical studies conducted to date, Myotrophin has demonstrated
the ability to promote the  survival of neurons and to enhance the  regeneration
of peripheral  nerves,  suggesting its potential use as a therapeutic  agent for
ALS and certain peripheral neuropathies.  ALS is a fatal disorder of the nervous
system characterized by the chronic,  progressive degeneration of motor neurons.
Peripheral  neuropathy refers to a family of disorders of the peripheral nervous
system characterized by a degeneration of peripheral motor and sensory nerves.

In October 1996,  Cephalon announced they exercised their option to expand their
license to include  non-neurological  and neurological  applications  with Sibia
Neuroscience   Inc.  The  license   previously   covered   certain   proprietary
technologies   related  to  the   development   and  production  of  recombinant
insulin-like  growth factors,  which Cephalon uses in the production of IGF-1 or
Myotrophin, for neurological applications.

WARRANT
R&D III distributed the Cephalon warrant in January 1994.  Investors  received a
warrant to purchase 100 shares of Cephalon  common stock per $10,000  investment
in R&D III with an exercise  price of $11.32 per share  through  August 1997 and
$13.82 per share from September  1997 through August 1999.  Based on the closing
price of $17.50 per share on the date of distribution  and the initial  exercise
price of $11.32 per share,  a warrant to purchase 100 shares of Cephalon  common
stock had a value of  approximately  $618 per $10,000 unit.  The available  gain
from the distributed  Cephalon  warrant has ranged from $0 to $3,018 per $10,000
investment in R&D III.



<PAGE>


PAINEWEBBER R&D PARTNERS III, L.P.                            ANNUAL REPORT 1996
--------------------------------------------------------------------------------


GENSIA, INC.

COMPANY
Gensia, Inc. ("Gensia") focuses on the development, manufacture and marketing of
health care products for the acute care and alternate site markets.  Gensia also
conducts preclinical research and development on pharmaceutical products for the
treatment of cardiovascular,  neurological and inflammatory  diseases as well as
diabetes.   Gensia  Laboratories,   Ltd.,  a  subsidiary  of  Gensia,  develops,
manufactures  and  markets  multisource   (generic)   injectable  drugs.  Gensia
currently markets 25 multisource  injectable drugs and has 13 ANDAs under review
at the FDA.

In November 1996,  Gensia  entered into a definitive  agreement to acquire three
pharmaceutical  companies  from  Rakepoll  Finance  N.V. in exchange  for common
shares. Gensia will issue new shares of Gensia common stock to acquire the three
pharmaceutical  companies:  Sicor S.p.A. of Milan, Italy; Sintesis Lerma S.A. de
C.V.;  and Lemery S.A. de C.V.,  both of Mexico.  The new company will be called
Gensia  Sicor Inc. and will be  headquartered  in San Diego.  Gensia  intends to
reorganize its research and development  programs as a new public company called
Metabasis  Therapeutics,   subject  to  certain  consents  and  availability  of
financing.  Gensia is planning to transfer all medical device assets,  including
the GenESA(R) System,  into a subsidiary to be called Gensia Automedics Inc. The
transaction was recently  approved by a shareholder vote at a special meeting of
stockholders on February 26, 1997.

PROGRAM
R&D III committed $4.0 million to a $26.3 million limited  partnership formed to
complete the  development  and human  clinical  trials of the GenESA  System,  a
product designed to enhance the diagnosis of cardiovascular  disease. The GenESA
System   combines   a  drug,   arbutamine,   and  a   computer-controlled   drug
administration  system  designed to  pharmacologically  stress the heart.  It is
expected  that  this  system  will  aid in the  diagnosis  of  patients  who are
suspected  of having  cardiovascular  disease  but who are  unable to  undergo a
traditional  exercise  stress test due to an inability  to exercise  adequately.
Arbutamine  is a drug  developed to stimulate  the heart  pharmacologically  and
thereby elicit certain cardiovascular responses caused by exercise.

In November 1996, Gensia filed an amendment to its new drug application, or NDA,
in the U.S. for the GenESA System.  Gensia believes the additional clinical data
in the NDA amendment is supportive of the approval of the GenESA System.  Gensia
has  received  approval of the GenESA  System from the  European  Committee  for
Proprietary  Medicinal  Products and from nine member  countries of the European
community.  Gensia Europe has commenced  selling the GenESA System in the United
Kingdom and Germany. Gensia continues to believe that the GenESA System provides
significant  clinical  benefit  when used in the  diagnosis  of coronary  artery
disease in patients unable to exercise adequately.  Gensia hopes to receive U.S.
approval of the GenESA System during 1997.

WARRANT
R&D III  distributed  the Gensia  warrant in August 1993.  Investors  received a
warrant to purchase 60 shares of Gensia  common stock per $10,000  investment in
R&D III with an exercise price of $17.47 per share,  which expired July 1996 and
$19.47 per share from August 1996 through July 1998.  Based on the closing price
of $22.50 on the date of distribution  and the initial  exercise price of $17.47
per share, a warrant to purchase 60 shares of Gensia common stock had a value of
approximately  $302 per $10,000 unit.  The available  gain from the  distributed
Gensia warrant has ranged from $0 to $857 per $10,000 investment in R&D III.



<PAGE>


PAINEWEBBER R&D PARTNERS III, L.P.                            ANNUAL REPORT 1996
--------------------------------------------------------------------------------


PHARMAGENICS, INC.

COMPANY
PharmaGenics,   Inc.  ("PGI")  recently   announced  that  Genzyme   Corporation
("Genzyme")  has signed a  definitive  agreement  to acquire PGI in exchange for
shares,  subject to adjustment,  of a new Genzyme tracking stock. PGI's programs
and  technologies  will  be  combined  with  several  oncology  projects  within
Genzyme's General Division to form Genzyme Molecular Oncology, a new division of
the  corporation.  This  new  unit  will  develop  and  commercialize  molecular
approaches to cancer diagnosis and therapy by integrating four key technologies:
genomics, gene therapy, genetic diagnostics,  and a small-molecule combinatorial
chemistry drug discovery program.

PGI,  established in 1990, has benefited from leading-edge cancer research being
conducted by its  collaborators  Drs. Bert Vogelstein and Kenneth Kinzler of The
Johns Hopkins  University School of Medicine.  PGI has also built a portfolio of
rights to specific cancer-related genes and has generated proprietary screens to
identify small-molecule drug discovery targets.  Genzyme Molecular Oncology will
combine the  strengths of these four key  technologies  which will include PGI's
proprietary   SAGE   (serial   analysis   of   gene   expression)   a   powerful
high-throughput,  high-efficiency  method of simultaneously  measuring levels of
gene expression.

The unit begins  operations with extensive  academic and medical  collaborations
with groups such as the National Cancer Institute,  the Imperial Cancer Research
Fund, The Johns Hopkins University, Dana Farber Cancer Center and Memorial Sloan
Kettering Cancer Institute.

PROGRAM
R&D III  committed  $5.0  million  to a  product  development  program  with PGI
utilizing   PGI's   combinatorial   chemistry   technology  to  discover   novel
therapeutics  selected  from  combinatorial  chemistry  libraries for up to four
targets. In addition,  R&D III made a $1.0 million equity investment in 1995 and
received 480,242 shares of PharmaGenics Series C Convertible Preferred Stock.

WARRANTS
R&D III holds a Core  Warrant to purchase  1,000,000  shares of PGI common stock
exercisable  from July 1,  1996 to June 30,  2001 (if PGI does not  complete  an
initial  public  offering  of its  common  stock by July 1, 1996) and a Callable
Warrant to purchase 666,667 shares of PGI common stock that is exercisable under
certain  conditions  in connection  with  PharmaGenics'  purchase  option and an
initial public offering. The exercise price of the Core and Callable Warrants is
$2.15 per share.

REPLIGEN CORPORATION

COMPANY
Prior to  restructuring  in March 1996,  Repligen  Corporation  ("Repligen") has
developed pharmaceutical products primarily in the areas of cancer, inflammatory
disease and cardiovascular  conditions.  In April 1996, Repligen communicated to
investors in the Repligen Clinical  Partners,  L.P. ("RCP") that the company had
terminated  the research  funding  program with  recombinant  Platelet  Factor-4
("rPF4"),  the product being developed with funding from RCP, the partnership in
which R&D III had  participated.  Repligen stated in a letter to shareholders in
April 1996,  that rPF4 had been evaluated in several  clinical trials and showed
an excellent safety profile and potentially useful clinical activity.



<PAGE>




PAINEWEBBER R&D PARTNERS III, L.P.                            ANNUAL REPORT 1996
--------------------------------------------------------------------------------


PROGRAM
R&D III committed $6.0 million to Repligen Clinical  Partners,  L.P. ("RCP"),  a
$45.0  million  limited   partnership   formed  to  fund  the  further  clinical
development of rPF4.  rPF4 is being developed to reverse the effects of heparin,
a drug  commonly  used  in  patients  undergoing  heart  surgery  and  in  other
situations  to prevent the  formation of blood  clots.  rPF4 may also retard the
growth  of solid  tumors  by  inhibiting  the  formation  of new  blood  vessels
necessary for tumors to grow.

Since the RCP funds  have been  depleted  and  Repligen  was not  successful  in
attempts to raise additional  funds for the rPF4 program,  Repligen has returned
rights to rPF4 to RCP in exchange for the  termination of the research  program.
The Board of  Directors  of the  general  partner of RCP are  exploring  various
alternatives to maximize the value of the rPF4 technology to limited partners.

WARRANTS
R&D III holds a warrant to purchase  385,700  shares of Repligen  common  stock.
133,000 shares are exercisable at $2.50 per share and 252,700 are exercisable at
$3.50 per share. The warrant is exercisable from April 1, 1995 through March 31,
2001.





<PAGE>


EXHIBIT C              PAINEWEBBER R&D PARTNERS III, L.P.
                        (A DELAWARE LIMITED PARTNERSHIP)


                   POLICY REGARDING REQUESTS FOR PARTNER LISTS
                   -------------------------------------------


      In accordance with the provisions of the Delaware  Revised Uniform Limited
Partnership  Act  (the  "Act"),  and  without  limiting  its  rights  under  the
Partnership  Agreement or the Act, as each may be amended from time to time, the
General  Partner of the  Partnership  has  established  standards  applicable to
requests for lists of Limited Partners. These standards have been established in
order to assure (1) that the lists are not used for an improper or inappropriate
purpose  or in any way  that  might be  detrimental  to the  Partnership  or the
Limited Partners;  (2) that the Limited Partners have sufficient information and
opportunity to decide how they should react in response to any  solicitation  or
other  communication  addressed to them;  and (3) that the  Partnership  and the
Limited  Partners do not face an increased risk of adverse tax consequences as a
direct or indirect result of any such solicitation or communication.

      The General Partner requires any request to be made in writing by a record
holder of limited partner interests with standing to request the list, to comply
strictly with all applicable  requirements of law and the Partnership Agreement,
to state the purpose for which the request is made with  sufficient  specificity
to enable the General Partner to make the determinations specified above, and to
include an  undertaking  under oath by the  person  requesting  the list and the
persons or  entities  on whose  behalf it is  requested  (1) to hold the list in
strict confidence,  and not to give any information derived from the list to any
third party for any purpose  whatsoever,  (2) to reimburse the  Partnership  for
costs  incurred  in  connection  with  the  request  and for a  list,  including
confirming compliance with the undertakings required hereby and (3) to submit to
the  jurisdiction  of the courts of the State of Delaware in any dispute arising
in connection  with such request and to appoint and maintain RL&F Service Corp.,
One Rodney Square, Tenth Floor,  Wilmington,  New Castle County,  Delaware 19801
(whose  reasonable  fees and expenses will be paid by the  Partnership)  as such
person's or  entity's  agent in the State of Delaware  for  acceptance  of legal
process in connection  therewith.  In addition, in the case of requests made for
the purpose of soliciting tenders of the Limited Partners' interests or units in
the  Partnership  or  soliciting  proxies or consents  from Limited  Partners or
facilitating, assisting or supporting any such solicitation, the General Partner
will,  if and to the  extent  required  by  applicable  law and the  Partnership
Agreement,  make lists available or agree to disseminate  such  solicitations on
behalf of requesting  Limited Partners only upon receipt of an undertaking under
oath by the person  requesting  the list and the  persons or  entities  on whose
behalf it is requested (1) to conduct the  solicitation  in accordance  with the
requirements  of the  Securities  and  Exchange Act of 1934 and the rules of the
Securities and Exchange Commission thereunder,  including full disclosure of all
material  facts and, in the case of any tender  offer,  rights of proration  and
withdrawal rights,  irrespective of the number of interests or units sought, and
(2) to refrain  from  acquiring  interests or units of any number if the General
Partners,  based upon advice from counsel,  conclude that such acquisition would
increase  the  risk  of  adverse  tax  consequences  to the  Partnership  or the
Partners.

      The General  Partner shall endeavor to inform the requesting  party within
30 days of receipt of the requisite  undertakings whether they consider that the
proposed use of the list is improper or inappropriate or would increase the risk
of such adverse tax consequences, and may request such further assurances as may
be necessary in order to enable them to make any of the determinations specified
above.