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**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 
| x                                                                                                                                                                                                                                       | **Quarterly report pursuant to Section 13 or  15(d) of the Securities Exchange Act of 1934**  |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                                                                              | ** **                                                                                              |
| **For the  Quarterly Period Ended September 30, 2009**                                                                                                                                                                             |
| ** **                                                                                                                                                                                                                              | ** **                                                                                              |
| **Or**                                                                                                                                                                                                                                  |
| ** **                                                                                                                                                                                                                              | ** **                                                                                              |
| o                                                                                                                                                                                                                                       | **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 001-33761**

 

**PZENAINVESTMENT MANAGEMENT, INC.**

(Exact Name of Registrant asSpecified in its Charter)

 

| **Delaware**(State or Other Jurisdiction of  Incorporation or Organization) | ** ** | **20-8999751**(I.R.S. Employer  Identification No.) |
|-----------------------------------------------------------------------------|------------|-----------------------------------------------------|

 

**120 West 45th Street**

**New York, New York 10036**

(Address of PrincipalExecutive Offices) (Zip Code)

 

Registrant’s telephonenumber, including area code: **(212) 355-1600**

 

**NotApplicable**(Former name, former address, and former fiscal year if changed since lastreport)

 

Indicate by check markwhether the registrant: (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes x  No o

 

Indicate by check mark whether the registrant hassubmitted electronically and posted on its corporate web site, if any, everyInteractive Date File required to be submitted and posted pursuant to Rule 405of Regulation S-T during the preceding 12 months (or for such shorter periodthat the registrant was required to submit and post such files). Yes o  No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer or a smaller reporting company. See the definitions of“large accelerated filer,” “accelerated filer” and “smaller reporting company”in Rule 12b-2 of the Exchange Act.

 
| Large accelerated  filer o                                                  | Accelerated filer x          |
|----------------------------------------------------------------------------------|-----------------------------------|
|                                                                             |                              |
| Non-accelerated filer o  (Do not check if a smaller reporting company) | Smaller reporting  company o |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act) Yes o  No x

 

As of November 9, 2009,there were 8,633,041 outstanding shares of the registrant’s Class A commonstock, par value $0.01 per share.

 

As of November 9, 2009,there were 55,607,962 outstanding shares of the registrant’s Class Bcommon stock, par value $0.000001 per share.

 

 

 

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**PZENA INVESTMENT MANAGEMENT, INC.**

**FORM 10-Q**

**TABLE OF CONTENTS**

 
| ** **   | ** **                                                                                                                                                                             | ** ** | **Page** |
|--------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
| ** **   | **PART I — FINANCIAL INFORMATION**                                                                                                                                           |       |     |
| Item 1. | Consolidated  Statements of Financial Condition of Pzena Investment Management, Inc.  as of September 30, 2009 (unaudited) and December 31, 2008                        |       | 1        |
|         | Consolidated  Statements of Operations (unaudited) of Pzena Investment Management, Inc.  for the Three and Nine Months Ended September 30, 2009 and  September 30, 2008 |       | 2        |
|         | Consolidated  Statements of Cash Flows (unaudited) of Pzena Investment  Management, Inc. for the Three and Nine Months Ended September 30,  2009 and September 30, 2008 |       | 3        |
|         | Consolidated Statements of Changes in Equity  (unaudited) of Pzena Investment Management, Inc. for the Nine Months  Ended September 30, 2009 and September 30, 2008     |       | 4        |
|         | Notes to the Consolidated Financial Statements  (unaudited)                                                                                                                            |       | 5        |
| Item 2. | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                                            |       | 23       |
| Item 3. | Quantitative  and Qualitative Disclosures About Market Risk                                                                                                                            |       | 35       |
| Item 4  | Controls and  Procedures                                                                                                                                                               |       | 35       |
|         |                                                                                                                                                                                   |       |     |
| ** **   | **PART II  — OTHER INFORMATION**                                                                                                                                             |       |     |
| Item 1. | Legal Proceedings                                                                                                                                                                      |       | 36       |
| Item 1A | Risk Factors                                                                                                                                                                           |       | 37       |
| Item 2. | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                                                           |       | 47       |
| Item 3. | Defaults  Upon Senior Securities                                                                                                                                                       |       | 47       |
| Item 4. | Submission  of Matters to a Vote of Security Holders                                                                                                                                   |       | 47       |
| Item 5. | Other Information                                                                                                                                                                      |       | 47       |
| Item 6  | Exhibits                                                                                                                                                                               |       | 47       |

 

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**CAUTIONARY STATEMENT REGARDING FORWARD-LOOKINGSTATEMENTS**

 

This Quarterly Report on Form 10-Qcontains forward-looking statements. Forward-looking statements provide our current expectations, orforecasts, of future events. Forward-looking statements include statements about our expectations,beliefs, plans, objectives, intentions, assumptions and other statements thatare not historical facts.  Words orphrases such as “anticipate,” “believe,” “continue,” “ongoing,” “estimate,”“expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project” or similarwords or phrases, or the negatives of those words or phrases, may identifyforward-looking statements, but the absence of these words does not necessarilymean that a statement is not forward-looking.

 

Forward-looking statementsare subject to known and unknown risks and uncertainties and are based onpotentially inaccurate assumptions that could cause actual results to differmaterially from those expected or implied by the forward-looking statements.  Our actual results could differ materiallyfrom those anticipated in forward-looking statements for many reasons,including the factors described herein, in “Part II - Item 1A - RiskFactors.”  Accordingly, you should notunduly rely on these forward-looking statements, which speak only as of thedate of this Quarterly Report on Form 10-Q.  We undertake no obligation to publicly reviseany forward-looking statements to reflect circumstances or events after thedate of this Quarterly Report on Form 10-Q, or to reflect the occurrenceof unanticipated events.  You should,however, review the factors and risks we describe in the reports we will filefrom time to time with the Securities and Exchange Commission, or SEC, afterthe date of this Quarterly Report on Form 10-Q.

 

Forward-looking statementsinclude, but are not limited to, statements about:

 

·                  our anticipatedfuture results of operations and operating cash flows;

 

·                  our businessstrategies and investment policies;

 

·                  our financingplans and the availability of short- or long-term borrowing, or equityfinancing;

 

·                  our competitiveposition and the effects of competition on our business;

 

·                  potentialgrowth opportunities available to us;

 

·                  the recruitmentand retention of our employees;

 

·                  our expectedlevels of compensation for our employees;

 

·                  our potentialoperating performance, achievements, efficiency and cost reduction efforts;

 

·                  our expectedtax rate;

 

·                  changes ininterest rates;

 

·                  our expectationwith respect to the economy, capital markets, the market for asset managementservices and other industry trends; and

 

·                  the impact offuture legislation and regulation, and changes in existing legislation andregulation, on our business.

 

The reports that we filewith the SEC, accessible on the SEC’s website at *www.sec.gov*, identify additional factors that can affectforward-looking statements.

 

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**PART I. FINANCIAL INFORMATION**

 

**Item 1. Financial Statements.**

 

**PZENA INVESTMENT MANAGEMENT, INC.**

**CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION**

**(in thousands, except share and per-share amounts)**

 
| ** **                                                                                                                                                               | ** ** | **As of**                    | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                                                                                                               | ** ** | **September 30,  2009** | ** ** | **December 31,  2008** | ** ** |
| ** **                                                                                                                                                               | ** ** | **(unaudited)**              | ** ** | ** ** | ** ** |
| **ASSETS**                                                                                                                                                               |       |                         |       |   |   |
|                                                                                                                                                                     |       |                         |       |   |   |
| Cash and Cash Equivalents                                                                                                                                                |       | $                            | 19,147     |   | $ | 27,421 |   |
| Due from Broker                                                                                                                                                          |       | 54                           |       | 41 |   |
| Advisory Fees Receivable                                                                                                                                                 |       | 12,681                       |       | 13,606 |   |
| Investments in Equity  Securities, at Fair Value                                                                                                                         |       | 18,373                       |       | 14,045 |   |
| Receivable from Related  Parties                                                                                                                                         |       | 170                          |       | 191 |   |
| Other Receivables                                                                                                                                                        |       | 103                          |       | 74 |   |
| Prepaid Expenses and Other  Assets                                                                                                                                       |       | 2,227                        |       | 949 |   |
| Deferred Tax Asset, net                                                                                                                                                  |       | 7,234                        |       | 3,444 |   |
| Property and Equipment,  Net of Accumulated Depreciation of $2,265 and $1,913, respectively                                                                              |       | 2,392                        |       | 2,748 |   |
| TOTAL ASSETS                                                                                                                                                             |       | $                            | 62,381     |   | $ | 62,519 |   |
| ** **                                                                                                                                                               |       |                         |       |   |   |
| **LIABILITIES  AND EQUITY**                                                                                                                                              |       |                         |       |   |   |
| Liabilities:                                                                                                                                                             |       |                         |       |   |   |
| Accounts Payable and  Accrued Expenses                                                                                                                                   |       | $                            | 10,472     |   | $ | 4,338 |   |
| Due to Broker                                                                                                                                                            |       | 29                           |       | 47 |   |
| Term Loan                                                                                                                                                                |       | —                       |       | 22,000 |   |
| Senior Subordinated Notes                                                                                                                                                |       | 16,000                       |       | 16,000 |   |
| Liability to Selling and  Converting Shareholders                                                                                                                        |       | 5,503                        |       | 1,787 |   |
| Other Liabilities                                                                                                                                                        |       | 1,082                        |       | 2,007 |   |
| TOTAL LIABILITIES                                                                                                                                                        |       | 33,086                       |       | 46,179 |   |
|                                                                                                                                                                     |       |                         |       |   |   |
| Equity:                                                                                                                                                                  |       |                         |       |   |   |
| Preferred Stock (Par Value  $0.01; 200,000,000 Shares Authorized; None Outstanding)                                                                                      |       | —                       |       | — |   |
| Class A Common Stock  (Par Value $0.01; 750,000,000 Shares Authorized; 8,633,041and 6,187,068  Shares Issued and Outstanding in 2009 and 2008, respectively)        |       | 86                           |       | 61 |   |
| Class B Common Stock  (Par Value $0.000001; 750,000,000 Shares Authorized; 55,607,962 and  57,975,724 Shares Issued and Outstanding in 2009 and 2008, respectively) |       | —                       |       | — |   |
| Additional Paid-In Capital                                                                                                                                               |       | 9,836                        |       | 9,749 |   |
| Accumulated Deficit                                                                                                                                                      |       | (2,554                       | )          | (5,289 | ) |
| Total Pzena Investment  Management, Inc.’s Equity                                                                                                              |       | 7,368                        |       | 4,521 |   |
| Non-Controlling Interests                                                                                                                                                |       | 21,927                       |       | 11,819 |   |
| TOTAL EQUITY                                                                                                                                                             |       | 29,295                       |       | 16,340 |   |
| TOTAL LIABILITIES AND  EQUITY                                                                                                                                            |       | $                            | 62,381     |   | $ | 62,519 |   |

 

See accompanying notes to consolidatedfinancial statements

 

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**PZENA INVESTMENT MANAGEMENT, INC.**

**UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(in thousands, except share and per-share amounts)**

 
| ** **                                                                               | ** ** | **For the Three Months********Ended  September 30,** | ** ** | **For the  Nine Months********Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                                               | ** ** | **2009**                                                  | ** ** | **2008**                                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                                                     |       |                                                      |       |                                                      |       |   |   |   |   |
| **REVENUE**                                                                              |       | $                                                         | 16,813     |                                                      | $          | 25,072 |   | $ | 44,717 |   | $ | 83,389 |   |
|                                                                                     |       |                                                      |       |                                                      |       |   |   |   |   |
| **EXPENSES**                                                                             |       |                                                      |       |                                                      |       |   |   |   |   |
| Compensation and Benefits  Expense                                                       |       | 6,232                                                     |       | 8,160                                                     |       | 18,255 |   | 25,773 |   |
| General and Administrative  Expenses                                                     |       | 1,904                                                     |       | 2,626                                                     |       | 6,330 |   | 8,321 |   |
| TOTAL OPERATING EXPENSES                                                                 |       | 8,136                                                     |       | 10,786                                                    |       | 24,585 |   | 34,094 |   |
| Operating Income                                                                         |       | 8,677                                                     |       | 14,286                                                    |       | 20,132 |   | 49,295 |   |
|                                                                                     |       |                                                      |       |                                                      |       |   |   |   |   |
| **OTHER  INCOME/(EXPENSE)**                                                              |       |                                                      |       |                                                      |       |   |   |   |   |
| Interest and Dividend  Income                                                            |       | 116                                                       |       | 473                                                       |       | 363 |   | 1,510 |   |
| Interest Expense                                                                         |       | (376                                                      | )          | (777                                                      | )          | (1,231 | ) | (2,814 | ) |
| Realized and Unrealized  Gain/(Loss), Net on Equity Securities and Securities Sold Short |       | 4,152                                                     |       | (4,075                                                    | )          | 6,061 |   | (10,955 | ) |
| Other Income/(Expense)                                                                   |       | (2,341                                                    | )          | 53,704                                                    |       | (3,437 | ) | 53,716 |   |
| Total Other Income                                                                       |       | 1,551                                                     |       | 49,325                                                    |       | 1,756 |   | 41,457 |   |
| Income Before Income Taxes                                                               |       | 10,228                                                    |       | 63,611                                                    |       | 21,888 |   | 90,752 |   |
| Income Tax  Provision/(Benefit)                                                          |       | (2,040                                                    | )          | 63,964                                                    |       | (2,379 | ) | 66,962 |   |
| Consolidated Net  Income/(Loss)                                                          |       | 12,268                                                    |       | (353                                                      | )          | 24,267 |   | 23,790 |   |
| Less: Net Income  Attributable to Non-Controlling Interests                              |       | 10,836                                                    |       | 8,357                                                     |       | 21,531 |   | 30,900 |   |
| Net Income/(Loss)  Attributable to Pzena Investment Management, Inc.                |       | $                                                         | 1,432      |                                                      | $          | (8,710 | ) | $ | 2,736 |   | $ | (7,110 | ) |

 

Earnings Per Share — Basic and Diluted Attributable to Pzena InvestmentManagement, Inc. Common Stockholders:

 
| Net Income/(Loss) for  Basic Earnings per Share   |   | $          | 1,432  |      | $      | (8,710     | )      | $         | 2,736  |   | $ | (7,110 | ) |
|---------------------------------------------------|--------|------------|--------|-----------|--------|------------|--------|-----------|--------|--------|---|--------|---|
| Basic Earnings per Share                          |   | $          | 0.17   |      | $      | (1.42      | )      | $         | 0.34   |   | $ | (1.16  | ) |
| Basic Weighted Average  Shares Outstanding        |   | 8,633,041  |   | 6,123,494 |   | 8,077,545  |   | 6,122,229 |   |
|                                              |   |       |   |      |   |       |   |      |   |
| Net Income/(Loss) for  Diluted Earnings per Share |   | $          | 6,051  |      | $      | (8,710     | )      | $         | 12,889 |   | $ | (7,110 | ) |
| Diluted Earnings per Share                        |   | $          | 0.09   |      | $      | (1.42      | )      | $         | 0.20   |   | $ | (1.16  | ) |
| Diluted Weighted Average  Shares Outstanding      |   | 64,994,278 |   | 6,123,494 |   | 64,756,331 |   | 6,122,229 |   |

 

See accompanying notes to consolidatedfinancial statements

 

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**PZENA INVESTMENT MANAGEMENT, INC.**

**UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands)**

 
| ** **                                                                               | ** ** | **For the Three Months  Ended  September 30,** | ** ** | **For the Nine Months********Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                               | ** ** | **2009**                                            | ** ** | **2008**                                                 | ** ** | **2009** | ** ** | **2008** | ** ** |
| **OPERATING ACTIVITIES**                                                                 |       |                                                |       |                                                     |       |   |   |   |   |
| Consolidated Net Income/(Loss)                                                           |       | $                                                   | 12,268     |                                                     | $          | (353 | ) | $ | 24,266 |   | $ | 23,790 |   |
| Adjustments  to Reconcile Net Income/(Loss) to Cash Provided by Operating Activities:    |       |                                                |       |                                                     |       |   |   |   |   |
| Depreciation                                                                             |       | 121                                                 |       | 135                                                      |       | 362 |   | 368 |   |
| Non-Cash Compensation                                                                    |       | 255                                                 |       | 272                                                      |       | 816 |   | 905 |   |
| Director Share Grant                                                                     |       | —                                              |       | —                                                   |       | 280 |   | 140 |   |
| Realized and Unrealized (Gain)/Loss, Net on Equity  Securities and Securities Sold Short |       | (4,152                                              | )          | 4,075                                                    |       | (6,061 | ) | 10,955 |   |
| Increase/(Decrease) in Liability to Selling and  Converting Shareholders                 |       | 2,382                                               |       | (53,337                                                  | )          | 3,586 |   | (53,337 | ) |
| Deferred Income Taxes                                                                    |       | (2,611                                              | )          | 63,165                                                   |       | (3,804 | ) | 64,229 |   |
| Changes in Operating Assets and Liabilities:                                             |       |                                                |       |                                                     |       |   |   |   |   |
| Advisory Fees Receivable                                                                 |       | (2,113                                              | )          | (115                                                     | )          | 881 |   | 5,449 |   |
| Due from Broker                                                                          |       | (19                                                 | )          | 58                                                       |       | (13 | ) | 237 |   |
| Prepaid Expenses and Other Assets                                                        |       | (1,550                                              | )          | (588                                                     | )          | (1,544 | ) | 569 |   |
| Due to Broker                                                                            |       | (1                                                  | )          | 1,844                                                    |       | (18 | ) | 1,199 |   |
| Accounts Payable, Accrued Expenses, and Other  Liabilities                               |       | 2,790                                               |       | 2,969                                                    |       | 5,115 |   | 6,253 |   |
| Due to Principals                                                                        |       | (653                                                | )          | —                                                   |       | — |   | — |   |
| Purchases of Equity Securities and Securities Sold  Short                                |       | (2,913                                              | )          | (5,990                                                   | )          | (7,771 | ) | (28,133 | ) |
| Proceeds from Sale of Equity Securities and  Securities Sold Short                       |       | 3,891                                               |       | 4,211                                                    |       | 9,506 |   | 16,067 |   |
| **Net Cash Provided by Operating  Activities**                                           | ** ** | **7,695**                                           | ** ** | **16,346**                                               | ** ** | **25,601** | ** ** | **48,691** | ** ** |
| ** **                                                                               |       |                                                |       |                                                     |       |   |   |   |   |
| **INVESTING ACTIVITIES**                                                                 |       |                                                |       |                                                     |       |   |   |   |   |
| Receivable from Related Parties                                                          |       | (43                                                 | )          | (87                                                      | )          | 6 |   | (55 | ) |
| Purchases of Property and Equipment                                                      |       | —                                              |       | (76                                                      | )          | (6 | ) | (160 | ) |
| **Net Cash Used in Investing  Activities**                                               | ** ** | **(43**                                             | **)**      | **(163**                                                 | **)**      | **—** | ** ** | **(215** | **)** |
| ** **                                                                               |       |                                                |       |                                                     |       |   |   |   |   |
| **FINANCING ACTIVITIES**                                                                 |       |                                                |       |                                                     |       |   |   |   |   |
| Contributions from Non-Controlling Interests                                             |       | 322                                                 |       | 149                                                      |       | 322 |   | 7,082 |   |
| Distributions to Non-Controlling Members                                                 |       | (4,719                                              | )          | (11,277                                                  | )          | (12,199 | ) | (36,136 | ) |
| Contributions from Shareholder                                                           |       | —                                              |       | 172                                                      |       | — |   | 172 |   |
| Term Loan Repayment                                                                      |       | (10,000                                             | )          | (10,000                                                  | )          | (22,000 | ) | (13,000 | ) |
| Dividends                                                                                |       | —                                              |       | (674                                                     | )          | — |   | (2,018 | ) |
| **Net Cash Used in Financing  Activities**                                               | ** ** | **(14,397**                                         | **)**      | **(21,630**                                              | **)**      | **(33,877** | **)** | **(43,900** | **)** |
| ** **                                                                               |       |                                                |       |                                                     |       |   |   |   |   |
| **NET CHANGE IN CASH**                                                                   | ** ** | **$**                                               | **(6,745** | **)**                                                    | **$**      | **(5,447** | **)** | **$** | **(8,276** | **)** | **$** | **4,576** | ** ** |
| ** **                                                                               |       |                                                |       |                                                     |       |   |   |   |   |
| **CASH AND CASH EQUIVALENTS—Beginning  of Period**                                  |       | $                                                   | 25,892     |                                                     | $          | 37,207 |   | $ | 27,421 |   | $ | 27,184 |   |
| Net Change in Cash                                                                       |       | (6,745                                              | )          | (5,447                                                   | )          | (8,274 | ) | 4,576 |   |
| **CASH AND CASH EQUIVALENTS—End of  Period**                                        |       | $                                                   | 19,147     |                                                     | $          | 31,760 |   | $ | 19,147 |   | $ | 31,760 |   |
| Supplementary Cash Flow Information:                                                     |       |                                                |       |                                                     |       |   |   |   |   |
| Interest Paid                                                                            |       | $                                                   | 332        |                                                     | $          | 1,450 |   | $ | 1,191 |   | $ | 3,464 |   |
| Income Taxes Paid                                                                        |       | $                                                   | 535        |                                                     | $          | 805 |   | $ | 1,907 |   | $ | 3,847 |   |

 

See accompanying notes to consolidatedfinancial statements

 

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**PZENA INVESTMENT MANAGEMENT, INC.**

**UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY**

**(in thousands, except share and per-share amounts)**

 
| ** **                                                                       | ** ** | **Shares of  Class A  Common  Stock** | ** ** | **Shares of  Class B  Common  Stock** | ** ** | **Class A  Common  Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Retained  Earnings/********(Accumulated  Deficit)** | ** ** | **Non-  Controlling  Interests** | ** ** | **Total**   | ** ** |
|----------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|---------------------------------|------------|----------------------------------|------------|-------------------------------------------------------|------------|----------------------------------|------------|-------------|------------|
| **Balance at December 31, 2008**                                            | ** ** | **6,187,068**                                   | ** ** | **57,975,724**                                  | ** ** | **$**                           | **61**     | ** **                       | **$**      | **9,749**                                             | ** ** | **$**                            | **(5,289** | **)**       | **$**      | **11,819** | ** ** | **$** | **16,340** | ** ** |
| Unit Conversion                                                                  |       | 2,445,973                                       |       | (2,445,973                                      | )          | 25                              |       | 107                              |       | —                                                |       | (108                             | )          | **24**      | ** ** |
| Amortization of Non-Cash Compensation                                            |       | —                                          |       | —                                          |       | —                          |       | 67                               |       | —                                                |       | 475                              | ** ** | **542**     | ** ** |
| Option Exercise                                                                  |       | —                                          |       | 78,211                                          |       | —                          |       | —                           |       | —                                                |       | —                           |       | —      |       |
| Net Income                                                                       |       | —                                          |       | —                                          |       | —                          |       | —                           |       | 2,735                                                 |       | 21,531                           | ** ** | **24,266**  | ** ** |
| Capital Contribution                                                             |       | —                                          |       | —                                          |       | —                          |       | —                           |       | —                                                |       | 322                              | ** ** | **322**     | ** ** |
| Capital Distribution                                                             |       | —                                          |       | —                                          |       | —                          |       | (87                              | )          | —                                                |       | (12,112                          | )          | **(12,199** | **)**      |
| **Balance at September 30, 2009**                                           | ** ** | **8,633,041**                                   | ** ** | **55,607,962**                                  | ** ** | **$**                           | **86**     | ** **                       | **$**      | **9,836**                                             | ** ** | **$**                            | **(2,554** | **)**       | **$**      | **21,927** | ** ** | **$** | **29,295** | ** ** |
| ** **                                                                       |       |                                            |       |                                            |       |                            |       |                             |       |                                                  | ** ** | ** **                       | ** ** | ** **  | ** ** |
| **Balance at December 31, 2007**                                            | ** ** | **6,111,118**                                   | ** ** | **57,937,910**                                  | ** ** | **$**                           | **61**     | ** **                       | **$**      | **(2,043**                                            | **)**      | **$**                            | **61**     | ** **  | **$**      | **16,355** | ** ** | **$** | **14,434** | ** ** |
| Issuance of Class A Common Stock                                            |       | 12,376                                          |       | —                                          |       | —                          |       | 11                               |       | —                                                |       | 126                              | ** ** | **137**     | ** ** |
| Issuance of Class B Common Stock and  Amortization of Non-Cash Compensation |       | —                                          |       | 13,000                                          |       | —                          |       | 42                               |       | —                                                |       | 398                              | ** ** | **440**     | ** ** |
| Net Income/(Loss)                                                                |       | —                                          |       | —                                          |       | —                          |       | —                           |       | (7,110                                                | )          | 30,900                           | ** ** | **23,790**  | ** ** |
| Capital Contributions                                                            |       | —                                          |       | —                                          |       | —                          |       | 172                              |       | —                                                |       | 5,908                            | ** ** | **6,080**   | ** ** |
| Equity Effect of Operating Company Net Deficit on  Non-Controlling Interests     |       | —                                          |       | —                                          |       | —                          |       | 8,941                            |       | —                                                |       | (8,941                           | )          | **—**  | ** ** |
| Capital Distribution                                                             |       | —                                          |       | —                                          |       | —                          |       | —                           |       | —                                                |       | (28,585                          | )          | **(28,585** | **)**      |
| Class A Cash Dividends Paid ($0.22 per share)                               |       | —                                          |       | —                                          |       | —                          |       | —                           |       | (1,347                                                | )          | —                           | ** ** | **(1,347**  | **)**      |
| Class A Cash Dividends Declared ($0.05 per  share)                          |       | —                                          |       | —                                          |       | —                          |       | —                           |       | (306                                                  | )          | —                           | ** ** | **(306**    | **)**      |
| **Balance at September 30, 2008**                                           | ** ** | **6,123,494**                                   | ** ** | **57,950,910**                                  | ** ** | **$**                           | **61**     | ** **                       | **$**      | **7,123**                                             | ** ** | **$**                            | **(8,702** | **)**       | **$**      | **16,161** | ** ** | **$** | **14,643** | ** ** |

 

See accompanying notes to consolidatedfinancial statements

 

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**Pzena Investment Management, Inc.**

**Unaudited Notes to theConsolidated Financial Statements**

 

**Note 1—Organization**

 

Pzena Investment Management, Inc. (the “Company”) functions as theholding company through which the business of its operating company, PzenaInvestment Management, LLC, is conducted. The Company was incorporated inthe State of Delaware on May 8, 2007. Concurrently with the consummation of the Company’s initial publicoffering, on October 30, 2007, the Operating Agreement of Pzena InvestmentManagement, LLC (the “operating agreement”) was amended and restated suchthat, among other things, the Company became the sole managing member of PzenaInvestment Management, LLC.  Theacquisition of the operating company’s membership interests by the Company wastreated as a reorganization of entities under common control.  As a result of these transactions, as of andsubsequent to October 30, 2007, (i) the Company has consolidated thefinancial results of Pzena Investment Management, LLC with its own andreflected the membership interest in it that it does not own as anon-controlling interest in its consolidated financial statements, and (ii) theCompany recognizes income generated from its economic interest in PzenaInvestment Management, LLC’s net income.

 

Pzena InvestmentManagement, LLC is an investment adviser which is registered under theInvestment Advisers Act of 1940 and is headquartered in New York, New York.  As of September 30, 2009, the Companymanaged assets in a variety of value-oriented investment strategies across awide range of market capitalizations in both U.S. and non-U.S. capital markets.

 

The Company, through itsinvestment in its operating company, has consolidated the results of operationsand financial condition of the following private investment partnerships as of September 30,2009:

 
| **Entity**                                    | ** ** | **Type of Entity (Date of Formation)**          | ** ** | **Ownership  at  September 30,  2009** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------|------------|---------------------------------------------|------------|
| Pzena Large Cap Value Fund                    |       | Massachusetts Trust (11/01/2002)                |       | 99.6%                                       |       |   |
| Pzena International Value  Service            |       | Delaware Limited Liability Company (12/22/2003) |       | 16.7%                                       |       |   |   |
| Pzena Global Value Service                    |       | Delaware Limited Liability Company (12/22/2003) |       | 0.8%                                        |       |   |   |
| Pzena Emerging Markets  Country Value Service |       | Delaware Limited Liability Company (12/28/2007) |       | 99.9%                                       |       |   |   |
| Pzena Emerging Markets  Focused Value Service |       | Delaware Limited Liability Company (12/28/2007) |       | 99.9%                                       |       |   |   |

 

Pursuant to its operatingagreement, the operating company will continue until December 31, 2026,unless a terminating event, as defined in the operating agreement, occurs priorto this date. Operating company members are not liable for repayment,satisfaction or discharge of any debts, liabilities or obligations of theoperating company, except to the extent of their capital accounts.

 

**Note 2—SignificantAccounting Policies**

 

***Basis of Presentation:***

 

The consolidated financial statements are prepared in conformity withU.S. generally accepted accounting principles (“GAAP”) and related Securitiesand Exchange Commission (“SEC”) rules and regulations.  The Company follows accounting standards setby the Financial Accounting Standards Board, commonly referred to as the“FASB.”  The FASB sets GAAP that theCompany follows to ensure the Company consistently report its financialcondition, results of operations, and cash flows.  Over the years, the FASB and other designatedGAAP-setting bodies, have issued standards in the form of FASB Statements, Interpretations,FASB Staff Positions, Emerging Issues Task Force consensuses, AmericanInstitute of Certified Public Accountants Statements of Position, etc.  The FASB recognized the complexity of its standard-setting process and embarkedon a revised process in 2004 that culminated in the release on July 1,2009, of the *FASB Accounting StandardsCodification,* (“ASC”), sometimes referred to as theCodification.  To the Company, this meansthe accounting literature that the Company will refer to in its fair valueaccounting disclosures, for example, will be disclosed as the *Fair Value Measurements and Disclosures Topic*ofthe FASB ASC.  The Codification does notchange how the Company accounts for its transactions or the nature of relateddisclosures made; however, when referring to guidance issued by the FASB, theCompany refers to topics in the ASC rather than specific statementnumbers.  The change was made effectiveby the FASB for periods ending on or after September 15, 2009.  The Company has updated references to GAAP inits notes throughout the consolidated financial statements to reflect theguidance in the Codification.

 

The Company’s policy is to consolidate all majority-owned subsidiariesin which it has a controlling financial interest and variable interest entitieswhere the Company is deemed to be the primary beneficiary (“ConsolidatedSubsidiaries”).  As required by the *Consolidation Topic* of the FASB ASC, the Company alsoconsolidates non-variable-interest entities in which it acts as the generalpartner or managing member.  All of theseentities represent private investment partnerships over which the Companyexercises or exercised control. Non-controlling interests recorded on the consolidated financialstatements of the Company include the non-controlling interests of the outsideinvestors in each of these entities, as well as those of the operatingcompany.  All significant inter-companytransactions and balances have been eliminated.

 

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**Pzena Investment Management, Inc.**

**Unaudited Notes to the Consolidated Financial Statements (Continued)**

 

**Note 2—SignificantAccounting Policies****(continued)**

 

The Pzena Global ValueService and the Pzena International Value Service are limited liabilitycompanies whose managing members are omembers of the executive committee of theoperating company or the operating company itself.  Neither of these entities are considered variable-interestentities, as the managing members have substantive interests in thepartnerships.  Each of these limitedliability companies are considered entities “similar” to limited partnershipsand thus subject to the guidance of the *Consolidation Topic*of the FASB ASC.  Under each of theirrespective operating agreements, none of these entities’ non-managing membershave the ability to remove the managing member under any circumstance, nor dothey have any participating rights.  As aresult, nothing substantive exists to overcome the presumption of control bythe managing member as required by the *Consolidation Topic*of the FASB ASC.  As the managing membersof these entities are, or were, either the operating company or one of thecontrolling persons of the operating company, their results of operations andfinancial position have been consolidated.

 

During the fourth quarter of2008, the decision was made to close the Pzena Large Cap Value Fund II, thePzena Emerging Markets Value Service, the Pzena Mega Cap Value Fund, and PzenaValue Partners.  The results ofoperations and financial position of each of these entities were consolidateduntil the dates of their respective liquidations.

 

All of the consolidatedinvestment partnerships are, or were, investment companies under the American Instituteof Certified Public Accountants Audit and Accounting Guide for InvestmentCompanies.  The Company has retained thespecialized accounting for these partnerships pursuant to the *Consolidation Topic* of the FASB ASC.  Thus, the Company reports the investmentpartnerships’ investments in equity securities and securities sold short atfair value, with net realized and unrealized gains and losses reported inearnings in the consolidated statements of operations.

 

The Company records in itsown equity its pro-rata share of transactions that impact the operatingcompany’s net equity, including equity and option issuances and adjustments toaccumulated other comprehensive income. The operating company’s pro-rata share of such transactions are recordedas adjustments to additional paid-in capital or non-controlling interests, asapplicable, on the consolidated statements of financial position.  As discussed further in Note 13,Non-Controlling Interests, the Company did not initially record anon-controlling interest associated with the acquisition of its operatingcompany, as the post-offering net equity of the operating company was less thanzero.  As required by the *Consolidation Topic* of the FASB ASC, a non-controllinginterest in the equity of the operating company was recorded after the initialdeficit that existed at acquisition was extinguished in 2008.

 

The Company acts as theinvestment manager for four trusts and one offshore investment company, each ofwhich are considered variable-interest entities.  All of these entities are vehicles throughwhich the Company offers its Global Value strategies and/or its Europe,Australasia, and Far East (“EAFE”) Value strategies.  The Company is not considered the primarybeneficiary of any of these entities. Correspondingly, their results of operations and financial condition arenot consolidated by the Company.  Thetotal net assets of these variable-interest entities was approximately $528.7million and $446.0 million at September 30, 2009 and December 31,2008, respectively.  The Company is notexposed to losses as a result of its involvement with these entities because ithas no direct investment in them.

 

***Management’s Use of Estimates:***

 

The preparation of financialstatements in conformity with U.S. generally accepted accounting principlesrequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities, disclosure of contingent assets andliabilities at the date of the financial statements, and the reported amountsof revenues and expenses for the period. Actual results could differ from those estimates.

 

***Fair Values of FinancialInstruments:***

 

The carrying amounts of allfinancial instruments in the consolidated statements of financial condition,including investments in equity securities, approximate their fair value.

 

***Revenue Recognition:***

 

Revenue, comprised ofadvisory fee income, is recognized over the period in which investmentmanagement services are provided. Advisory fee income includes management fees that are calculated basedon percentages of assets under management (“AUM”), generally billed quarterly,either in arrears or advance, depending on their contractual terms.  Advisory fee income also includes incentive feesthat may be earned by the Company depending on the investment return of theassets under management.

 

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**Pzena Investment Management, Inc.**

**Unaudited Notes to the Consolidated Financial Statements (Continued)**

 

**Note 2—SignificantAccounting Policies****(continued)**

 

Incentive fee arrangements generally entitlethe Company to participate, on a fixed-percentage basis, in any returnsgenerated in excess of an agreed-upon benchmark.  The Company’s participation percentage insuch return differentials is then multiplied by assets under management todetermine the incentive fees earned. Returns are calculated on an annualized basis over the contract’smeasurement period, which may extend up to three years.  Incentive fees are generally payableannually.  As required by the *Revenue Recognition Topic* of the FASB ASC, such incentivefee income is recorded at the conclusion of the contractual performance period,when all contingencies are resolved.  TheCompany recognized no such incentive fees for the three and nine months ended September 30,2009 and 2008.

 

***Earnings per Share:***

 

Basic earnings per share iscomputed by dividing the Company’s net income or loss attributable to theCompany’s common stockholders by the weighted average number of sharesoutstanding during the reporting period. Diluted earnings per share adjusts this calculation to reflect theimpact of all outstanding operating company membership units, as well asoutstanding operating company options and phantom units, to the extent theywould have a dilutive effect on net income per share for the reportingperiod.  Net income for diluted earningsper share generally assumes all operating company membership units areconverted into Company stock at the beginning of the reporting period and theresulting change to Company net income associated with its increased interestin the operating company is taxed at the Company’s effective tax rate.

 

For the three and ninemonths ended September 30, 2009, the Company’s diluted net income wasdetermined as follows (in thousands):

 
| ** **                                                     | ** ** | **For the  Three  Months Ended  September 30,  2009** | ** ** |
|----------------------------------------------------------------|------------|------------------------------------------------------------|------------|
| ** **                                                     | ** ** | ** **                                                 | ** ** |
| Non-Controlling Interests  of Pzena Investment Management, LLC |       | $                                                          | 8,082      |   |
| Less: Assumed Corporate  Income Taxes                          |       | 3,463                                                      |       |
| Assumed After-Tax Income  of Pzena Investment Management, LLC  |       | $                                                          | 4,619      |   |
|                                                           |       |                                                       |       |
| Assumed After-Tax Income  of Pzena Investment Management, LLC  |       | $                                                          | 4,619      |   |
| Net Income of Pzena  Investment Management, Inc.          |       | 1,432                                                      |       |
| Diluted Net Income                                             |       | $                                                          | 6,051      |   |

 
| ** **                                                     | ** ** | **For the  Nine  Months Ended  September 30,  2009** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                     | ** ** | ** **                                                | ** ** |
| Non-Controlling Interests  of Pzena Investment Management, LLC |       | $                                                         | 17,767     |   |
| Less: Assumed Corporate  Income Taxes                          |       | 7,613                                                     |       |
| Assumed After-Tax Income  of Pzena Investment Management, LLC  |       | $                                                         | 10,154     |   |
|                                                           |       |                                                      |       |
| Assumed After-Tax Income  of Pzena Investment Management, LLC  |       | $                                                         | 10,154     |   |
| Net Income of Pzena  Investment Management, Inc.          |       | 2,735                                                     |       |
| Diluted Net Income                                             |       | $                                                         | 12,889     |   |

 

For each of the three andnine months ended September 30, 2009, 954,310 options to purchaseoperating company units were excluded from the calculation of diluted netincome per share, as their inclusion would have had an antidilutive effect forthe period.  For each of the three andnine months ended September 30, 2008, 57,950,910 operating company units,954,310 options to purchase operating company units, and 89,826 phantom unitswere excluded from the calculation of diluted net income per share, as theirinclusion would have had an antidilutive effect for both periods.

 

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**Pzena Investment Management, Inc.**

**Unaudited Notes to the Consolidated Financial Statements (Continued)**

 

**Note 2—SignificantAccounting Policies****(continued)**

 

For the three and ninemonths ended September 30, 2009, the Company’s basic and diluted earningsper share were determined as follows (in thousands, except for share andper-share amounts):

 
| ** **                                   | ** ** | **For the  Three  Months Ended  September 30, 2009** | ** ** |
|----------------------------------------------|------------|-----------------------------------------------------------|------------|
|                                         |       |                                                      |       |
| Net Income for Basic  Earnings per Share     |       | $                                                         | 1,432      |   |
| Basic Weighted Average  Shares Outstanding   |       | 8,633,041                                                 |       |
| Basic Earnings per Share                     |       | $                                                         | 0.17       |   |
|                                         |       |                                                      |       |
| Net Income for Diluted  Earnings per Share   |       | $                                                         | 6,051      |   |
| Basic Weighted Average  Shares Outstanding   |       | 8,633,041                                                 |       |
| Dilutive Effect of  Operating Company Units  |       | 55,606,508                                                |       |
| Dilutive Effect of Phantom  Units            |       | 754,729                                                   |       |
| Diluted Weighted Average  Shares Outstanding |       | 64,994,278                                                |       |
| Diluted Earnings per Share                   |       | $                                                         | 0.09       |   |

 
| ** **                                   | ** ** | **For the  Nine********Months Ended  September 30, 2009** | ** ** |
|----------------------------------------------|------------|----------------------------------------------------------------|------------|
|                                         |       |                                                           |       |
| Net Income for Basic  Earnings per Share     |       | $                                                              | 2,736      |   |
| Basic Weighted Average  Shares Outstanding   |       | 8,077,545                                                      |       |
| Basic Earnings per Share                     |       | $                                                              | 0.34       |   |
|                                         |       |                                                           |       |
| Net Income for Diluted  Earnings per Share   |       | $                                                              | 12,889     |   |
| Basic Weighted Average  Shares Outstanding   |       | 8,077,545                                                      |       |
| Dilutive Effect of  Operating Company Units  |       | 56,131,004                                                     |       |
| Dilutive Effect of Phantom  Units            |       | 547,782                                                        |       |
| Diluted Weighted Average  Shares Outstanding |       | 64,756,331                                                     |       |
| Diluted Earnings per Share                   |       | $                                                              | 0.20       |   |

 

For the three andnine months ended September 30, 2008, the Company generated net losses of$8.7 million and $7.1 million, respectively. Consequently, basic and diluted net loss, net loss per share, andweighted average shares outstanding are identical for each of these periods.

 

***Cash and Cash Equivalents:***

 

The Company considers allhighly-liquid debt instruments with an original maturity of three months orless at the time of purchase to be cash equivalents.  The Company maintains its cash in bankdeposits and other accounts, the majority of which are held at two financialinstitutions.  These balances, at times,exceed federally insured limits.

 

Interest on cash and cashequivalents is recorded as interest income on an accrual basis on theconsolidated statements of operations.

 

***Investments in Equity Securities, atFair Value:***

 

Investments in equitysecurities represent primarily the securities held by the Company’sconsolidated investment partnerships. All such securities are recorded at fair value, with net realized andunrealized gains and losses reported in earnings in the consolidated statementsof operations.

 

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**Pzena Investment Management, Inc.**

**Unaudited Notes to the Consolidated Financial Statements (Continued)**

 

**Note 2—SignificantAccounting Policies****(continued)**

 

The *Fair ValueMeasurements and Disclosures Topic* of the FASB ASC defines fairvalue as the price that would be received to sell an asset, or paid to transfera liability, in an orderly transaction between market participants at themeasurement date.  The *Fair Value Measurements and Disclosures Topic* of the FASBASC also establishes a framework for measuring fair value and a valuationhierarchy based upon the transparency of inputs used in the valuation of anasset or liability.  Classificationwithin the hierarchy is based upon the lowest level of input that issignificant to the fair value measurement. The valuation hierarchy contains three levels: (i) valuation inputsare unadjusted quoted market prices for identical assets or liabilities inactive markets (Level 1); (ii) valuation inputs are quoted prices foridentical assets or liabilities in markets that are not active, quoted marketprices for similar assets and liabilities in active markets, and otherobservable inputs directly or indirectly related to the asset or liabilitybeing measured (Level 2); and (iii) valuation inputs are unobservableand significant to the fair value measurement (Level 3).  Additionally, entities are required to disclose ininterim and annual periods the inputs and valuation techniques used to measurefair value and define assets and liabilities measured at fair value by majorcategory.

 

The Company’s fair value measurements relate to its interest rate swap,as well as its investments in equity securities, which are primarilyexchange-traded securities with quoted prices in active markets.  The fair value measurement of the interestrate swap was determined primarily based upon the market prices for interestrate swaps with similar provisions and the use of forward interest ratecurves.  Prior to its termination in September 2009,the interest rate swap was classified as Level 2 and recorded in otherliabilities on the consolidated statement of financial condition.  The fair value measurements of the securitieshave been classified as Level 1.

 

The following table presents these instruments’ fair value at September 30,2009 (in thousands):

 
| ** **        | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
|-------------------|------------|-------------|------------|-------------|------------|-------------|------------|
| Assets:           |       |        |       |        |       |        |       |
| Equity Securities |       | $           | 18,373     |        | $          | —      |       | $ | — |   |
| Total Fair Value  |       | $           | 18,373     |        | $          | —      |       | $ | — |   |

 

The following table presentsthese instruments’ fair value at December 31, 2008 (in thousands):

 
| ** **         | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
|--------------------|------------|-------------|------------|-------------|------------|-------------|------------|
| Assets:            |       |        |       |        |       |        |       |
| Equity Securities  |       | $           | 14,045     |        | $          | —      |       | $ | — |   |
| Liabilities:       |       |        |       |        |       |        |       |
| Interest Rate Swap |       | —      |       | (628        | )          | —      |       |
| Total Fair Value   |       | $           | 14,045     |        | $          | (628        | )          | $ | — |   |

 

***Securities Valuation:***

 

Investments in equitysecurities which are traded on a national securities exchange are carried atfair value based on the last reported sales price on the valuation date.  If no reported sales occurred on thevaluation date, investments in securities are valued at the bid price.  Securities transactions are recorded on thetrade date.

 

The net realized gain orloss on sales of securities is determined on a specific identification basisand is included in realized and unrealized loss, net on equity securities andsecurities sold short in the consolidated statements of operations.

 

***Concentrations of Credit Risk:***

 

Financial instruments thatpotentially subject the Company to concentrations of credit risk consistprincipally of cash and cash equivalents, amounts due from brokers and advisoryfees receivable.  The Company maintains itscash and temporary cash investments in bank deposits and other accounts whosebalances, at times, exceed federally insured limits.

 

The concentration of creditrisk with respect to advisory fees receivable is generally limited due to theshort payment terms extended to clients by the Company.  On a periodic basis, the Company evaluatesits advisory fees receivable and establishes an allowance for doubtfulaccounts, if necessary, based on a history of past write-offs and collectionsand current credit conditions.  For thethree months ended September 30, 2009 and 2008, approximately 10.6% and13.1%, respectively, of the Company’s advisory fees were generated from anadvisory agreement with one client.  Forthe nine months ended September 30, 2009 and 2008, fees generated fromthis agreement comprised 11.4% and 14.4%, respectively, of the Company’s totaladvisory fees.  At September 30,2009 and December 31, 2008, no allowance for doubtful accounts was deemednecessary.

 

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**Pzena Investment Management, Inc.**

**Unaudited Notes to the Consolidated Financial Statements (Continued)**

 

**Note 2—SignificantAccounting Policies****(continued)**

 

***Financial Instruments:***

 

On February 28, 2008,the operating company entered into an interest rate swap agreement to manageits exposure to changes in interest rates associated with the Credit Agreement(the “Credit Agreement”) discussed in Note 9, Debt.  This interest rate swap was subsequentlyunwound in conjunction with the termination of the Credit Agreement in September 2009.  The counterparty to this agreement was amajor financial institution.  The Companyoriginally designated the interest rate swap agreement as a cash flow hedge ofthe Credit Agreement, effective February 28, 2008.  As required by the *Derivativesand Hedging Topic*of the FASB ASC, the Company recorded the cashflow hedge at fair value on the consolidated statement of financialcondition.  Additionally, the Company’spro-rata share of the changes in the fair value of this agreement were recordedas a component of accumulated other comprehensive income.

 

During the quarter ended September 30,2008, the Company changed the designation of its swap agreement from a cash flowhedge to a trading derivative, as a significant portion of the cash flowsassociated with the originally forecasted transaction were probable not tooccur due to amortization payments required to be made pursuant to the terms ofits amended Credit Agreement. Accordingly, the Company reclassified the cumulative changes in fairvalue related to this swap from accumulated other comprehensive income to otherincome/(expense).  The Company recordedall subsequent changes to the swap’s fair value as a component of otherincome/(expense).  The Company recognizedless than $0.1 million in other income for the three months ended September 30,2009 related to such changes.  For thenine months ended September 30, 2009, the Company recognized approximately$0.1 million in other income related to such changes.  For each of the three and nine months ended September 30,2008, the Company recognized approximately $0.3 million in other incomeassociated with the change in fair value of the swap agreement.

 

At December 31, 2008,the approximate fair value of the liability associated with the swap agreementwas $0.6 million, and has been included in other liabilities on theconsolidated statements of financial condition.

 

The following table summarizes the impact of the Company’s derivativefinancial instruments on its results of operations for the three months ended September 30,2009 and 2008 (in thousands):

 
| **Derivatives Not Accounted For As  Hedging** | ** ** | ** **             | ** ** | **Amount of Income Recognized** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|---------------------------------|------------|
| **Instruments Under the Derivatives  and**    | ** ** | **Statement of**       |       | **In Income on Derivative**     |       |
| **Hedging Topic of the FASB ASC**             | ** ** | **Operations Account** | ** ** | **2009**                        | ** ** | **2008** | ** ** |
|                                          |       |                   |       |                            |       |   |   |
| Interest Rate Contracts                       |       | Other Income           |       | $                               | 20         |   | $ | 342 |   |
| Total                                         |       |                   |       | $                               | 20         |   | $ | 342 |   |

 

The following table summarizes the impact of the Company’s derivativefinancial instruments on its results of operations for the nine months ended September 30,2009 and 2008 (in thousands):

 
| **Derivatives Not Accounted For As Hedging  Instruments Under the Derivatives and** | ** ** | **Statement of**       | ** ** | **Amount of Income Recognized********In Income on Derivative** | ** ** |
|-------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------------------------------------------------|------------|
| **Hedging Topic of the FASB ASC**                                                   | ** ** | **Operations Account** | ** ** | **2009**                                                       | ** ** | **2008** | ** ** |
|                                                                                |       |                   |       |                                                           |       |   |   |
| Interest Rate Contracts                                                             |       | Other Income           |       | $                                                              | 88         |   | $ | 342 |   |
| Total                                                                               |       |                   |       | $                                                              | 88         |   | $ | 342 |   |

 

The following table summarizes the impact of the Company’s derivativefinancial instruments on its financial position as of December 31, 2008(in thousands):

 
| ** **                                                                                                          | ** ** | **Asset  Derivatives**                          | ** ** | **Liability  Derivatives** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|----------------------------|------------|
| **Derivatives  Not Accounted For As Hedging  Instruments Under the Derivatives and  Hedging Topic of the FASB ASC** | ** ** | **Statement  of  Financial  Condition Account** | ** ** | **Fair  Value**            | ** ** | **Statement  of  Financial  Condition Account** | ** ** | **Fair  Value** | ** ** |
|                                                                                                                |       |                                            |       |                       |       |   |   |   |   |
| Interest Rate Contracts                                                                                             |       | —                                          |       | $                          | —     |   | Other Liabilities |   | $ | 628 |   |
| Total                                                                                                               |       |                                            |       | $                          | —     |   |   |   | $ | 628 |   |

 

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**Pzena Investment Management, Inc.**

**Unaudited Notes to the Consolidated Financial Statements (Continued)**

 

**Note 2—Significant Accounting Policies****(continued)**

*** ***

***Property and Equipment:***

 

Property and equipment iscarried at cost, less accumulated depreciation and amortization.  Depreciation is provided on a straight-linebasis over the estimated useful lives of the respective assets, which rangefrom three to seven years.

 

Leasehold improvements are amortized on astraight-line basis over the shorter of the useful life of the improvements orthe remaining lease term.

 

***Business Segments:***

 

The Company views itsoperations as comprising one operating segment.

 

***Income Taxes:***

 

The Company is a “C”corporation under the Internal Revenue Code, and thus liable for federal,state, and local taxes on the income derived from its economic interest in itsoperating company.  The operating companyis a limited liability company that has elected to be treated as a partnershipfor tax purposes.  It has not made aprovision for federal or state income taxes because it is the individualresponsibility of each of the operating company’s members (including theCompany) to separately report their proportionate share of the operatingcompany’s taxable income or loss. Similarly, the income of the Company’s consolidated investmentpartnerships is not subject to income taxes, as it is allocated to eachpartnership’s individual partners.  Theoperating company has made a provision for New York City UnincorporatedBusiness Tax (“UBT”).

 

The Company and itsconsolidated subsidiaries account for all federal, state, and local taxationpursuant to the asset and liability method, which requires deferred income taxassets and liabilities to be recorded for temporary differences between thefinancial statement and tax bases of assets and liabilities that will result intaxable or deductible amounts in the future, based on enacted tax laws andrates applicable to the periods in which the temporary differences are expectedto affect taxable income.  Valuationallowances are established, when necessary, to reduce deferred tax assets tothe amount more likely than not to be realized. At September 30, 2009 and December 31, 2008, the Company had a$60.3 million and a $62.7 million valuation allowance, respectively,recorded against the deferred tax asset associated with the Company’sacquisition of operating company units in conjunction with the offering.  The income tax provision, or credit, is thetax payable or refundable for the period, plus or minus the change during theperiod in deferred tax assets and liabilities. The Company records its deferred tax liabilities as a component of otherliabilities on the consolidated statements of financial condition.

 

***Foreign Currency:***

 

Investment securities andother assets and liabilities denominated in foreign currencies are remeasuredinto U.S. dollar amounts at the date of valuation.  Purchases and sales of investment securitiesand income and expense items denominated in foreign currencies are remeasuredinto U.S. dollar amounts on the respective dates of such transactions.

 

The Company does not isolatethat portion of the results of its operations resulting from changes in foreignexchange rates on investments from the fluctuations arising from changes inmarket prices of securities held.  Suchfluctuations are included in the net realized and unrealized loss, net onequity securities and securities sold short in the consolidated statements ofoperations.

 

Reported net realizedforeign exchange gains or losses arise from sales of foreign currencies,currency gains or losses realized between the trade and settlement dates onsecurities transactions, and the difference between the amounts of dividends,interest, and foreign withholding taxes recorded on the Company’s books and theU.S. dollar equivalent of the amounts actually received or paid.  Net realized foreign exchange gains andlosses arise from changes in the fair values of assets and liabilitiesresulting from changes in exchange rates.

 

***New Accounting Pronouncements:***

 

In June 2009, the FASBissued an accountingstandard for variable interest entities (“VIEs”) which changes the approach todetermining the primary beneficiary of a VIE and requires companies to assessmore frequently whether they must consolidate VIEs.  Under the new accounting standard, anenterprise has a controlling financial interest when it has: a) the powerto direct the activities of a VIE that most significantly impact the entity’seconomic performance, and b) the obligation to absorb losses of the entityor the right to receive benefits from the entity that could potentially besignificant to the VIE.  The newaccounting standard also requires an enterprise to assess whether it has animplicit financial responsibility to ensure that a VIE operates as designedwhen determining

 

11

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Tableof Contents

 

**Pzena Investment Management, Inc.**

**Unaudited Notes to the Consolidated Financial Statements (Continued)**

 

**Note 2—Significant Accounting Policies****(continued)**

 

whether it haspower to direct the activities of the VIE that most significantly impact theentity’s economic performance.  The newaccounting standard also requires ongoing assessments of whether an enterpriseis the primary beneficiary of a VIE, requires enhanced disclosures andeliminates the scope exclusion for qualifying special-purpose entities.  The new accounting standard is effective forinterim and annual periods beginning after November 15, 2009.  Earlier application is prohibited.  The Company is currently evaluating theimpact that the adoption of the new accounting standard will have on itsconsolidated financial statements.

 

**Note 3—Property and Equipment**

 

Property and equipment, net,is comprised of the following:

 
| ** **                                       | ** ** | **As of**                          | ** ** |
|--------------------------------------------------|------------|------------------------------------|------------|
| ** **                                       | ** ** | **September 30,********2009** | ** ** | **December 31,  2008** | ** ** |
| ** **                                       | ** ** | **(in  thousands)**                | ** ** |
|                                             |       |                               |       |   |   |
| Computer Hardware                                |       | $                                  | 917        |   | $ | 921 |   |
| Computer Software                                |       | 191                                |       | 191 |   |
| Furniture and Fixtures                           |       | 1,161                              |       | 1,161 |   |
| Office Equipment                                 |       | 243                                |       | 243 |   |
| Leasehold Improvements                           |       | 2,145                              |       | 2,145 |   |
| Total                                            |       | 4,657                              |       | 4,661 |   |
| Less: Accumulated Depreciation  and Amortization |       | (2,265                             | )          | (1,913 | ) |
| Total                                            |       | $                                  | 2,392      |   | $ | 2,748 |   |

 

Depreciation is included ingeneral and administrative expenses and totaled $0.1 million for each ofthe three months ended September 30, 2009 and 2008.  Such expenses totaled $0.4 million foreach of the nine months ended September 30, 2009 and 2008.

 

**Note 4—Related Party Transactions**

 

For the three and ninemonths ended September 30, 2009, the Company earned $1.1 million and$2.7 million, respectively, in investment advisory fees fromunconsolidated entities for which it acts as the investment manager.  For the three and nine months ended September 30,2008, such advisory fees totaled $1.6 million and $5.3 million,respectively.

 

At September 30, 2009and December 31, 2008, the Company had advanced $0.1 million to aninternational investment company for organization and start-up costs, which areincluded in receivable from related parties on the consolidated statements offinancial condition. The Company is the sponsor and investment manager of thisentity.

 

At September 30, 2009,and December 31, 2008, loans to employees included in receivables fromrelated parties were each $0.1 million. These loans are in the form of forgivable promissory notes which areamortized through compensation expense pursuant to their terms.

 

Certain qualified employeesof the Company have the ability to open individual accounts, or invest incertain of the Company’s consolidated investment partnerships, without beingassessed advisory fees.  Investments byemployees in individual accounts are permitted only at the discretion of theExecutive Committee of the Company, but are generally not subject to the sameminimum investment levels that are required of outside investors.

 

During the quarter ended September 30,2008, an unaffiliated shareholder who held more than 10% of the Company’soutstanding shares sold shares in transactions deemed to be short-swingsales.  Under Section 16(b) ofthe Securities Exchange Act of 1934, the shareholder was required to disgorgeto the Company the $0.2 million in profits realized from these stocksales.  The Company recognized theseproceeds as a capital contribution and reflected a corresponding increase toadditional paid-in capital in its consolidated statements of changes inequity.  Proceeds from these transactionsdid not affect the Company’s consolidated statements of operations.

 

As discussed in Note 9,Debt, on October 28, 2008, the operating company issued an aggregate of$16.0 million principal amount of Senior Subordinated Notes to entitiesestablished by Richard S. Pzena, the Company’s Chief Executive Officer,for the benefit of certain of his family members, to an entity controlled by aCompany director, and to a former employee.

 

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**Pzena Investment Management, Inc.**

**Unaudited Notes to the Consolidated Financial Statements (Continued)**

 

**Note 5—Commitments and Contingencies**

 

In the normal course ofbusiness, the Company enters into agreements that include indemnities in favorof third parties, such as engagement letters with advisors andconsultants.  In certain cases, theCompany may have recourse against third parties with respect to theseindemnities.  The Company maintainsinsurance policies that may provide coverage against certain claims under theseindemnities.  The *GuaranteesTopic* of the FASB ASC provides accounting and disclosurerequirements for certain guarantees.  TheCompany has had no claims or payments pursuant to these agreements, and itbelieves the likelihood of a claim being made is remote.  Utilizing the methodology in the *Guarantees Topic* of the FASB ASC, the Company’s estimate ofthe value of such guarantees is de minimis, and, therefore, an accrual has notbeen made in the consolidated financial statements.

 

Inthe normal course of business, the Company may be subject to various legal andadministrative proceedings.  On November 21,2007 and January 16, 2008, respectively, substantively identical putativeclass action lawsuits were commenced in the United States District Court forthe Southern District of New York against the Company and Richard S. Pzena, theCompany’s chief executive officer, seeking remedies under Section 11 ofthe Securities Act of 1933, as amended.  The Court consolidated thelawsuits and appointed co-lead plaintiffs, who filed a consolidated amendedcomplaint.  The consolidated amended complaint named as defendants theCompany, Richard S. Pzena, and two of the underwriters of the Company’s initialpublic offering, Goldman Sachs & Co., Inc. and UBS SecuritiesLLC.  Plaintiffs sought to represent a class of all persons who purchasedor otherwise acquired Class A common stock issued pursuant or traceable tothe Company’s initial public offering.  The consolidated amended complaintalleged that the registration statement and prospectus relating to the initialpublic offering of the Company’s Class A common stock contained materialmisstatements and omissions and wrongfully failed to disclose net redemptionsin the John Hancock Classic Value Fund for which the Company acts assub-investment advisor.  The consolidated amended complaint sought damagesin an unspecified amount including rescission or rescissory damages. The Courtgranted the Company’s and the other defendants’ motions to dismiss theconsolidated amended complaint, and on September 4, 2008, entered aJudgment in favor of defendants.  Plaintiffs appealed the Court’s judgmentto the United States Court of Appeals for the Second Circuit, which, on August 13,2009, affirmed the judgment of the United States District Court for theSouthern District of New York dismissing the putative class actionlawsuits.  Plaintiffs did not seek rehearing of the Court of Appeals’decision and, to date, have not petitioned the Supreme Court of the UnitedStates for a writ of certiorari.  The Company believes that theallegations and claims are without merit and will continue to contest these claimsvigorously.

 

The Company leases officespace under two non-cancelable operating lease agreements which expire on October 31,2015.  The Company reflects lease expenseon a straight-line basis over the lease term in general and administrativeexpenses.  Lease expenses totaled $0.5million for each of the three months ended September 30, 2009 and2008.  Such expenses totaled $1.6 millionand $1.5 million for the nine months ended September 30, 2009 and 2008,respectively.

 

After terminating the Credit Agreement and relatedRevolving Credit Facility in September 2009, the Company depositedapproximately $1.6 million with its landlord as security in case of default orfailure to comply with lease requirements.  This security deposit isincluded in prepaid expenses and other assets on the consolidated statements offinancial condition.

 

**Note 6—Retirement Plan**

 

Prior to 2009, the Companymaintained a defined contribution pension plan which covered substantially allmembers and employees.  The Company madecontributions to the plan at the discretion of management.  Under the terms of the plan, all suchcontributions vested immediately. Company contributions for the three and nine months ended September 30,2008 were $0.4 million and $1.4 million, respectively.  These expenses are included in compensationand benefits expense in the consolidated statements of operations.

 

**Note 7—Compensationand Benefits**

 

For the three months ended September 30,2009 and 2008, compensation and benefits expense to employees and members iscomprised of the following:

 
| ** **                               | ** ** | **For the  Three Months********Ended  September 30,** | ** ** |
|------------------------------------------|------------|------------------------------------------------------------|------------|
| ** **                               | ** ** | **2009**                                                   | ** ** | **2008** | ** ** |
| ** **                               | ** ** | **(in  thousands)**                                        | ** ** |
|                                     |       |                                                       |       |   |   |
| Cash Compensation and  Other Benefits    |       | $                                                          | 5,977      |   | $ | 7,888 |   |
| Other Non-Cash  Compensation             |       | 255                                                        |       | 272 |   |
| Total Compensation and  Benefits Expense |       | $                                                          | 6,232      |   | $ | 8,160 |   |

 

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Tableof Contents

 

**Pzena Investment Management, Inc.**

**Unaudited Notes to the Consolidated Financial Statements (Continued)**

 

**Note 7—Compensationand Benefits (continued)**

 

For the nine months ended September 30,2009 and 2008, compensation and benefits expense to employees and members iscomprised of the following:

 
| ** **                               | ** ** | **For the  Nine Months Ended********September 30,** | ** ** |
|------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                               | ** ** | **2009**                                                 | ** ** | **2008** | ** ** |
| ** **                               | ** ** | **(in  thousands)**                                      | ** ** |
|                                     |       |                                                     |       |   |   |
| Cash Compensation and  Other Benefits    |       | $                                                        | 17,439     |   | $ | 24,868 |   |
| Other Non-Cash  Compensation             |       | 816                                                      |       | 905 |   |
| Total Compensation and  Benefits Expense |       | $                                                        | 18,255     |   | $ | 25,773 |   |

 

For the three and ninemonths ended September 30, 2009, the operating company granted no optionsto purchase capital units pursuant to the Pzena Investment Management, LLC2006 Equity Incentive Plan (the “Plan”). Similarly, no such grants occurred during the three months ended September 30,2008.  For the nine months ended September 30,2008, the operating company granted 446,000 options to purchase capital units.The options granted in 2008 had varying vesting schedules and were issued atstrike prices equal to the assessed fair market value per unit at the time ofaward issuance.  The Company determinedthat the total grant-date fair value of the options awarded in 2008 wasapproximately $1.2 million, using the Black-Scholes option pricing model.  For the three and nine months ended September 30,2009 and 2008, the Company recognized approximately $0.1 million and $0.2million, respectively, in compensation and benefits expense associated with theamortization of the awards.

 

On January 1, 2009 and2008, the operating company granted 30,000 and 13,000, respectively, restrictedClass B units to certain members pursuant to the Plan.  These unit grants each vest ratably overfour-year periods commencing January 1, 2009 and 2008, respectively.  The amortization of these awards was lessthan $0.1 million for each of the three and nine months ended September 30,2009 and 2008.

 

Pursuantto the operating company’s Bonus Plan, which became effective January 1,2007, eligible employees whose cash compensation is in excess of certainthresholds have a portion of that excess mandatorily deferred.  Amounts deferred may be credited to aninvestment account, take the form of phantom Class B units, or be investedin money market funds at the employee’s discretion, and vest ratably over fouryears.  On January 1, 2008, theoperating company issued 86,458 phantom Class B units as part of its BonusPlan.  In December 2008,participants in the Company’s deferred compensation program converted a portionof their holdings in investment accounts into an aggregate of 89,826 phantom Class Bunits.  No such phantom units weregranted for the three and nine months ended September 30, 2009.  All outstanding phantom units vest ratablyover a four-year period that commenced January 1, 2008.  At September 30, 2009 and December 31,2008, the liability associated with deferred compensation investment accountswas approximately $0.3 million, and has been included as a component ofother liabilities on the consolidated statements of financial condition.  For the three and nine months ended September 30,2009, the Company recognized approximately $0.3 million and $0.6 million,respectively, in compensation and benefits expense associated with theamortization of all deferred compensation awards.  For the three and nine months ended September 30,2008, the Company recognized approximately $0.2 million and $0.7 million,respectively, in compensation and benefits expense associated with theamortization of all deferred compensation awards.

 

**Note 8—Short Term Borrowings**

 

Simultaneously with theCredit Agreement described below, on July 23, 2007, the operating companyobtained a $20.0 million revolving credit facility, expiring on July 23,2010, in order to finance its short term working capital needs.  This facility carried a commitment fee of0.2% on any unused amounts, and the operating company’s approximately $1.8 millionletter of credit

 

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Tableof Contents

 

**Pzena Investment Management, Inc.**

**Unaudited Notes to the Consolidated Financial Statements (Continued)**

 

**Note 8—Short TermBorrowings (continued)**

 

reduced the amounts otherwise available to beused.  On February 11, 2008, theoperating company entered into Amendment No. 1 to the Credit Agreement,which, among other provisions, lowered the capacity of the revolving creditfacility to $5.0 million.   On September 19,2008, the operating company entered into Amendment No. 2 to the CreditAgreement.  The amendment reduced thecapacity of the revolving credit facility from $5.0 million to $3.0 million andextended its maturity to July 23, 2011. On October 28, 2008, the operating company entered into Amendment No. 3to its Credit Agreement, which further reduced the commitments under the revolvingcredit agreement to approximately $1.8 million. The Credit Agreement and the revolving credit facility were terminatedin September 2009.  No balance wasoutstanding and no amounts were drawn down against the facility over the courseof its existence.

 

**Note 9—Debt**

 

On July 23, 2007, the operating company entered into a$60.0 million, three-year Credit Agreement, the proceeds of which wereused to finance a one-time distribution to its members.  Following the repayment by the operatingcompany of the remaining principal amount outstanding in September 2009,this Credit Agreement was terminated. The principal amount borrowed bore interest at a variable rate based, atthe Company’s option, on (i) the one, two, three, nine or twelve-monthLIBOR rate plus 1.00%, or (ii) the higher of the lender’s prime rate andthe Federal Funds Rate.  The principalamount was payable in full at the end of the three-year term, with no penaltyfor prepayment.  Approximately$0.1 million in debt issuance costs were incurred in association with thisloan.  Such costs were recorded inprepaid expenses and other assets on the consolidated statements of financialcondition and were being amortized over the term of the loan.  The remaining unamortized debt issuance costswere written off upon termination of the Credit Agreement in September 2009.

 

On February 11, 2008,the operating company entered into Amendment No. 1 to the CreditAgreement.  The agreement, as amended,required the operating company to maintain assets under management of at least$15.0 billion and generate consolidated earnings before interest, taxes,depreciation and amortization (“EBITDA”), as defined, of at least$40.0 million in any consecutive four fiscal quarterly periods.  Pursuant to the terms of the amendedagreement, term loan amortization was required beginning in any period whenassets under management were less than $20.0 billion and ending whenassets under management was greater than $21.5 billion.  Further, a 50% excess cash flow sweep wasrequired if assets under management were below $17.5 billion.  Additionally, the LIBOR interest rate optionwas increased to LIBOR plus 1.50%.  Forthe period from February 11, 2008 through July 23, 2008, the interestrate in effect was 6.91%, which was equal to the twelve-month LIBOR rate ineffect at the time of the closing of the agreement of 5.41%, plus 1.50%.  During the quarter ended September 30,2008, the Company’s assets under management fell below $20 billion.  On June 30, 2008, the Company made arequired amortization payment of $3.0 million.

 

On September 19, 2008,the operating company entered into Amendment No. 2 to its CreditAgreement.  The agreement, as amended,required the operating company to maintain assets under management of at least$12.0 billion and to make minimum quarterly amortization payments of$2.0 million until maturity, which was extended to July 23,2011.  Additionally, the LIBOR interestrate option was increased to LIBOR plus 1.75% and the EBITDA financial covenantstipulated in Amendment No. 1 was eliminated.  The excess cash flow sweep was also increasedto 75% of excess cash flow.  On September 22,2008, the Company made a required amortization payment of $5.0 million asa condition precedent to the effectiveness of this amendment.  On September 30, 2008, the Company madea quarterly amortization payment of $5.0 million.

 

On October 28, 2008,the operating company entered into Amendment No. 3 to its CreditAgreement.  This amendment provided forthe following changes to the Credit Agreement, among others:

 

(i).                                  the minimumassets under management financial covenant was eliminated;

 

(ii).                               the excess cashflow mandatory repayment was eliminated;

 

(iii).                            the commitmentsunder the revolving credit facility were reduced from $3.0 million toapproximately $1.8 million;

 

(iv).                           with respect toloans borrowed at base rate, the margin added to base rate was increased from0.00% to 0.75%; with respect to loans borrowed at LIBOR, the margin was notmodified;

 

(v).                              certainadditional restrictions were placed on the operating company’s ability to makeRestricted Payments (as defined in the Credit Agreement), including dividends;and

 

(vi).                           amendments weremade to certain covenants in order to permit the incurrence of subordinateddebt by the operating company.

 

Conditions precedent to theexecution of Amendment No. 3 included, among others, (i) therepayment by the operating company of $25.0 million of the$47.0 million principal amount outstanding under the Credit Agreement asof October 28, 2008, and (ii) the grant by the operating company andone of its subsidiaries of a security interest in their accounts receivable.

 

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Tableof Contents

 

**Pzena Investment Management, Inc.**

**Unaudited Notes to the Consolidated Financial Statements (Continued)**

 

**Note 9—Debt (continued)**

 

In order to fund the$25.0 million repayment by the operating company, the Company used$9.0 million in cash reserves and the proceeds from the issuance by theoperating company of an aggregate of $16.0 million principal amount ofSenior Subordinated Notes (collectively, the “Notes”) to entities establishedby Richard S. Pzena, the Company’s Chief Executive Officer, for thebenefit of certain of his family members, to an entity controlled by a Companydirector, and to a former employee.  Theissuance of these Notes was approved by the three independent members of theCompany’s Board of Directors.

 

The Notes were issued on October 28,2008.  Each of these Notes is unsecured,has a ten-year maturity and bears interest at 6.30% per annum.  The provisions of the Notes include arestricted payments covenant (including dividends), a prohibition on incurringindebtedness which is not subordinated to the Notes, and events of defaultbased on failure to make payments, bankruptcy, change of control andacceleration of material indebtedness. In addition, the Notes were subordinated to the repayment in full of theloans under the Credit Agreement.

 

As discussed above,subsequent to Amendment No. 2 and Amendment No. 3 to the Company’sCredit Agreement in 2008, the minimum EBITDA and minimum AUM covenants wereeliminated.  The Company was incompliance with these covenants as of and for all 2008 periods in which theywere in effect.

 

During the six months ended June 30,2009, the Company repaid $12.0 million of the principal amount outstandingunder the Credit Agreement.  The Companyrepaid the remaining $10.0 million of the principal amount outstanding underthe Credit Agreement during the three months ended September 30,2009.  Concurrently with the terminationof the credit agreement, the security interest in the accounts receivable ofthe operating company and one of its subsidiaries was released in September 2009.

 

**Note 10—Interest Rate Swap**

 

The Company manages itsexposure to changes in market rates of interest.  The Company’s use of derivative instrumentswas limited to an interest rate swap used to manage the interest rate exposurerelated to its Credit Agreement.

 

On February 28, 2008,the operating company entered into a $60.0 million notional amountinterest rate swap agreement that commenced on July 23, 2008.  This interest rate swap was subsequentlyunwound in conjunction with the termination of the Credit Agreement in September 2009.  The swap obligated the operating company topay a 2.825% fixed rate of interest on the notional amount and required thecounterparty to pay the operating company a floating interest rate based on themonthly LIBOR interest rate.  The spreadon the Credit Agreement was in addition to these amounts.

 

During the three monthsended September 30, 2008, the Company changed the designation of its swapagreement from a cash flow hedge to a trading derivative, as a significantportion of the cash flows associated with the original forecasted transactionwere probable not to occur due to the amortization payments required to be madepursuant to the terms of its amended Credit Agreement.  Accordingly, the Company reclassified thecumulative changes in fair value related to this swap from accumulated othercomprehensive income to other income/(expense). The Company recorded all changes to the swap’s fair value as a componentof other income/(expense).  For the threeand nine months ended September 30, 2009, the Company recognized less than$0.1 million in other expense related to such changes.  For each of the three and nine months ended September 30,2008, the Company recognized approximately $0.3 million in other incomeassociated with the change in fair value of the swap agreement.

 

Concurrently with thereductions in principal outstanding under the Credit Agreement in 2008, theCompany reduced the notional amount of its interest rate swap to$22.0 million.  The amounts paid tothe counterparty in exchange for these reductions were approximately$0.1 million.  During 2009, theCompany similarly reduced the notional amount of its interest rate swap intandem with the remaining $22.0 million reductions in principal amountsoutstanding under the Credit Agreement. The amounts paid to the counterparty in exchange for these reductionswere approximately $0.2 million and $0.5 million for the three and nine monthsended September 30, 2009, respectively.

 

**Note 11—Income Taxes**

 

The operating company is alimited liability company that has elected to be treated as a partnership fortax purposes.  Neither it nor theCompany’s other consolidated subsidiaries has made a provision for federal orstate income taxes because it is the individual responsibility of each of theseentities’ members (including the Company) to separately report theirproportionate share of the respective entity’s taxable income or loss.  The operating company has made a provisionfor New York City UBT.  Subsequent to theoffering and reorganization on October 30, 2007, the Company, as a “C”corporation under the Internal Revenue Code, is liable  for

 

16

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Tableof Contents

 

**Pzena Investment Management, Inc.**

**Unaudited Notes to the Consolidated Financial Statements (Continued)**

 

**Note 11—Income Taxes(continued)**

 

federal, state and local taxes on the incomederived from its economic interest in its operating company, which is net ofUBT.  Correspondingly, in itsconsolidated financial statements, the Company reports both the operatingcompany’s provision for UBT, as well as its provision for federal, state andlocal corporate taxes.

 

For the three months ended September 30,2009 and 2008, the Company’s taxable income was determined as follows:

 
| ** **                            | ** ** | **For the  Three Months Ended** | ** ** |
|---------------------------------------|------------|---------------------------------|------------|
| ** **                            | ** ** | **September 30,**          | ** ** |
| ** **                            | ** ** | **2009**                        | ** ** | **2008** | ** ** |
| ** **                            | ** ** | **(in  thousands)**             | ** ** |
|                                  |       |                            |       |   |   |
| Income Before Taxes                   |       | $                               | 10,228     |   | $ | 63,611 |   |
| Unincorporated Business  Taxes        |       | (516                            | )          | (769 | ) |
| Non-Controlling Interests             |       | (8,082                          | )          | (10,785 | ) |
| Income Before Corporate  Income Taxes |       | $                               | 1,630      |   | $ | 52,057 |   |

 

For the nine months ended September 30,2009 and 2008, the Company’s taxable income was determined as follows:

 
| ** **                            | ** ** | **For the  Nine Months Ended** | ** ** |
|---------------------------------------|------------|--------------------------------|------------|
| ** **                            | ** ** | **September 30,**         | ** ** |
| ** **                            | ** ** | **2009**                       | ** ** | **2008** | ** ** |
| ** **                            | ** ** | **(in  thousands)**            | ** ** |
|                                  |       |                           |       |   |   |
| Income Before Taxes                   |       | $                              | 21,888     |   | $ | 90,752 |   |
| Unincorporated Business  Taxes        |       | (1,259                         | )          | (2,594 | ) |
| Non-Controlling Interests             |       | (17,767                        | )          | (36,997 | ) |
| Income Before Corporate  Income Taxes |       | $                              | 2,862      |   | $ | 51,161 |   |

 

The *Income TaxesTopic* of the FASB ASC establishes the minimum threshold forrecognizing, and a system for measuring, the benefits of tax return positionsin financial statements.  It is theCompany’s policy to recognize accrued interest and penalties associated withuncertain tax positions as part of the tax provision.  For the three and nine months ended September 30,2009 and 2008, no such expenses were recognized.  As of September 30, 2009 and December 31,2008, no such accruals were recorded.

 

The Company and theoperating company are generally no longer subject to U.S. federal, or state andlocal income tax examinations by tax authorities for any year prior to2006.  All tax years subsequent to andincluding 2006 are considered open and subject to examination by taxauthorities.

 

The components of the incometax provision are as follows (in thousands):

 
| ** **                               | ** ** | **For the  Three Months Ended  September 30,** | ** ** |
|------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                               | ** ** | **2009**                                            | ** ** | **2008** | ** ** |
| Current Provision:                       |       |                                                |       |   |   |
| Unincorporated Business  Taxes           |       | $                                                   | 572        |   | $ | 824 |   |
| Local Corporate Tax                      |       | —                                              |       | (3 | ) |
| State Corporate Tax                      |       | —                                              |       | (2 | ) |
| Federal Corporate Tax                    |       | —                                              |       | (20 | ) |
| Total Current Provision                  |       | $                                                   | 572        |   | $ | 799 |   |
| Deferred Provision:                      |       |                                                |       |   |   |
| Unincorporated Business  Taxes           |       | $                                                   | (56        | ) | $ | (55 | ) |
| Local Corporate Tax                      |       | 57                                                  |       | 50 |   |
| State Corporate Tax                      |       | 108                                                 |       | 116 |   |
| Federal Corporate Tax                    |       | 372                                                 |       | 334 |   |
| Total Deferred Provision                 |       | $                                                   | 481        |   | $ | 445 |   |
| Deferred Income Tax  Valuation Allowance |       | (3,093                                              | )          | 62,720 |   |
| Income Tax  Provision/(Benefit)          |       | $                                                   | (2,040     | ) | $ | 63,964 |   |

 

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**Pzena Investment Management, Inc.**

**Unaudited Notes to the Consolidated Financial Statements (Continued)**

 

**Note 11—Income Taxes (continued)**

 
| ** **                               | ** ** | **For the  Nine Months Ended  September 30,** | ** ** |
|------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                               | ** ** | **2009**                                           | ** ** | **2008** | ** ** |
| Current Provision:                       |       |                                               |       |   |   |
| Unincorporated Business  Taxes           |       | $                                                  | 1,426      |   | $ | 2,758 |   |
| Local Corporate Tax                      |       | —                                             |       | (3 | ) |
| State Corporate Tax                      |       | —                                             |       | (2 | ) |
| Federal Corporate Tax                    |       | —                                             |       | (20 | ) |
| Total Current Provision                  |       | $                                                  | 1,426      |   | $ | 2,733 |   |
| Deferred Provision:                      |       |                                               |       |   |   |
| Unincorporated Business  Taxes           |       | $                                                  | (167       | ) | $ | (164 | ) |
| Local Corporate Tax                      |       | 121                                                |       | 176 |   |
| State Corporate Tax                      |       | 231                                                |       | 338 |   |
| Federal Corporate Tax                    |       | 793                                                |       | 1,159 |   |
| Total Deferred Provision                 |       | $                                                  | 978        |   | $ | 1,509 |   |
| Deferred Income Tax  Valuation Allowance |       | (4,783                                             | )          | 62,720 |   |
| Income Tax  Provision/(Benefit)          |       | $                                                  | (2,379     | ) | $ | 66,962 |   |

 

Prior to October 30,2007, the operating company was a cash basis taxpayer.  As a result of the Company’s acquisition ofmembership units in conjunction with the offering, the operating company wasrequired to become an accrual basis taxpayer. Pursuant to Section 481 of the Internal Revenue Code, thecumulative difference between the two methods of taxpaying are amortizable overfour years.  These differences generatedapproximately $0.3 million and $0.4 million in deferred tax liabilities asof September 30, 2009 and December 31, 2008, respectively.  Such amounts are recorded in otherliabilities in the consolidated statements of financial condition.

 

The acquisition of theoperating company membership units noted above has allowed the Company to makean election under Section 754 of the Internal Revenue Code (“Section 754”)to step up its tax basis in the net assets acquired.  This step up is deductible for tax purposesover a 15-year period.  Based on the netproceeds of the offering and tax basis of the operating company as of October 30,2007, this election gave rise to a deferred tax asset of approximately $68.7million.

 

Pursuant to a Tax ReceivableAgreement signed between the members of the operating company and the Company,85% of the cash savings generated by this election will be distributed to theselling and converting shareholders upon the realization of this benefit.

 

In September 2008, theCompany evaluated the asset associated with this election, after the decline inits AUM resulted in, for the first time, projections below the point at whichthe Company would generate sufficient full-year taxable income to fully utilizethis deferred tax asset.  Other negativeevidence it reviewed included: (i) the generally uncertain economicenvironment, which has been reflected in declining stock markets and had acorresponding impact on our AUM and revenue levels; (ii) the acceleratingnegative trends affecting the asset management industry in particular; and (iii) thedifficulty of projecting AUM in the current volatile environment.  These factors were moderated by: (i) theCompany’s ability to control its compensation costs, which is its singlelargest expense; (ii) management’s experience in the asset managementindustry, and minimal turnover of key personnel; and (iii) the ability ofthe Company to utilize tax losses generated by this asset over a longer timehorizon.  In conducting its analysis, theCompany believed that the inherent difficulty in projecting future income wasexacerbated by the economic environment. It correspondingly limited its projections to three years.  Over this time period, the Company projectedtaxable income assuming no AUM growth and modest reductions in its coststructure.

 

The Company determined that,after weighing both the positive and negative evidence discussed above, aportion of the benefits associated with this deferred tax asset were morelikely than not to go unrealized due to estimates of future taxableincome.  As a result, on September 30,2008, the Company established a $62.7 million valuation allowance toreduce the net deferred tax asset

 

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**Pzena Investment Management, Inc.**

**Unaudited Notes to the Consolidated Financial Statements (Continued)**

 

**Note 11—Income Taxes(continued)**

 

to an amount more likely than not to berealized.  This deferred tax asset remainsavailable to the Company and can be used to reduce taxable income in futureyears.  The Company similarly reduced theassociated liability to selling and converting shareholders to reflect thischange in the estimated realization of the asset.  On September 30, 2008, the Companyrecorded an approximate $53.3 million increase to other income associatedwith this reduction in the liability to selling and converting shareholders.

 

In October 2008, theselling unitholders agreed to waive any payments that the Company is or will berequired to make to them for the 2008 and 2009 tax years pursuant to the TaxReceivable Agreement.  During the quarterended December 31, 2008, the Company recognized approximately$2.9 million in other income associated with this waiver.

 

As discussed further in Note14 below, on March 3, 2009, certain of the operating company’s membersexchanged an aggregate of 2,445,973 of their Class B units for anequivalent number of shares of Company Class A common stock.   The Company elected to step up its tax basisin the incremental assets acquired in accordance with Section 754.  Based on the exchange-date fair value of theCompany’s common stock and the tax basis of the operating company, thiselection gave rise to a $2.5 million deferred tax asset and a corresponding$2.2 million liability to selling and converting shareholders under the TaxReceivable Agreement.  Using themethodology described above, the Company assessed the realizability of thedeferred tax asset associated with this exchange and determined that a portionof its benefits would go unutilized. Consequently, the Company established a $2.4 million valuation allowanceto reduce the deferred tax asset to an amount more likely than not to berealized.  This deferred tax assetremains available to the Company and can be used to reduce taxable income infuture years.  The Company similarlyreduced the associated liability to selling and converting shareholders toreflect this change in the estimated realization of the asset.  As required by the*IncomeTaxes Topic* of the FASB ASC, the Company recorded the effects ofthese transactions in equity.

 

During the three and ninemonths ended September 30, 2009, the Company reduced its valuationallowance by approximately $3.1 million and $4.8 million, respectively, due torevised estimates of future taxable income. To reflect this change in the estimated realization of the asset, theCompany correspondingly increased its liability to selling and convertingshareholders by $2.4 million for the three months ended September 30,2009, and by $3.6 million for the nine months ended September 30,2009.  The effects of these changes tothe deferred tax asset and liability to selling and converting shareholderswere recorded as a component of the income tax provision and other expense,respectively, on the consolidated statements of operations.  As of September 30, 2009 and December 31,2008, the net values of all deferred tax assets were approximately$7.2 million and $3.4 million, respectively.

 

As of September 30,2009 and December 31, 2008, the net value of the liability to selling andconverting shareholders were approximately $5.5 million and$1.8 million, respectively.

 

The change in the Company’snet deferred tax assets for the three months ended September 30, 2009 issummarized as follows (in thousands):

 
| ** **                          | ** ** | **Section 754** | ** ** | **Other**  | ** ** | **Valuation  Allowance** | ** ** | **Total**  | ** ** |
|-------------------------------------|------------|----------------------|------------|------------|------------|--------------------------|------------|------------|------------|
| ** **                          | ** ** | ** **           | ** ** | ** ** | ** ** | ** **               | ** ** | ** ** | ** ** |
| Balance at June 30, 2009       |       | $                    | 66,459     |       | $          | 1,617                    |       | $          | (63,399    | ) | $ | 4,677 |   |
| Deferred Tax Expense                |       | (726                 | )          | 190        |       | —                   |       | (536       | )          |
| Change in Valuation  Allowance      |       | —               |       | —     |       | 3,093                    |       | 3,093      |       |
| Balance at  September 30, 2009 |       | $                    | 65,733     |       | $          | 1,807                    |       | $          | (60,306    | ) | $ | 7,234 |   |

 

The change in the Company’s net deferred tax assets for the nine monthsended September 30, 2009 is summarized as follows (in thousands):

 
| ** **                          | ** ** | **Section 754** | ** ** | **Other**  | ** ** | **Valuation  Allowance** | ** ** | **Total**  | ** ** |
|-------------------------------------|------------|----------------------|------------|------------|------------|--------------------------|------------|------------|------------|
| ** **                          | ** ** | ** **           | ** ** | ** ** | ** ** | ** **               | ** ** | ** ** | ** ** |
| Balance at December 31, 2008   |       | $                    | 65,368     |       | $          | 785                      |       | $          | (62,709    | ) | $ | 3,444 |   |
| Deferred Tax Expense                |       | (2,166               | )          | 1,022      |       | —                   |       | (1,144     | )          |
| Unit Conversion                     |       | 2,531                |       | —     |       | (2,380                   | )          | 151        |       |
| Change in Valuation  Allowance      |       | —               |       | —     |       | 4,783                    |       | 4,783      |       |
| Balance at  September 30, 2009 |       | $                    | 65,733     |       | $          | 1,807                    |       | $          | (60,306    | ) | $ | 7,234 |   |

 

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**Pzena Investment Management, Inc.**

**Unaudited Notes to the Consolidated Financial Statements (Continued)**

 

**Note 12—Investments in Equity Securities, at FairValue**

 

Investments in equitysecurities consisted of the following at September 30, 2009:

 
| ** ** | ** ** | **Cost**            | ** ** | **Unrealized  Loss** | ** ** | **Fair Value** | ** ** |
|------------|------------|---------------------|------------|----------------------|------------|----------------|------------|
| ** ** | ** ** | **(in  thousands)** | ** ** |
|       | ** ** | ** **          | ** ** | ** **           | ** ** | ** **     | ** ** |
| Equities   |       | $                   | 18,420     |                 | $          | (47            | )          | $ | 18,373 |   |
|            |            |                     |            |                      |            |                |            |  |  |  |

 

Investments in equitysecurities consisted of the following at December 31, 2008:

 
| ** ** | ** ** | **Cost**            | ** ** | **Unrealized  Loss** | ** ** | **Fair Value** | ** ** |
|------------|------------|---------------------|------------|----------------------|------------|----------------|------------|
| ** ** | ** ** | **(in  thousands)** | ** ** |
|       | ** ** | ** **          | ** ** | ** **           | ** ** | ** **     | ** ** |
| Equities   |       | $                   | 24,097     |                 | $          | (10,052        | )          | $ | 14,045 |   |
|            |            |                     |            |                      |            |                |            |  |  |  |

 

**Note 13—Non-Controlling Interests**

 

The Company did notinitially record a non-controlling interest associated with the acquisition ofits operating company, as the post-offering net equity of the operating companywas less than zero.  As required by the *Consolidation Topic* of the FASB ASC, a non-controllinginterest in the equity of the operating company was recorded after the initialdeficit that existed at acquisition was extinguished in 2008.

 

Non-controlling interests inthe operations of the Company’s operating company and consolidated subsidiariesare comprised of the following:

 
| ** **                                                    | ** ** | **For the  Three Months Ended********September 30,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                    | ** ** | **2009**                                                  | ** ** | **2008** | ** ** |
| ** **                                                    | ** ** | **(in  thousands)**                                       | ** ** |
|                                                          |       |                                                      |       |   |   |
| Non-Controlling Interest  of Pzena Investment Management, LLC |       | $                                                         | 8,082      |   | $ | 10,785 |   |
| Non-Controlling Interest  in Consolidated Subsidiaries        |       | 2,754                                                     |       | (2,428 | ) |
| Non-Controlling Interests                                     |       | $                                                         | 10,836     |   | $ | 8,357 |   |

** **
| ** **                                                    | ** ** | **For the  Nine Months Ended********September 30,** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                    | ** ** | **2009**                                                 | ** ** | **2008** | ** ** |
| ** **                                                    | ** ** | **(in  thousands)**                                      | ** ** |
|                                                          |       |                                                     |       |   |   |
| Non-Controlling Interest  of Pzena Investment Management, LLC |       | $                                                        | 17,767     |   | $ | 36,997 |   |
| Non-Controlling Interest  in Consolidated Subsidiaries        |       | 3,764                                                    |       | (6,097 | ) |
| Non-Controlling Interests                                     |       | $                                                        | 21,531     |   | $ | 30,900 |   |

 

Non-controlling interests inthe equity of the Company’s operating company and consolidated subsidiaries aresummarized as follows at September 30, 2009 and December 31, 2008:

 
| ** **                                                    | ** ** | **As of**                          | ** ** |
|---------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                    | ** ** | **September 30,********2009** | ** ** | **December 31,  2008** | ** ** |
| ** **                                                    | ** ** | **(in thousands)**                 | ** ** |
|                                                          |       |                               |       |   |   |
| Non-Controlling Interest  of Pzena Investment Management, LLC |       | $                                  | 10,415     |   | $ | 3,397 |   |
| Non-Controlling Interest  in Consolidated Subsidiaries        |       | 11,512                             |       | 8,422 |   |
| Non-Controlling Interests                                     |       | $                                  | 21,927     |   | $ | 11,819 |   |

 

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**Pzena Investment Management, Inc.**

**Unaudited Notes to the Consolidated Financial Statements (Continued)**

 

**Note 14—Members’ Equity Interests of Operating Company**

 

Exceptas otherwise provided by law, the liability of a member of the operatingcompany is limited to the amount of its capital account.  A member may transfer or assign all, or anypart of, its membership interest to any other party (a “Transferee”).  A Transferee of such membership interestshall not become a member unless its membership in the operating company is unanimously approved by the thenexisting member(s) in writing.  AnyTransferee admitted as a member shall succeed to the capital account, or portion thereof, transferred orassigned, as if no such transfer or assignment had occurred.

 

The Company was incorporatedin the State of Delaware on May 8, 2007. On May 10, 2007, the Company issued 100 shares of its common stock,par value $0.01 per share (the “Old Common Stock”), for $100 to Richard S.Pzena, the sole director of the Company as of that date.  On October 5, 2007, the Company effecteda 100-for-6 reverse stock split of all shares of its Old Common Stock thenoutstanding.  All share amounts have beenadjusted to reflect this split.  As ofthe effectiveness of the amendment and restatement of the Company’s certificateof incorporation on October 30, 2007, each share of the Old Common Stockoutstanding immediately prior to effectiveness was reclassified as one share ofthe Company’s Class A common stock, par value $0.01 per share.

 

OnOctober 30, 2007, the Company consummated an initial public offering of6,100,000 shares of its Class A common stock, par value $0.01 per share,for net proceeds of approximately $98.9 million, after payment ofunderwriting discounts and offering expenses. These net proceeds were used to purchase 6,100,000 membership units ofthe operating company, representing 9.5% of its then outstanding membershipunits, from its two outside investors and one former employee.  Concurrently with the consummation of theCompany’s initial public offering, the operating agreement of the operatingcompany was amended and restated such that, among other things, (i) the Companybecame the sole managing member of the operating company, (ii) the6,100,000 membership units of the operating company that the Company acquiredwere reclassified as Class A units of the operating company, (iii) anadditional 11,118 Class A units were issued to the Company in respect ofits issuance of 11,112 shares of Class A common stock to certain directorsof the Company on October 30, 2007, and contribution of the $100 initialinvestment the Company received in exchange for issuance of six shares of Class Acommon stock on May 10, 2007, and (iv) the holders of the remaining90.5% of the outstanding membership units of the operating company werereclassified as Class B units of the operating company.  Class A and Class B units of theoperating company have the same economic rights per unit.  Accordingly, immediately following theconsummation of the offering and reorganization, the holders of Class Acommon stock (through the Company) and the holders of Class B units of theoperating company held approximately 9.5% and 90.5%, respectively, of theeconomic interests in the operations of the business.  As of September 30, 2009, the holders ofClass A common stock (through the Company) and the holders of Class Bunits of the operating company held approximately 13.4% and 86.6%,respectively, of the economic interests in the operations of the business.

 

For each membership unit ofthe operating company that was reclassified as a Class B unit in thereorganization, the Company issued the holder one share of its Class Bcommon stock, par value $0.000001 per share, in exchange for the payment ofthis par value.  Each share of theCompany’s Class B common stock entitles its holder to five votes, untilthe first time that the number of shares of Class B common stockoutstanding constitutes less than 20% of the number of all shares of theCompany’s common stock outstanding.  Fromthis time and thereafter, each share of the Company’s Class B common stockentitles its holder to one vote.  When a Class Bunit is exchanged for a share of the Company’s Class A common stock orforfeited, a corresponding share of the Company’s Class B common stockwill automatically be redeemed and cancelled. Conversely, to the extent that the Company causes Pzena InvestmentManagement, LLC to issue additional Class B units to employeespursuant to its equity incentive plan, these additional holders of Class Bunits would be entitled to receive a corresponding number of shares of theCompany’s Class B common stock (including if the Class B unitsawarded are subject to vesting).

 

Simultaneously with theconsummation of the offering and reorganization, all holders of the Company’s Class Bcommon stock entered into a stockholders’ agreement, pursuant to which theyagreed to vote all shares of Class B common stock then held by them, andacquired in the future, together on all matters submitted to a vote of thecommon stockholders.

 

The outstanding shares ofthe Company’s Class A common stock represent 100% of the rights of theholders of all classes of the Company’s capital stock to receive distributions,except that holders of Class B common stock will have the right to receivethe class’s par value upon the Company’s liquidation, dissolution or windingup.

 

Pursuant to the amended andrestated operating agreement of the operating company, each vested Class Bunit is exchangeable for a share of the Company’s Class A common stock,subject to certain exchange timing and volume limitations.

 

Theacquisition of the operating company’s membership interests by the Company hasbeen treated as a reorganization of entities under common control as requiredby the *Business Combinations Topic* of the FASBASC.  Accordingly, the net assets assumedby

 

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**Pzena Investment Management, Inc.**

**Unaudited Notes to the Consolidated Financial Statements (Continued)**

 

**Note 14—Members’ Equity Interests of Operating Company(continued)**

 

theCompany through the offering have been reported at the operating company’shistorical cost basis.  As a result ofthese transactions, as of and subsequent to October 30, 2007, (i) theCompany has consolidated the financial results of the operating company withits own and reflected the membership interest in it that it does not own as anon-controlling interest in its consolidated financial statements, and (ii) theCompany’s income will be generated by its economic interest in the operatingcompany’s net income.

 

This acquisition ofmembership units in the operating company has allowed the Company to make anelection to step up its tax basis in the net assets acquired.  This step up is deductible for tax purposesover a 15-year period.  Pursuant to a taxreceivable agreement between the Company and the operating company, 85% of thebenefits of this election, less amounts waived, will be returned to the sellingand converting unitholders of the operating company as they are realized.

 

On February 17, 2009,the Company’s Form S-3 registration statement, filed in order to registerthe Company’s issuance to Class B unitholders the total number of sharesof Class A common stock issuable upon exchange of all Class B unitsoutstanding immediately after the consummation of the operating company’sreorganization, was declared effective.

 

On March 3, 2009certain of the operating company’s members exchanged an aggregate of 2,445,973of their Class B units for an equivalent number of shares of Company Class Acommon stock.  The incrementalacquisition of additional operating company membership interests was similarlytreated as a reorganization of entities under common control as required by the*Business Combinations Topic* of the FASBASC.

 

The incremental assets andliabilities assumed in the exchange were recorded on March 3, 2009 asfollows:

 
| ** **                                              | ** ** | **(in  thousands)** | ** ** |
|---------------------------------------------------------|------------|---------------------|------------|
|                                                    |       |                |       |
| Pzena Investment  Management, LLC Members’ Capital |       | $                   | 33,788     |   |
| Pzena Investment  Management, LLC Retained Deficit      |       | (33,679             | )          |
| Realizable Deferred Tax Asset                           |       | 152                 |       |
| Net Tax Receivable Liability to Converting  Unitholders |       | (129                | )          |
| Total                                                   |       | $                   | 132        |   |
|                                                    |       |                |       |
| Common Stock, at Par                                    |       | $                   | 25         |   |
| Additional Paid-in Capital                              |       | 107                 |       |
| Total                                                   |       | $                   | 132        |   |

 

On August 6, 2009, anet amount of 78,211 options to purchase Class B units wereexercised.  Subsequent to the exchangeand option exercise, the holders of Class A common stock (through theCompany) and the holders of Class B units of the operating company heldapproximately 13.4% and 86.6%, respectively, of the economic interest in theoperations of the business.

 

**Note 15—SubsequentEvents**

 

As required by the *Subsequent Events Topic* of the FASB ASC, the Companyevaluated subsequent events through the issuance date of its financialstatements on November 9, 2009.

 

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**Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations.**

 

**Overview**

 

We are an investment managementfirm that utilizes a classic value investment approach in each of ourinvestment strategies.  We currentlymanage assets in a variety of value-oriented investment strategies across awide range of market capitalizations in both U.S. and non-U.S. capitalmarkets.  At September 30, 2009, ourassets under management (or “AUM”), was $13.9 billion.  We manage separate accounts on behalf ofinstitutions and high net worth individuals and act as sub-investment adviserfor a variety of SEC-registered mutual funds and offshore funds.

 

We function as the holdingcompany through which the business of our operating company, Pzena InvestmentManagement, LLC, is conducted. Following our initial public offering and reorganization on October 30,2007, we became the sole managing member of Pzena InvestmentManagement, LLC.  As such, we nowcontrol its business and affairs and, therefore, consolidate its financialresults with ours.  In light of ouremployees’ and other investors’ collective membership interest in our operatingcompany, we reflect their ownership as a non-controlling interest in ourconsolidated financial statements.  As aresult, subsequent to October 30, 2007, our income is generated by oureconomic interest in our operating company’s net income.  As of September 30, 2009, the holders ofClass A common stock (through the Company) and the holders of Class Bunits of the operating company held approximately 13.4% and 86.6%,respectively, of the economic interests in the operations of the business.

 

**Revenue**

 

We generate revenue frommanagement fees and incentive fees, which we collectively refer to as ouradvisory fees, by managing assets on behalf of separate institutional accountsand acting as a sub-investment adviser for retail clients, including mutualfunds and certain other investment funds. Our advisory fee income is recognized over the period in whichinvestment management services are provided. As preferred by the *Revenue Recognition Topic*of the FASB ASC, income from incentive fees is recorded at the conclusion ofthe contractual performance period, when all contingencies are resolved.

 

Our advisory fees areprimarily driven by the level of our AUM. Our AUM increases or decreases with the net inflows or outflows of fundsinto our various investment strategies and with the investment performancethereof.  In order to increase our AUMand expand our business, we must develop and market investment strategies thatsuit the investment needs of our target clients and provide attractive returnsover the long term.  The value andcomposition of our AUM, and our ability to continue to attract clients, willdepend on a variety of factors including, among other things:

 

·                  our ability toeducate our target clients about our classic value investment strategies andprovide them with exceptional client service;

 

·                  the relativeinvestment performance of our investment strategies, as compared to competingproducts and market indices;

 

·                  competitiveconditions in the investment management and broader financial services sectors;

 

·                  generaleconomic conditions;

 

·                  investorsentiment and confidence; and

 

·                  our decision toclose strategies when we deem it to be in the best interests of our clients.

 

For our institutionalaccounts, we are paid fees according to a schedule, which varies by investmentstrategy.  The substantial majority ofthese accounts pay us management fees pursuant to a schedule in which the ratewe earn on the AUM declines as the amount of AUM increases.  Certain of these clients pay us feesaccording to the performance of their accounts relative to certain agreed-uponbenchmarks, which results in a slightly lower base fee, but allows us to earnhigher fees if the relevant investment strategy outperforms the agreed-uponbenchmark.

 

Pursuant to our sub-investmentadvisory agreements with our retail clients, we are generally paid a managementfee according to a schedule in which the rate we earn on the AUM declines asthe amount of AUM increases.  Certain ofthese funds pay us fixed rate management fees. Due to the substantially larger account size of certain of theseaccounts, the average advisory fees we earn on them, as a percentage of AUM,are lower than the advisory fees we earn on our institutional accounts.

 

The majority of advisoryfees we earn on institutional accounts are based on the value of AUM at aspecific date on a quarterly basis, either in arrears or advance.  Advisory fees on certain of our institutionalaccounts, and with respect to most of our retail accounts, are calculated basedon the average of the monthly or daily market value.  Advisory fees are also adjusted for any cashflows into or out of a portfolio, where the cash flow represents greater than10% of the value of the portfolio.  Whilea specific group of accounts may use the same fee rate, the method used tocalculate the fee according to the fee rate schedule may differ as describedabove.

 

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Our advisory fees mayfluctuate based on a number of factors, including the following:

 

·                  changes in AUMdue to appreciation or depreciation of our investment portfolios, and thelevels of the contribution and withdrawal of assets by new and existingclients;

 

·                  distribution ofAUM among our investment strategies, which have different fee schedules;

 

·                  distribution ofAUM between institutional accounts and retail accounts, for which we generallyearn lower overall advisory fees; and

 

·                  the level ofour performance with respect to accounts on which we are paid incentive fees.

 

**Expenses**

 

Our expenses consistprimarily of compensation and benefits expenses, as well as general andadministrative expenses.  These expensesmay fluctuate due to a number of factors, including the following:

 

·                  variations inthe level of total compensation expense due to, among other things, bonuses,awards of equity to our employees and members of our operating company, changesin our employee count and mix, and competitive factors; and

 

·                  expenses, suchas rent, professional service fees and data-related costs, incurred, asnecessary, to run our business.

 

**Compensation and Benefits Expense**

 

Our largest expense iscompensation and benefits, which includes the salaries, bonuses, equity-basedcompensation, and related benefits and payroll costs attributable to ourmembers and employees.  Compensation andbenefits packages are benchmarked against relevant industry and geographic peergroups in order to attract and retain qualified personnel.  Cash compensation has declined as a result oflower overall compensation levels, as well as lower revenue-based variablecompensation costs and a decline in headcount. The table included in the section below describes the components of ourcompensation expense for the three and nine months ended September 30,2009 and 2008:

 
| ** **                               | ** ** | **For the Three  Months Ended********September 30,** | ** ** |
|------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                               | ** ** | **2009**                                                  | ** ** | **2008** | ** ** |
| ** **                               | ** ** | **(in  thousands)**                                       | ** ** |
|                                     |       |                                                      |       |   |   |
| Cash Compensation and  Other Benefits    |       | $                                                         | 5,977      |   | $ | 7,888 |   |
| Other Non-Cash  Compensation             |       | 255                                                       |       | 272 |   |
| Total Compensation and  Benefits Expense |       | $                                                         | 6,232      |   | $ | 8,160 |   |

 
| ** **                               | ** ** | **For the  Nine Months Ended********September 30,** | ** ** |
|------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                               | ** ** | **2009**                                                 | ** ** | **2008** | ** ** |
| ** **                               | ** ** | **(in  thousands)**                                      | ** ** |
|                                     |       |                                                     |       |   |   |
| Cash Compensation and  Other Benefits    |       | $                                                        | 17,439     |   | $ | 24,868 |   |
| Other Non-Cash  Compensation             |       | 816                                                      |       | 905 |   |
| Total Compensation and  Benefits Expense |       | $                                                        | 18,255     |   | $ | 25,773 |   |

 

On January 1, 2007, weadopted the PIM LLC 2006 Equity Incentive Plan, pursuant to which we haveissued restricted units, and options to acquire units, in our operatingcompany, both of which vest ratably over a four-year period.  We used a fair-value method in recording thecompensation expense associated with the granting of these restricted units,and options to acquire units, to new and existing members under thePIM LLC 2006 Equity Incentive Plan. Under this method, compensation expense is measured at the grant datebased on the estimated fair value of the award and is recognized over theaward’s vesting period.  The fair valueof the units is determined by reference to the market price of our Class Acommon stock on the date of grant, since these units are exchangeable forshares of our Class A common stock on a one-for-one basis.  The fair value of the options to acquireunits is determined by using an appropriate option pricing model on the grantdate.

 

On January 1, 2007, weinstituted a deferred compensation plan, in which employees who earn in excessof $600,000 per year are required to defer a portion of their compensation inexcess of this amount.  These deferredamounts may be invested, at the employee’s discretion, in certain of our investmentstrategies, restricted phantom units of our operating company, or money marketfunds.  Amounts deferred in any periodreduce that period’s cash compensation expense and vest ratably over afour-year period

 

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beginning on January 1 of the nextcalendar year; therefore, the amortization of a ratable portion of 2007deferred amounts has been reflected in our expenses for the three and ninemonths ended September 30, 2009 and 2008. Should additional amounts be deferred in future periods, we would expectthe non-cash portion of our compensation expense to increase as the existingand subsequently deferred amounts are amortized through income.

 

As of September 30,2009, we had approximately $1.6 million in unrecorded compensation expenserelated to phantom operating company units issued pursuant to our deferredcompensation plan and operating company unit and option grants issued under ourPIM LLC 2006 Equity Incentive Plan.  Weexpect that the amortization of these amounts will be approximately$0.7 million for 2009 and 2010, with a negligible amount amortizedthereafter.

 

**General and Administrative Expenses**

 

General and administrativeexpenses include office expenses, professional and outside services fees,depreciation, and the costs associated with operating and maintaining ourresearch, trading, and portfolio accounting systems.  Our occupancy-related costs and professionalservices expenses, in particular, generally increase or decrease in relativeproportion to the overall size and scale of our business operations.

 

As a result of our offeringon October 30, 2007, we have incurred, and expect to incur, additionalexpenses associated with being a public company for, among other things,director and officer insurance, director fees, SEC reporting and compliance(including Sarbanes-Oxley compliance), professional fees, transfer agent fees,and other similar expenses.  Theseadditional expenses have and will reduce our net income.

 

**Other Income**

 

Other income is derivedprimarily from investment income or loss arising from our investments invarious private investment vehicles that we employ to incubate new strategies,interest expense on our outstanding debt, mark-to-market movements on our swapagreement prior to its termination, and interest income generated on our excesscash balances.  Other income is alsoaffected by changes in our estimates of the liability due to our selling andconverting shareholders associated with payments owed to them under the taxreceivable agreement which was implemented subsequent to our reorganization andoffering on October 30, 2007.  Asdiscussed further below, under “Tax Receivable Agreement,” this liabilityrepresents 85% of the amount of cash savings, if any, in U.S. federal, state,and local income tax that we realize as a result of the amortization of theincreases in tax basis generated from the Company’s acquisitions of operatingcompany units from its selling and converting shareholders.  Amounts waived by our selling and convertingshareholders reduce this liability.  Weexpect the interest and investment components of other income, in theaggregate, to fluctuate based on market conditions and the performance of ourinvestment strategies.

 

**Non-Controlling Interests**

 

Our operating company hashistorically consolidated the results of operations of the private investmentpartnerships over which we exercise a controlling influence.  After our reorganization, we became the solemanaging member of our operating company and now control its business andaffairs and, therefore, consolidate its financial results with ours.  In light of our employees’ and outsideinvestors’ interest in our operating company, we have reflected theirmembership interests as a non-controlling interest in our consolidatedfinancial statements.  As a result,subsequent to October 30, 2007, our income is generated by our economicinterest in our operating company’s net income. As of September 30, 2009, the holders of Class A common stock(through the Company) and the holders of Class B units of the operatingcompany held approximately 13.4% and 86.6%, respectively, of the economicinterests in the operations of the business.

 

**Income Tax Provision/(Benefit)**

 

While our operating companyhas historically not been subject to U.S. federal and certain state incometaxes, it has been subject to New York City Unincorporated Business Tax.  As a result of our reorganization, we are nowsubject to taxes applicable to C-corporations. As such, our effective tax rate has increased as a result of ourreorganization.  Valuation allowances areestablished, when necessary, to reduce deferred tax assets to the amountexpected to be realized.  As of September 30,2009 and December 31, 2008, the Company’s valuation allowance against thedeferred tax asset associated with our acquisition of operating company unitsin conjunction with the offering and subsequent grants was $60.3 million and a$62.7 million, respectively.

 

**Operating Results**

 

***General***

 

Our earnings and cash flowsare heavily dependent upon prevailing financial market conditions.  Significant increases or decreases in thevarious securities markets, particularly the equities markets, can have a materialimpact on our results of operations, financial condition, and cash flows.

 

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In 2008 and continuingthrough the quarter ended March 31, 2009, the performance of ourinvestment strategies was negatively impacted by significant volatility in theequity markets.  Investment performanceduring 2008 was influenced by our overweight exposure to the financial servicessector in particular, which underperformed. As a result, our assets under management declined by $1.6 billion,or 10.3%, from $15.5 billion at September 30, 2008, to $13.9 billionat September 30, 2009, due to net outflows of $1.2 billion and negativeperformance of $0.4 billion.

 

During the three monthsended September 30, 2009, we experienced gross inflows of$1.2 billion, which were partially offset by gross outflows of$0.7 billion.    Our institutionalaccounts experienced $0.9 billion in gross inflows, partially offset by$0.3 billion in gross outflows.  Ourretail accounts experienced gross outflows of $0.4 billion, which werepartially offset by $0.3 billion in gross inflows.  The $0.5 billion in overall net inflowswas mainly attributable to strong institutional inflows into our Europe,Australasia, and Far East (“EAFE”) Value investment strategies.

 

During the nine months endedSeptember 30, 2009, we experienced gross outflows of $3.0 billion,which were partially offset by gross inflows of $2.7 billion.  Our institutional accounts experienced$1.8 billion in gross inflows, partially offset by $1.5 billion in grossoutflows.  Our retail accountsexperienced gross outflows of $1.5 billion, which were partially offset by$0.9 billion in gross inflows.  The$0.3 billion in overall net outflows was mainly attributable to the weakerperformance of our retail funds compared to that of their peers, which offsetthe institutional inflows described above.

 

Our average AUM fluctuatesbased on changes in the market value of accounts advised and managed by us, andon fund flows.  Accordingly, given ourlower AUM levels, our revenues in 2009 have declined from the prior year.  A decrease in revenue results in loweroperating income and net income.

 

We expect that we willexperience continued pressure on our operating margins in the future if AUMwere to further decline.  Our operatingexpenses have declined modestly in 2009 from the comparable 2008 periods, as weidentified and implemented potential cost savings opportunities.

 

***Assets Under Management and Flows***

 

The change in AUM in ourinstitutional accounts and our retail accounts for the three and nine monthsended September 30, 2009 and 2008 is described below:

 
| ** **                  | ** ** | **For the  Three Months Ended  September 30,** | ** ** |
|-----------------------------|------------|-----------------------------------------------------|------------|
| **Assets Under Management** | ** ** | **2009**                                            | ** ** | **2008** | ** ** |
| ** **                  | ** ** | **(in  billions)**                                  | ** ** |
| Institutional Accounts      |       |                                                |       |   |   |
| Beginning of Period Assets  |       | $                                                   | 7.5        |   | $ | 13.0 |   |
| *Inflows*                   | * *   | *0.9*                                               | * *   | *0.7* | * * |
| *Outflows*                  | * *   | *(0.3*                                              | *)*        | *(2.0* | *)* |
| Net Flows                   |       | 0.6                                                 |       | (1.3 | ) |
| Performance                 |       | 2.1                                                 |       | (0.9 | ) |
| End of Period Assets        |       | $                                                   | 10.2       |   | $ | 10.8 |   |
| Retail Accounts             |       |                                                |       |   |   |
| Beginning of Period Assets  |       | $                                                   | 3.1        |   | $ | 5.5 |   |
| *Inflows*                   | * *   | *0.3*                                               | * *   | *0.5* | * * |
| *Outflows*                  | * *   | *(0.4*                                              | *)*        | *(0.9* | *)* |
| Net Flows                   |       | (0.1                                                | )          | (0.4 | ) |
| Performance                 |       | 0.7                                                 |       | (0.4 | ) |
| End of Period Assets        |       | $                                                   | 3.7        |   | $ | 4.7 |   |
| Total                       |       |                                                |       |   |   |
| Beginning of Period Assets  |       | $                                                   | 10.6       |   | $ | 18.5 |   |
| *Inflows*                   | * *   | *1.2*                                               | * *   | *1.2* | * * |
| *Outflows*                  | * *   | *(0.7*                                              | *)*        | *(2.9* | *)* |
| Net Flows                   |       | 0.5                                                 |       | (1.7 | ) |
| Performance                 |       | 2.8                                                 |       | (1.3 | ) |
| End of Period Assets        |       | $                                                   | 13.9       |   | $ | 15.5 |   |

 

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| ** **                  | ** ** | **For the  Nine Months Ended  September 30,** | ** ** |
|-----------------------------|------------|----------------------------------------------------|------------|
| **Assets Under Management** | ** ** | **2009**                                           | ** ** | **2008** | ** ** |
| ** **                  | ** ** | **(in  billions)**                                 | ** ** |
| Institutional Accounts      |       |                                               |       |   |   |
| Beginning of Period Assets  |       | $                                                  | 7.4        |   | $ | 15.9 |   |
| *Inflows*                   | * *   | *1.8*                                              | * *   | *2.3* | * * |
| *Outflows*                  | * *   | *(1.5*                                             | *)*        | *(3.3* | *)* |
| Net Flows                   |       | 0.3                                                |       | (1.0 | ) |
| Performance                 |       | 2.5                                                |       | (4.1 | ) |
| End of Period Assets        |       | $                                                  | 10.2       |   | $ | 10.8 |   |
| Retail Accounts             |       |                                               |       |   |   |
| Beginning of Period Assets  |       | $                                                  | 3.3        |   | $ | 7.7 |   |
| *Inflows*                   | * *   | *0.9*                                              | * *   | *2.3* | * * |
| *Outflows*                  | * *   | *(1.5*                                             | *)*        | *(3.3* | *)* |
| Net Flows                   |       | (0.6                                               | )          | (1.0 | ) |
| Performance                 |       | 1.0                                                |       | (2.0 | ) |
| End of Period Assets        |       | $                                                  | 3.7        |   | $ | 4.7 |   |
| Total                       |       |                                               |       |   |   |
| Beginning of Period Assets  |       | $                                                  | 10.7       |   | $ | 23.6 |   |
| *Inflows*                   | * *   | *2.7*                                              | * *   | *4.6* | * * |
| *Outflows*                  | * *   | *(3.0*                                             | *)*        | *(6.6* | *)* |
| Net Flows                   |       | (0.3                                               | )          | (2.0 | ) |
| Performance                 |       | 3.5                                                |       | (6.1 | ) |
| End of Period Assets        |       | $                                                  | 13.9       |   | $ | 15.5 |   |

 

InSeptember 2009, we changed the classification of our assets undermanagement to better reflect the underlying behavior and composition of ourclient base.  We now group our assetsinto two categories: Institutional Accounts and Retail Accounts, which betterillustrate the characteristics and trends inherent in our clientrelationships.  The change inclassification did not impact reported totals of assets under management.

 

Our InstitutionalAccounts are primarily comprised of foundations and endowments, defined benefitand defined contribution plans for corporations and municipalities, and fundswhich service institutional investors. Our Retail Accounts are generally open-end mutual funds which caterprimarily to retail clients.  Historicalinformation has been reclassified for all periods presented.

 

AtSeptember 30, 2009, our $13.9 billion of AUM were invested invalue-oriented investment strategies which represent distinct geographicalsegments of the U.S., Global, and EAFE markets. The following table describes the allocation of our AUM, as of September 30,2009, among our investment strategies:

 
| **Investment  Strategy** | ** ** | **AUM at********September 30,********2009** | ** ** |
|--------------------------|------------|--------------------------------------------------|------------|
| ** **               | ** ** | **(in  billions)**                               | ** ** |
|                     |       |                                             |       |
| U.S. Value Strategies    |       | $                                                | 9.9        |   |
| Global Value Strategies  |       | 2.4                                              |       |
| EAFE Value Strategies    |       | 1.6                                              |       |
| Total                    |       | $                                                | 13.9       |   |

 

*ThreeMonths Ended September 30, 2009 versus September 30, 2008*

 

At September 30, 2009,the Company managed $13.9 billion in total assets, a decrease of$1.6 billion, or 10.3%, from $15.5 billion at September 30,2008.  The year-over-year decrease in AUMwas due primarily to $1.2 billion in net outflows, and, to a lesserextent, market depreciation of $0.4 billion.  Generally negative economic conditions andour 2008 overweight investment exposure to the financial services sector inparticular, which underperformed, contributed to the performance-relateddecline in our AUM.  Our retail accountsexperienced net outflows of $0.1 billion for the three months ended September 30,2009.  These net outflows were 

 

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driven in part by our investment strategies’underperformance relative to their respective benchmarks and client assetre-balancing in response to the volatile economic environment.

 

The Company managed$10.2 billion in institutional accounts and $3.7 billion in retailaccounts, for a total of $13.9 billion in assets at September 30,2009.  Assets in institutional accountsincreased by $2.7 billion, or 36.0%, during the three months ended September 30,2009, due to $2.1 billion in market appreciation and inflows of $0.9billion, partially offset by outflows of $0.3 billion.  Assets in retail accounts increased by $0.6billion, or 19.4%, during the three months ended September 30, 2009, as aresult of $0.7 billion in market appreciation and $0.3 billion in grossinflows, offset by $0.4 billion in gross outflows.

 

*Nine months ended September 30, 2009 versus September 30,2008*

 

At September 30, 2009,the Company managed $13.9 billion in total assets, a decrease of$1.6 billion, or 10.3%, from $15.5 billion at September 30,2008.  The year-over-year decrease in AUMwas due primarily to net outflows of $1.2 billion, and, to a lesserextent, $0.4 billion in market depreciation.

 

The Company managed$10.2 billion in institutional accounts and $3.7 billion in retailaccounts, for a total of $13.9 billion in assets at September 30,2009.  Assets in institutional accountsincreased by $2.8 billion, or 37.8%, during the nine months ended September 30,2009, due to $2.5 billion in market appreciation and $0.3 billion netinflows.  This compared with a decreasein institutional accounts of $5.1 billion, or 32.1%, during the nine monthsended September 30, 2008, as a result of $4.1 billion in marketdepreciation and $1.0 billion in net outflows.  Assets in our retail accounts increased by$0.4 billion, or 12.1%, during the nine months ended September 30,2009, as a result of $1.0 billion of market appreciation, offset by $0.6million in net outflows.  This comparedto a decrease in retail accounts of $3.0 billion, or 39.0%, during thenine months ended September 30, 2008, due to $2.0 billion of marketdepreciation and $1.0 billion in net outflows.

 

At September 30, 2009,institutional accounts represented 73.4% of our total AUM, and retail accountsrepresented 26.6% of our total AUM, as compared to 69.7% and 30.3%,respectively, at September 30, 2008. At September 30, 2009, our U.S. value strategies accounted for71.2% of our AUM and our Global Value and EAFE Value investment strategies,combined, accounted for 28.8% of our AUM, compared to 81.3% and 18.7%,respectively, at September 30, 2008.

 

Our revenues from advisoryfees earned on our institutional accounts and our retail accounts for the threeand nine months ended September 30, 2009 and 2008 is described below:

 
| ** **             | ** ** | **Three Months Ended********September 30,** | ** ** |
|------------------------|------------|--------------------------------------------------|------------|
| **Revenue**            | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
| ** **             | ** ** | **(in  millions)**                               | ** ** |
|                   |       |                                             |       |   |   |
| Institutional Accounts |       | $                                                | 13.8       |   | $ | 20.1 |   |
| Retail Accounts        |       | 3.0                                              |       | 5.0 |   |
| Total                  |       | $                                                | 16.8       |   | $ | 25.1 |   |

* *
| ** **             | ** ** | **Nine Months Ended********September 30,** | ** ** |
|------------------------|------------|-------------------------------------------------|------------|
| **Revenue**            | ** ** | **2009**                                        | ** ** | **2008** | ** ** |
| ** **             | ** ** | **(in  millions)**                              | ** ** |
|                   |       |                                            |       |   |   |
| Institutional Accounts |       | $                                               | 36.5       |   | $ | 66.8 |   |
| Retail Accounts        |       | 8.2                                             |       | 16.6 |   |
| Total                  |       | $                                               | 44.7       |   | $ | 83.4 |   |

 

*Three Months Ended September 30, 2009 versus September 30,2008*

 

Our total revenue decreased$8.3 million, or 33.1%, to $16.8 million for the three months ended September 30,2009, from $25.1 million for the three months ended September 30,2008.  This change was driven primarilyby a reduction in weighted average AUM, which decreased $5.4 billion, or 30.7%,to $12.2 billion for the three months ended September 30, 2009, from$17.6 billion from the three months ended September 30, 2008.

 

Our total weighted averagefees were 0.550% and 0.569% for the three months ended September 30, 2009and 2008, respectively.  This decreasewas due in part to an increase in the average account size of our institutionalclients; our tiered fee schedules generally charge lower rates as account sizeincreases.  Weighted average assets ininstitutional accounts decreased $3.5 billion, or 28.5%, to $8.8 billionfor the three months ended September 30, 2009, from $12.3 billion forthe three months ended 

 

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September 30, 2008.  Institutional accounts had weighted averagefees of 0.630% and 0.654% for the three months ended September 30, 2009and 2008, respectively.  Theyear-over-year decrease in weighted average fees was primarily a result ofhigher institutional average account size, which generally causes a lower feerate.  Weighted average assets in retailaccounts decreased $1.9 billion, for the three months ended September 30,2009, from $5.3 billion for the three months ended September 30,2008.  Retail accounts had weightedaverage fees of 0.346% and 0.372% for the three months ended September 30,2009 and 2008, respectively.  Theyear-over-year decline in weighted average fees was due primarily to the effectof a temporary, voluntary partial fee waiver on the John Hancock Classic ValueFund.  Our share of the reduction expires in May 2010.

 

*Nine months ended September 30, 2009 versus September 30,2008*

 

Our total revenue decreased$38.7 million, or 46.4%, to $44.7 million for the nine months ended September 30,2009, from $83.4 million for the nine months ended September 30,2008.  This decrease was driven primarilyby a decline in weighted average AUM, which decreased $9.4 billion, or 46.8%,to $10.7 billion for the nine months ended September 30, 2009, from$20.1 billion for the nine months ended September 30, 2008.

 

Our total weighted averagefees were 0.559% and 0.551% for the nine months ended September 30, 2009and 2008, respectively.  This increasewas primarily due to the higher mix of assets in our Global Value strategiesand EAFE Value strategies.  Weightedaverage assets in institutional accounts decreased $6.5 billion, or 46.1%, to$7.6 billion for the nine months ended September 30, 2009, from$14.1 billion for the nine months ended September 30, 2008.  Institutional accounts had weighted averagefees of 0.642% and 0.633% for the nine months ended September 30, 2009 and2008, respectively.  Weighted average assetsin retail accounts decreased $3.0 billion, or 49.2%, to $3.1 billion forthe nine months ended September 30, 2009, from $6.1 billion for thenine months ended September 30, 2008. Retail accounts had weighted average fees of 0.355% and 0.363% for thenine months ended September 30, 2009 and 2008, respectively.

 

***Expenses***

 

Our operating expenses aredriven primarily by our compensation costs. The table below describes the components of our compensation expense forthe three and nine months ended September 30, 2009 and 2008.

 
| ** **                               | ** ** | **For the Three  Months Ended********September 30,** | ** ** |
|------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                               | ** ** | **2009**                                                  | ** ** | **2008** | ** ** |
| ** **                               | ** ** | **(in  thousands)**                                       | ** ** |
|                                     |       |                                                      |       |   |   |
| Cash Compensation and  Other Benefits    |       | $                                                         | 5,977      |   | $ | 7,888 |   |
| Other Non-Cash  Compensation             |       | 255                                                       |       | 272 |   |
| Total Compensation and  Benefits Expense |       | $                                                         | 6,232      |   | $ | 8,160 |   |

 
| ** **                               | ** ** | **For the Nine Months****Ended**** September 30,** | ** ** |
|------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                               | ** ** | **2009**                                                     | ** ** | **2008** | ** ** |
| ** **                               | ** ** | **(in  thousands)**                                          | ** ** |
|                                     |       |                                                         |       |   |   |
| Cash Compensation and  Other Benefits    |       | $                                                            | 17,439     |   | $ | 24,868 |   |
| Other Non-Cash  Compensation             |       | 816                                                          |       | 905 |   |
| Total Compensation and  Benefits Expense |       | $                                                            | 18,255     |   | $ | 25,773 |   |

 

*Three Months Ended September 30, 2009 versus September 30,2008*

 

Total operating expensesdecreased by $2.7 million, or 25.0%, to $8.1 million for the three months endedSeptember 30, 2009, from $10.8 million for the three months ended September 30,2008.  This decline was primarily aresult of overall reductions in bonus-related and variable compensation costs,as well as decreases in professional services and data systems expenses.

 

Compensation and benefitsexpense decreased by $2.0 million, or 24.4%, to $6.2 million for thethree months ended September 30, 2009, from $8.2 million for thethree months ended September 30, 2008. This decline was primarily a result of lower cash compensation arisingfrom reduced staffing levels and firmwide decreases in bonus-related andAUM-based variable compensation expense. Our employee count decreased from 75 at September 30, 2008, to 65at September 30, 2009.  Theyear-over-year decrease in headcount was primarily a result of staff reductionsin back office operations undertaken in the fourth quarter of 2008, as well asnatural attrition throughout the year.

 

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General and administrativeexpenses decreased by $0.7 million, or 26.9%, to $1.9 million for thethree months ended September 30, 2009, from $2.6 million for thethree months ended September 30, 2008. This decrease was mainly attributable to declines in professionalservices fees and data systems costs arising from ongoing efforts to containcosts.

 

*Nine months ended September 30, 2009 versus September 30,2008*

 

Total operating expenses decreased by $9.5 million, or 27.9%,to $24.6 million for the nine months ended September 30, 2009, from$34.1 million for the nine months ended September 30, 2008.  This decrease was primarily attributable tofirm-wide reductions in staffing and bonus-related and variable compensationcosts, as well as decreases in professional services and data systems expenses.

 

Compensation and benefits expense decreased by$7.5 million, or 29.1%, to $18.3 million for the nine months ended September 30,2009, from $25.8 million for the nine months ended September 30,2008.  This decrease was primarilyattributable to firm-wide reductions in bonus-related and variable compensationcosts.  Our employee count decreasedfrom 75 at September 30, 2008, to 65 at September 30, 2009.  The year-over-year decrease in headcount wasprimarily a result of staff reductions in back office operations undertaken inthe fourth quarter of 2008, as well as natural attrition throughout the year.

 

General and administrativeexpenses decreased by $2.0 million, or 24.1%, to $6.3 million for thenine months ended September 30, 2009, from $8.3 million for the ninemonths ended September 30, 2008. This decrease was mainly attributable to declines in professionalservices fees and data systems costs.

 

***Other Income***

 

*Three Months Ended September 30, 2009 versus September 30,2008*

 

Other income was $1.6million for the three months ended September 30, 2009, and consistedprimarily of $4.2 million in income related to the positive performance of theCompany’s investments in its own products and $0.1 million in interest anddividend income.  This income was partiallyoffset by $0.4 million in interest expense and $2.4 million in other expenseassociated with an increase in the Company’s liability to its selling andconverting shareholders associated with changes in the realizability of itsrelated deferred tax asset.  Other incomewas $49.3 million for the three months ended September 30, 2008.  This year-over-year decrease was primarily aresult of a $53.3 million credit to other income associated with the reductionin the liability to selling and converting shareholders associated with changesin the realizability of its related deferred tax asset that was recorded in thethree months ended September 30, 2008 and not replicated in the threemonths ended September 30, 2009.

 

*Nine months ended September 30, 2009 versus September 30,2008*

 

Other income was $1.8million for the nine months ended September 30, 2009, and consistedprimarily of $6.1 million in income related to the positive performance ofCompany’s investments in its own products, largely offset by interest expenseand adjustments to the Company’s liability to its selling and convertingshareholders.  For the nine months ended September 30,2008, other income was $41.5 million and consisted primarily of a $53.3 millioncredit to other income associated with the reduction in the liability toselling and converting shareholders associated with changes in therealizability of its related deferred tax asset.  This was partially offset by $11.0 million inlosses related to the negative performance of the Company’s investments in itsown products.

 

***Income Tax Provision/(Benefit)***

 

*Three Months Ended September 30, 2009 versus September 30,2008*

 

The Company recognized a$2.0 million income tax benefit for the three months ended September 30,2009, and recorded a $64.0 million provision for the three months ended September 30,2008.  The income tax benefit for thethree months ended September 30, 2009 was generated primarily by a $3.1million reduction in the valuation allowance to the Company’s deferred taxasset associated with its tax receivable agreement.  For the three months ended September 30,2008, the provision for income taxes was generated primarily by theestablishment, on September 30, 2008, of a $62.7 million valuationallowance assessed against the deferred tax asset recorded as part of ourinitial public offering.  A comparison ofthe effective tax rate for the three months ended September 30, 2009 and2008 is not meaningful due to the effect of the valuation allowance.

 

*Nine months ended September 30, 2009 versus September 30,2008*

 

The Company recognized a$2.4 million income tax benefit for the nine months ended September 30,2009, and recorded a $67.0 million provision for the nine months ended September 30,2008.  The 2009 income tax benefit wasgenerated primarily by a $4.8 million reduction in the valuation allowance tothe Company’s deferred tax asset associated with its tax receivableagreement.  For the nine months ended September 30,2008, the provision for income taxes was generated primarily by the establishment,on 

 

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September 30, 2008,of a $62.7 million valuation allowance assessed against the deferred tax assetrecorded as part of our initial public offering.  A comparison of the effective tax rate forthe nine months ended September 30, 2009 and 2008 is not meaningful due tothe effect of the valuation allowance.

 

***Non-Controlling Interests***

 

*Three Months Ended September 30, 2009 versus September 30,2008*

 

Net income attributable tonon-controlling interests was $10.8 million for the three months ended September 30,2009, and consisted of $8.1 million associated with our employees’ and outsideinvestors’ interest in the income of the operating company and approximately$2.7 million associated with our consolidated subsidiaries’ interest in theincome of our consolidated investment partnerships.  For the three months ended September 30,2008, net income attributable to non-controlling interests was $8.4 million andconsisted of $10.8 million associated with our employees’ and outsideinvestors’ interest in the income of the operating company, offset by the$2.4 million effect of the absorption, by our consolidated subsidiaries,of their share of the losses of our consolidated investment partnerships.  The change in net income attributable tonon-controlling interests reflects primarily the decline in our weightedaverage AUM, which had a corresponding negative impact on revenues and income,offset by the positive return on the investments in our consolidated investmentpartnerships in 2009.

 

*Nine months ended September 30, 2009 versus September 30,2008*

 

Non-controlling interestswere $21.5 million for the nine months ended September 30, 2009, andconsisted of approximately $17.7 million associated with our employees’ andoutside investors’ interest in the income of the operating company and $3.8million associated with our consolidated subsidiaries’ interest in the incomeof our consolidated investment partnerships. For the nine months ended September 30, 2008, non-controllinginterests were $30.9, million and consisted of $37.0 million associated withour employees’ and outside investors’ interest in the income of the operatingcompany, offset by the $6.1 million effect of the absorption, by ourconsolidated subsidiaries, of their share of the losses of our consolidatedinvestment partnerships.  The change innon-controlling interests reflects primarily the decline in our weightedaverage AUM, which had a corresponding negative impact on our revenues andincome.

 

**Liquidity and Capital Resources**

 

Historically, the workingcapital needs of our business have primarily been met through cash generated byour operations.  Distributions to membersof our operating company and loan amortization payments have been our largestuse of cash from financing activities. Investing activities have historically been investments in our owninvestment strategies and, to a lesser extent, capital expenditures.

 

At September 30, 2009,our cash and cash equivalents was $19.1 million, inclusive of $0.6 millionin cash held by our consolidated investment partnerships.  Advisory fees receivable was$12.7 million.  We also hadapproximately $5.9 million in equity securities, net of $11.1 millionin non-controlling interests and approximately $1.4 million in investmentsset aside to satisfy our obligations under our deferred compensation program.

 

Weexpect to fund the liquidity needs of our business in the next twelve months,and over the long term, primarily through cash generated from operations.  As an investment management firm, ourbusiness has been materially affected by conditions in the global financialmarkets and economic conditions throughout the world.  Our liquidity is highly dependent on therevenue and income from our operations, which is directly related to our levelsof AUM.  As of and for the three monthsended September 30, 2009, our AUM and revenues declined by 10.3% and 33.1%, respectively, compared withthe three months ended September 30, 2008.   As of and for the nine months ended September 30,2009, our AUM and revenues declined by 10.3% and 46.4%, respectively, compared withthe nine months ended September 30, 2008. These reductions contributed to a 52.9% and 47.4% decline in our cashprovided by operating activities during the three and nine month periods ended September 30,2009, respectively.  To the extent thatour AUM experiences declines, the cash provided by operating activities may benegatively impacted.

 

In determining thesufficiency of liquidity and capital resources to fund our business, weregularly monitor our liquidity position, including, among other things, cash,working capital, investments, long-term liabilities, lease commitments, debtobligations, and operating company distributions.  Further, we consider compensation, one of ourlargest expenses, as sufficiently variable such that it can be adjusted tomitigate the decline in revenue we have experienced, and may continue toexperience in the next twelve months. We continuously evaluate our staffingrequirements and compensation levels with reference to our own liquidityposition and external peer benchmarking data. The result of this review directly influences management’srecommendations to our board of directors with respect to such staffing andcompensation levels.

 

We anticipate that taxallocations to the members of our operating company, which, as of September 30,2009, consisted of our three managing principals, 28 of our other employees,certain unaffiliated persons, two former employees, and us, will continue 

 

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to be a material financing activity.  Under the terms and conditions of our SeniorSubordinated Notes, we have suspended our dividend payments toshareholders.  Cash distributions tooperating company members for partnership tax allocations would decline shouldthe taxable income of the operating company decrease.

 

As discussed further below,on October 28, 2008, our operating company entered into a third amendmentto its Credit Agreement and issued $16.0 million in Senior SubordinatedNotes to entities established by Richard S. Pzena, the Company’s CEO, forthe benefit of certain of his family members, to an entity controlled by aCompany director, and to a former employee. The proceeds of the notes and $9.0 million of cash reserves wereused to reduce the principal amounts outstanding under the CreditAgreement.  Pursuant to the terms of theSenior Subordinated Notes, we are precluded from paying dividends toshareholders.  The Company repaid theremaining $10.0 million of the principal amount outstanding under the CreditAgreement during the three months ended September 30, 2009, and has$16.0 million outstanding of the Senior Subordinated Notes.  In the current economic environment, it isuncertain whether additional or alternative sources of debt or equity financingwould be available on acceptable terms.

 

We do not anticipatemeaningful outlays for internal investment or capital expenditures over thenext twelve months.

 

We believe that therepayment of our bank term loan, elimination of the dividend, reductions inheadcount, and ability to vary cash compensation levels have provided us withan appropriate degree of flexibility in providing for our liquidity needs.

 

**Dividend Policy**

 

We are a holding company andhave no material assets other than our ownership of membership interests in ouroperating company.  As a result, wedepend upon distributions from our operating company to pay any dividends thatour board of directors may declare to be paid to our Class A commonstockholders, if any.  When and if ourboard of directors declares any such dividends, we then cause our operatingcompany to make distributions to us in an amount sufficient to cover the amountof the dividends declared.  We may notpay dividends to our Class A common stockholders in amounts that have beenpaid to them in the past, or at all, if, among other things, we do not have thecash necessary to pay our intended dividends or any of our financing facilitiesor other agreements restrict us from doing so. Pursuant to restrictions set forth in our Senior Subordinated Notes, asof October 28, 2008, we suspended previous quarterly cash dividendpayments to our Class A common stockholders.  In the future, our board of directors may, inits discretion and subject to the Company’s operating results, debt agreementsand applicable law, reinstate the dividend in an amount to be determined byit.  To the extent we do not have cash onhand sufficient to pay dividends in the future, we may decide not to paydividends.  By paying cash dividendsrather than investing that cash in our future growth, we risk slowing the paceof our growth, or not having a sufficient amount of cash to fund our operationsor unanticipated capital expenditures, should the need arise.

 

**Credit Agreement**

 

On July 23, 2007, ouroperating company borrowed $60.0 million pursuant to a three-year termloan facility, the proceeds of which were used to finance a special one-timedistribution to the members of our operating company as of that date.  Concurrently, our operating company alsoobtained a $20.0 million revolving credit facility to finance ourshort-term working capital needs.  Werefer to the term loan and revolving loan facilities as our Credit Agreement.  On February 11, 2008, our operatingcompany entered into the first amendment to the Credit Agreement.  The amendment changed a number of CreditAgreement provisions, including: (i) the minimum AUM financial covenantwas reduced from $20.0 billion to $15.0 billion; (ii) theminimum Earnings Before Interest, Taxes, Depreciation and Amortization, orEBITDA, financial covenant for each four quarter period was reduced from$60.0 million to $40.0 million; (iii) the capacity of therevolving credit facility was reduced from $20.0 million to$5.0 million; and (iv) the interest rate was increased from LIBORplus 1.0% to LIBOR plus 1.5%.  Inaddition, two mandatory prepayment provisions were added: (a) term loanamortization was required beginning in any period when AUM was less than$20 billion and ending when AUM was greater than $21.5 billion, and (b) a50% excess cash flow sweep was required if AUM was below$17.5 billion.  During the threemonths ended September 30, 2008, our assets under management fell below$20 billion.  Pursuant to theprovisions of the term loan, as amended, our operating company was required tomake an amortization payment of $3.0 million on September 30, 2008.

 

On September 19, 2008,our operating company entered into Amendment No. 2 to its CreditAgreement.  The agreement, as amended,required the operating company to maintain assets under management of at least$12.0 billion and to make minimum quarterly amortization payments of$2.0 million until maturity, which was extended to July 23, 2011.Additionally, the LIBOR interest rate option was increased to LIBOR plus 1.75%and the EBITDA financial covenant stipulated in Amendment No.1 waseliminated.  The excess cash flow sweepwas also increased to 75% of excess cash flow. On September 22, 2008, our operating company made a requiredamortization payment of $5.0 million as a condition precedent to theeffectiveness of this amendment.  On September 30,2008, our operating company made a quarterly amortization payment of$5.0 million.

 

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On October 28, 2008,our operating company entered into Amendment No. 3 to its CreditAgreement.  This amendment provided forthe following changes to the Credit Agreement, among others:

 

i.                  the minimum assets undermanagement financial covenant was eliminated;

 

ii.               the excess cash flowmandatory repayment was eliminated;

 

iii.            the commitments under therevolving credit facility were reduced from $3.0 million to approximately$1.8 million;

 

iv.           with respect to loansborrowed at base rate, the margin added to base rate was increased from 0.00%to 0.75%; with respect to loans borrowed at LIBOR, the margin was not modified;

 

v.              certain additionalrestrictions were placed on the operating company’s ability to make RestrictedPayments (as defined in the Credit Agreement), including dividends; and

 

vi.           amendments to certaincovenants in order to permit the incurrence of subordinated debt by theoperating company.

 

Conditions precedent to theexecution of Amendment No.3 included, among others, (i) the repayment bythe operating company of $25.0 million of the $47.0 million principalamount outstanding under the Credit Agreement as of October 28, 2008, and (ii) thegrant by the operating company and one of its subsidiaries of a securityinterest in their accounts receivable.

 

In order to fund the$25.0 million repayment by our operating company, we used$9.0 million in cash reserves and the proceeds from the issuance on October 28,2008 of an aggregate of $16.0 million principal amount of SeniorSubordinated Notes (collectively, the “Notes”) to entities established byRichard Pzena, our Company’s Chief Executive Officer, for the benefit ofcertain of his family members, to an entity controlled by a Company director,and to a former employee of our operating company.  Each of these Notes is unsecured, has aten-year maturity and bears interest at 6.30% per annum.  The provisions of the Notes include arestricted payments covenant (including dividend payments), a prohibition onincurring indebtedness which is not subordinated to the Notes, and events ofdefault based on failure to make payments, bankruptcy, change of control andacceleration of material indebtedness. In addition, the Notes are subordinated to the repayment in full of theloans under the Credit Agreement.

 

During the six months ended June 30,2009, the Company repaid $12.0 million of the principal amount outstandingunder the Credit Agreement.  The Companyrepaid the remaining $10.0 million of the principal amount outstanding underthe Credit Agreement during the three months ended September 30,2009.  Concurrently with the terminationof the Credit Agreement, the security interest in the accounts receivable ofthe operating company and one of its subsidiaries was released in September 2009.

 

**Tax Receivable Agreement**

 

Our purchase of membershipunits of our operating company concurrently with our initial public offering,and the subsequent and future exchanges by holders of Class B units of ouroperating company for shares of our Class A common stock (pursuant to theexchange rights provided for in the Operating Company’s operating agreement),has resulted in, and are expected to continue to result in, increases in ourshare of the tax basis of the tangible and intangible assets of our operatingcompany at the time of our acquisition and these future exchanges, which willincrease the tax depreciation and amortization deductions that otherwise wouldnot have been available to us.  Theseincreases in tax basis and tax depreciation and amortization deductions havereduced and are expected to continue to reduce, the amount of tax that we wouldotherwise be required to pay in the future. We have entered into a tax receivable agreement with the current membersof our operating company, the one member of our operating company immediatelyprior to our initial public offering who sold all of its membership units to usin connection with our initial public offering, and any future holders of Class Bunits, that requires us to pay them 85% of the amount of cash savings, if any,in U.S. federal, state and local income tax that we actually realize (or aredeemed to realize in the case of an early termination payment by us, or achange in control, as described in the tax receivable agreement) as a result ofthe increases in tax basis described above and certain other tax benefitsrelated to entering into the tax receivable agreement, including tax benefitsattributable to payments under the tax receivable agreement.

 

In October 2008, theselling unitholders agreed to waive any payments that we are or will berequired to make to them for the 2008 and 2009 tax years pursuant to the taxreceivable agreement.

 

**Cash Flows**

 

Operating activitiesprovided $7.7 million for the three months ended September 30, 2009,compared with $16.3 million for the three months ended September 30,2008.  Operating activities provided$25.6 million for the nine months ended September 30, 2009, comparedwith $48.7 million for the nine months ended September 30, 2008.  This decline in cash flows from operatingactivities was driven primarily by a decrease in weighted average AUM from $17.6 billionfor the three months ended September 30, 

 

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2008, to $12.2 billion for the threemonths ended September 30, 2009, and a decrease in weighted average AUMfrom $20.1 billion for the nine months ended September 30, 2008, to $10.7billion for the nine months ended September 30, 2009, which negativelyimpacted total revenues and earnings.

 

Investing activities consistprimarily of investments in investment partnerships and capitalexpenditures.  Investing activities usedless than $0.1 million for the three and nine months ended September 30,2009.  Investing activities used $0.2million for the three and nine months ended September 30, 2008.

 

Financing activities consistprimarily of term loan repayments, distributions to members, and contributionsfrom/distributions to the non-controlling interests of our consolidatedsubsidiaries.  Financing activities used$14.4 million for the three months ended September 30, 2009, and used$21.6 million for the three months ended September 30, 2008.  This decline in cash used in financingactivities is due primarily to reductions in tax allocations paid to members ofour operating company as a result of lower taxable income.  For the nine months ended September 30,2009, financing activities used $33.9 million, compared to$43.9 million for the nine months ended September 30, 2008.  This decline was driven primarily by thedecreased tax allocations described above, partially offset by increasedprincipal payments on our term loan.

 

**Off-Balance Sheet Arrangements**

 

We did not have anyoff-balance sheet arrangements as of September 30, 2009.

 

**Critical Accounting Policies and Estimates**

 

The preparation of ourconsolidated financial statements in accordance with U.S. generally acceptedaccounting principles requires management to make estimates and judgments thataffect our reported amounts of assets, liabilities, revenues and expenses andrelated disclosure of contingent assets and liabilities.  We base our estimates on historicalexperience and on various other assumptions that are believed to be reasonableunder current circumstances, the results of which form the basis for makingjudgments about the carrying value of assets and liabilities that are notreadily available from other sources.  Weevaluate our estimates on an ongoing basis. Actual results may differ from these estimates under differentassumptions or conditions.

 

Accounting policies are anintegral part of our financial statements. A thorough understanding of these accounting policies is essential whenreviewing our reported results of operations and our financial condition.  Management believes that the criticalaccounting policies discussed below involve additional management judgment dueto the sensitivity of the methods and assumptions used.

 

**Consolidation**

 

Our policy is to consolidateall majority-owned subsidiaries in which we have a controlling financialinterest and variable-interest entities where we are deemed to be the primarybeneficiary.  We also consolidatenon-variable-interest entities which we control as the general partner ormanaging member.  We assess ourconsolidation practices regularly, as circumstances dictate.  All significant inter-company transactionsand balances have been eliminated.

 

**Income Taxes**

 

We are a “C” corporationunder the Internal Revenue Code, and thus liable for federal, state and localtaxes on the income derived from our economic interest in our operatingcompany.  The operating company is a limitedliability company that has elected to be treated as a partnership for taxpurposes.  Our operating company has notmade a provision for federal or state income taxes because it is theresponsibility of each of the operating company’s members (including us) toseparately report their proportionate share of the operating company’s taxableincome or loss.  Similarly, the income ofour consolidated investment partnerships is not subject to income taxes, assuch income is allocated to each partnership’s individual partners.  The operating company has made a provisionfor New York City UBT.

 

We recognize deferred taxassets and liabilities for the future tax consequences attributable todifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases, net operating losscarryforwards and tax credits.  Avaluation allowance is maintained for deferred tax assets that we estimate aremore likely than not to be unrealizable based on available evidence at the timethe estimate is made.  Determining thevaluation allowance requires significant management judgments andassumptions.  In determining thevaluation allowance, we use historical and forecasted future operating results,based upon approved business plans, including a review of the eligiblecarryforward periods, tax planning opportunities and other relevantconsiderations.  Each quarter, were-evaluate our estimate related to the valuation allowance, including ourassumptions about future profitability.

 

We believe that theaccounting estimate related to the $60.3 million valuation allowance,assessed as of September 30, 2009 against the deferred tax assetassociated with our acquisitions of operating company membership units, is acritical accounting estimate because the underlying assumptions can change fromperiod to period.  For example, tax lawchanges, or variances in future projected operating performance, could resultin a change in the valuation allowance. If we were not able to realize all or part of our 

 

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net deferred tax assets in the future, anadjustment to our deferred tax asset valuation allowance would be charged toincome tax expense in the period such determination was made.

 

Management judgment isrequired in determining our provision for income taxes, evaluating our taxpositions and establishing deferred tax assets and liabilities.  The calculation of our tax liabilitiesinvolves dealing with uncertainties in the application of complex taxregulations.  If our estimate of taxliabilities proves to be less than the ultimate assessment, a further charge toearnings would result.

 

**Recently Issued Accounting Pronouncements**

 

In June 2009, the FASBissued an accountingstandard for variable interest entities (“VIEs”) which changes the approach todetermining the primary beneficiary of a VIE and requires companies to assessmore frequently whether they must consolidate VIEs.  Under the new accounting standard, anenterprise has a controlling financial interest when it has: a) the powerto direct the activities of a VIE that most significantly impact the entity’seconomic performance, and b) the obligation to absorb losses of the entityor the right to receive benefits from the entity that could potentially besignificant to the VIE.  The newaccounting standard also requires an enterprise to assess whether it has animplicit financial responsibility to ensure that a VIE operates as designedwhen determining whether it has power to direct the activities of the VIE thatmost significantly impact the entity’s economic performance.  The new accounting standard also requiresongoing assessments of whether an enterprise is the primary beneficiary of aVIE, requires enhanced disclosures and eliminates the scope exclusion forqualifying special-purpose entities.  Thenew accounting standard is effective for interim and annual periods beginningafter November 15, 2009.  Earlierapplication is prohibited.  We arecurrently evaluating the impact that the adoption of the new accountingstandard will have on our consolidated financial statements.

 

**Item 3. Quantitative and Qualitative Disclosures AboutMarket Risk.**

 

**Market Risk**

 

Our exposure to market risk is directlyrelated to our role as investment adviser for the institutional separateaccounts we manage and the retail funds for which we act as a sub-investmentadviser.  Global markets have continuedto experience unprecedented volatility, and a challenging business climate isforecast for the foreseeable future. Market conditions have resulted in a significant reduction in our assetsunder management, which directly impacts our revenues and net income.  A continued economic downturn and volatilityin the global financial markets could also significantly affect the estimates,judgments, and assumptions used in the valuation of our financial instruments.

 

All of our revenue for the three and ninemonths ended September 30, 2009 and 2008 was derived from advisory fees,which are typically based on the market value of our AUM, which can be affectedby adverse changes in interest rates, foreign currency exchange and equityprices.  Accordingly, a decline in theprices of securities would cause our revenue and income to decline due to adecrease in the value of the assets we manage. In addition, such a decline could cause our clients to withdraw theirfunds in favor of investments offering higher returns or lower risk, whichwould cause our revenue and income to decline further.

 

Weare also subject to market risk due to a decline in the value of the holdingsof our consolidated subsidiaries, which consist primarily of equitysecurities.  At September 30, 2009,the fair value of these assets was $18.4 million.  Assuming a 10% increase or decrease, the fairvalue would have increased or decreased by $1.8 million at September 30,2009.

 

**Item4.   Controls and Procedures.**

 

Duringthe course of their review of our consolidated financial statements as of September 30,2009, our management, including our Chief Executive Officer and Chief FinancialOfficer, evaluated the effectiveness of our disclosure controls and procedurespursuant to Rule 13a-15(b) under the Securities Exchange Act of1934.  Based on that evaluation, ourChief Executive Officer and Chief Financial Officer have concluded that, as of September 30,2009, our disclosure controls and procedures (as defined in Rule 13a-15(e) underthe Securities Exchange Act of 1934) were effective to ensure that informationwe are required to disclose in reports that we file or submit under theSecurities Exchange Act of 1934 is recorded, processed, summarized and reportedwithin the time periods specified in SEC rules and forms, and that suchinformation is accumulated and communicated to our management, including ourChief Executive Officer and Chief Financial Officer, as appropriate, to allowtimely decisions regarding required disclosure.

 

Therewas no change in our internal control over financial reporting (as defined in Rule 13a-15(f) underthe Securities Exchange Act of 1934) that occurred during the first nine monthsof 2009 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

 

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**PART II. OTHER INFORMATION**

 

**Item 1.  Legal Proceedings.**

 

Inthe normal course of business, we may be subject to various legal andadministrative proceedings.  On November 21,2007 and January 16, 2008, respectively, substantively identical putativeclass action lawsuits were commenced in the United States District Court forthe Southern District of New York against the Company and Richard S. Pzena, ourchief executive officer, seeking remedies under Section 11 of theSecurities Act of 1933, as amended.  The Court consolidated the lawsuitsand appointed co-lead plaintiffs, who filed a consolidated amendedcomplaint.  The consolidated amended complaint named as defendants us,Richard S. Pzena, and two of the underwriters of the Company’s initial publicoffering, Goldman Sachs & Co., Inc. and UBS Securities LLC. Plaintiffs sought to represent a class of all persons who purchased orotherwise acquired Class A common stock issued pursuant or traceable tothe Company’s initial public offering.  The consolidated amended complaintalleged that the registration statement and prospectus relating to the initialpublic offering of the Company’s Class A common stock contained materialmisstatements and omissions and wrongfully failed to disclose net redemptionsin the John Hancock Classic Value Fund for which the Company acts assub-investment advisor.  The consolidated amended complaint sought damagesin an unspecified amount including rescission or rescissory damages. The Courtgranted our and the other defendants’ motions to dismiss the consolidatedamended complaint, and on September 4, 2008, entered a Judgment in favorof defendants.  Plaintiffs appealed the Court’s judgment to the UnitedStates Court of Appeals for the Second Circuit, which, on August 13, 2009,affirmed the judgment of the United States District Court for the SouthernDistrict of New York dismissing the putative class actionlawsuits.  Plaintiffs did not seek rehearing of the Court of Appeals’decision and, to date, have not petitioned the Supreme Court of the UnitedStates for a writ of certiorari.  We believe that the allegations andclaims are without merit and will continue to contest these claims vigorously.

 

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**Item 1A. Risk Factors.**

 

**ITEM 1A.  RISKFACTORS.**

 

*We face avariety of significant and diverse risks, many of which are inherent in ourbusiness.  Described below are certainrisks that we currently believe could materially affect us.  Other risks and uncertainties that we do notpresently consider to be material, or of which we are not presently aware, maybecome important factors that affect us in the future.  The occurrence of any of the risks discussedbelow, or such other risks, could materially and adversely affect our business,prospects, financial condition, results of operations or cash flow.*

 

**Risks Related to Our Business**

 

***We depend on Richard S. Pzena, JohnP. Goetz, and William L. Lipsey and the loss of the services of any of themcould have a material adverse effect on us.***

 

The success of our businessdepends on the participation of Richard S. Pzena, John P. Goetz, and William L.Lipsey, whom we collectively refer to as our managing principals, and who serveon our operating company’s Executive Committee. Their professional reputations, expertise in investing and relationshipswith our clients and within the investing community in the U.S. and abroad, arecritical elements to executing our business strategy and attracting andretaining clients.  Accordingly, the retentionof our managing principals is crucial to our future success.  There is no guarantee that they will notresign, join our competitors or form a competing company.  The terms of the current operating agreementof our operating company restrict each of Messrs. Pzena, Goetz and Lipseyfrom competing with us or soliciting our clients or other employees during theterm of their employment with us and for three years thereafter.  The penalty for their breach of theserestrictive covenants will be the forfeiture of a number of Class B unitsheld by the managing principal that is equal to 50% of the number of membershipunits collectively held by the managing principal and his permitted transfereesas of the earlier of the date of his breach or the termination of hisemployment, unless our board of directors, in its sole discretion, determinesotherwise.  Although we may also seekspecific performance of these restrictive covenants, there can be no assurancethat we would be successful in obtaining this relief.  Further, after this post-employment restrictiveperiod, we will not be able to prohibit them from competing with us orsoliciting our clients or employees.  Ifany of our managing principals were to join a competitor or form acompeting company, some of our current clients or other prominent members ofthe investing community could choose to invest with that competitor rather thanus.  Furthermore, we do not carry any“key man” insurance that would provide us with proceeds in the event of thedeath or disability of any of our managing principals.  The loss of the services of any of ourmanaging principals could have a material adverse effect on our business andcould impact our future performance.

 

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***If our investment strategies performpoorly, we could lose clients or suffer a decline in AUM which would impair ourrevenues and earnings.***

 

The performance of ourinvestment strategies is one of the most important factors in retaining clientsand AUM and competing for new business. If our investment strategies perform poorly, it could impair ourearnings because:

 

·                  our existingclients might withdraw their funds from our investment strategies, which wouldcause the level of our advisory fees to decline;

 

·                  the level ofthe performance-based fees paid by certain of our clients, which provides uswith a percentage of returns if our investment strategies outperform certainagreed upon benchmarks, would decline;

 

·                  third-partyfinancial intermediaries, advisers or consultants may rate our investmentproducts poorly, which may lead our existing clients to withdraw funds from ourinvestment strategies or to the reduction of asset inflows from these thirdparties or their clients; or

 

·                  the mutualfunds and other investment funds that we sub-advise may decide not to renew orto terminate the agreements pursuant to which we sub-advise them and we may notbe able to replace these relationships.

 

In 2006, 2007 and 2008, ourinvestment strategies underperformed their respective benchmarks, and there canbe no assurance that such underperformance will not occur again in the future.  The annualized gross returns (whichrepresents annualized returns prior to payment of advisory fees) of our LargeCap Value strategy (which represented approximately 48.6% of our AUM as of September 30,2009) for the 1-year, 3-year, 5-year and since inception (October 2000)periods ended September 30, 2009 were 2.4%, (11.0)%, (0.7)%, and 3.4%,respectively.  This compares to thereturns of the Russell 1000® Value Index, the market indexmost commonly used by our clients to compare the performance of our Large CapValue strategy, during the same periods of (10.7)%, (7.9)%, 0.9%, and 1.9%,respectively.

 

During periods of decliningAUM and revenues, such as we experienced from the quarter ended September 30,2007, through the quarter ended March 31, 2009, there can be no assurancethat we will be able to reduce our expenses at a commensurate rate, potentiallyleading to accelerated profitability declines. Additionally, given the nature of our business, there is a minimumexpense base necessary to retain our employees and maintain our operations, andit may be difficult to reduce expenses beyond certain levels.

 

***Our relationships with two clients represent a significant source ofour AUM and revenues, and the termination of one or both of these relationshipswould impair our revenues and earnings.***

 

Asof September 30, 2009, two client relationships represented 18.4% and10.4%, respectively, of our AUM.  For thequarter ended September 30, 2009, these relationships represented 10.6%and 3.9%, respectively, of our revenues. No other single account represented more than 5% of our AUM as of September 30,2009, or more than 5% of our revenues for the quarter ended September 30,2009.

 

Therecan be no assurance that our agreements with respect to these two client relationshipswill remain in place.   The terminationof either relationship would significantly reduce our revenues and earnings,and we may not be able to establish relationships with other accounts in orderto replace the lost revenues and earnings.

 

***Because our clients can reduce theamount of assets we manage for them, or terminate our agreements with them, onshort notice, we may experience unexpected declines in revenue andprofitability.***

 

Our investment advisory andsub-investment advisory agreements are generally terminable upon shortnotice.  Our sub-investment advisoryagreements with eight SEC-registered mutual funds each have an initial two-yearterm and are subject to annual renewal by the fund’s board of directorspursuant to the Investment Company Act of 1940, as amended, or the InvestmentCompany Act.  Seven of these eightsub-investment advisory agreements, including our largest sub-advisedrelationship, are beyond their initial two-year term, as of September 30,2009.  Institutional and individualclients, and the funds with which we have sub-investment advisory agreements,can terminate their relationships with us, or reduce the aggregate amount ofAUM, for a number of reasons, including investment performance, changes inprevailing interest rates, and financial market performance, or to shift theirfunds to competitors who may charge lower advisory fee rates, or for no statedreason.  Poor performance relative tothat of other investment management firms tends to result in decreasedinvestments in our investment strategies, increased withdrawals from ourinvestment strategies and the loss of institutional or individual accounts orsub-investment advisory relationships. In addition, the ability to terminate relationships may allow clients torenegotiate for lower fees paid for asset management services. If ourinvestment advisory agreements are terminated, or our clients reduce the amountof AUM, either of which may occur on short notice, we may experience declinesin revenue and profitability.

 

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***Difficult market conditions canadversely affect our business by reducing the market value of the assets wemanage or causing our clients to withdraw funds.***

 

Our business would beexpected to generate lower revenue in a declining stock market or generaleconomic downturn. Under our advisory fee arrangements, the fees we receivetypically are based on the market value of our AUM. Accordingly, a decline inthe prices of securities held in our clients’ portfolios would be expected tocause our revenue and profitability to decline by:

 

·                  causing thevalue of our AUM to decline, which would result in lower advisory fees; or

 

·                  causing some ofour clients to withdraw funds from our investment strategies in favor ofinvestments they perceive as offering greater opportunity or lower risk, whichalso would result in lower advisory fees.

 

We experienced declines inAUM from the quarter ended September 30, 2007, through the quarter ended March 31,2009, and declines in revenue and profitability from the quarter ended December 31,2007, through the quarter ended March 31, 2009, and there can be noassurance that there will not be declines in our AUM, revenue and profitabilityin the future.

 

V***olatility anddisruption of the capital and credit markets, and adverse changes in the globaleconomy may negatively impact our AUM, revenues and profitability.***

 

As a company thatoperates in both U.S. and non-U.S. markets, and with a global client base, ourbusiness is subject to changing conditions in the global financial markets andeconomic conditions in general. Beginning in the second half of 2007, and particularly during the secondhalf of 2008 through early 2009, the financial markets were characterized byunprecedented levels of volatility and limited liquidity.  This materially and adversely affected the capital andcredit markets andled to a widespread loss of investor confidence.  This has resulted in, and may continue toresult in, some client attrition and hence to reduced AUM, revenues andprofitability. The effects of the financial crisis on the economy — withcorporate losses and reduced profitability still occurring in some sectors,overall employee compensation coming under pressure, the decline of valuesacross asset classes, and thereby a need to liquidate or re-allocateinvestments — could be of significant importance to the investment behavior ofsome of our clients. As a result, we could be confronted with net outflows ofAUM, and could experience difficulties attracting new clients, resulting in amaterial adverse effect on our AUM, revenue andprofitability in the future.

 

As indicated above, weexperienced declines in AUM from the quarter ended September 30, 2007,through the quarter ended March 31, 2009, largely due to the volatilityand disruption in the capital and credit markets.  During those periods, we experienced declinesin revenue and profitability, and there can be no assurance that there will notbe declines in our AUM, revenue and profitability should volatility anddisruption in the capital and credit markets occur again in the future.

 

***We may need toraise additional capital or refinance existing debt in the future, andresources may not be available to us in sufficient amounts or on acceptableterms.***

 

Our ability to enter the capital markets in a timelymanner depends on a number of factors, including the state of global credit andequity markets, interest rates, credit spreads and our credit ratings. If weare unable to access capital markets to issue new debt, refinance existing debtor sell shares of our Class A Common Stock, as needed, or if we are unableto obtain such financing on acceptable terms, our business could be adverselyimpacted.

 

***Our ability to retain our seniorinvestment professionals and attract additional qualified investmentprofessionals is critical to our success. A decline in our revenues andprofitability may have an adverse effect on our business and our ability toattract and retain employees.***

 

Our success depends on ourability to retain the senior members of our investment team and to recruitadditional qualified investment professionals. However, we may not be successful in our efforts to retain them, as themarket for investment professionals is extremely competitive.  Our portfolio managers possess substantialexperience and expertise in investing and, in particular, our classic valueinvestment approach, which requires significant qualitative judgments as to thefuture earnings power of currently underperforming businesses.  Our portfolio managers also have significantrelationships with our clients. Accordingly, the loss of any one of our senior investment professionalscould limit our ability to successfully execute our classic value investmentapproach and, therefore, sustain the performance of our investment strategies,which, in turn, could have a material adverse effect on our results ofoperations.

 

***Future growth of our business may bedifficult to achieve, and may place significant demands on our resources andemployees, and may increase our expenses.***

 

Future growth of ourbusiness may be difficult to achieve, and may place significant demands on ourinfrastructure, our investment team and other employees, and may increase ourexpenses.  In addition, we are requiredto continuously develop our 

 

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infrastructure in response to the increasingsophistication of the investment management market, as well as due to legal andregulatory developments.

 

As a result of ourinvestment strategies underperforming their respective benchmarks in 2006, 2007and 2008, our future growth may be more challenging, as this may impact ourability to attract inflows of AUM. Additionally, the current overall market environment may impactpotential investors’ interest in committing new capital to equity strategiessuch as those offered by us, thereby making growth more difficult.

 

The future growth of ourbusiness, if achieved, will depend, among other things, on our ability tomaintain an infrastructure and staffing levels sufficient to address its growthand may require us to incur significant additional expenses and commitadditional senior management and operational resources.  We may face significant challenges inmaintaining adequate financial and operational controls, implementing new orupdated information and financial systems and procedures and training, managingand appropriately sizing our work force and other components of our business ona timely and cost-effective basis.  Inaddition, our efforts to retain or attract qualified investment professionalsmay result in significant additional expenses. There can be no assurance that we will be able to manage the growth ofour business effectively or that we will be able to continue to grow, and anyfailure to do so could adversely affect our ability to generate revenue andcontrol our expenses.

 

***The investment management businessis intensely competitive.***

 

Competition in theinvestment management business is based on a variety of factors, including:

 

·                  investmentperformance;

 

·                  investorperception of an investment manager’s drive, focus and alignment of interestwith them;

 

·                  quality ofservice provided to, and duration of relationships with, clients;

 

·                  businessreputation; and

 

·                  level of feescharged for services.

 

We compete in all aspects ofour business with a large number of investment management firms, commercialbanks, broker-dealers, insurance companies and other financialinstitutions.  Our competitive risks areheightened by the fact that some of our competitors may invest according todifferent investment styles or in alternative asset classes which the marketsmay perceive as more attractive than our investment approach in the publicequity markets.  If we are unable tocompete effectively, our earnings and revenues could be reduced, and ourbusiness could be materially adversely affected.

 

***Reductions in business sourcedthrough third-party distribution channels, or their poor reviews of us or ourproducts, could materially reduce our revenue and ability to attract newclients.***

 

New accounts sourced throughconsultant-led searches have been a large driver of our inflows in the past andare expected to be a major component of our future inflows. In addition, wehave established relationships with certain mutual fund providers who haveoffered us opportunities to access new market segments through sub-investmentadvisory roles.  We have also accessedthe high-net-worth segment of the investing community through relationshipswith well respected wealth advisers who utilize our investment strategies ininvestment programs they construct for their clients.  If we fail to successfully maintain thesethird-party distribution and sub-investment advisory relationships, ourbusiness could be materially adversely affected.  In addition, many of these parties review andevaluate our products and our organization. Poor reviews or evaluations of either the particular product or of usmay result in client withdrawals or may impact our ability to attract new assetsthrough such intermediaries.

 

***A change of control of us couldresult in termination of our sub-investment advisory and investment advisoryagreements.***

 

Pursuant to the InvestmentCompany Act, each of the sub-investment advisory agreements for the SEC-registeredmutual funds that we sub-advise automatically terminates upon its deemed“assignment” and a fund’s board and shareholders must approve a new agreementin order for us to continue to act as its sub-investment adviser.  In addition, pursuant to the InvestmentAdvisers Act, each of our investment advisory agreements for the separateaccounts we manage may not be “assigned” without the consent of theclient.  A sale of a controlling block ofour voting securities and certain other transactions would be deemed an“assignment” pursuant to both the Investment Company Act and the InvestmentAdvisers Act.  Such an assignment may bedeemed to occur in the event that the holders of the Class B units of ouroperating company exchange enough of their Class B units for shares of ourClass A common stock such that they no longer own a controlling interestin us.  If such a deemed assignmentoccurs, there can be no assurance that we will be able to obtain the necessaryconsents from clients whose funds are managed pursuant to separate accounts orthe necessary approvals from the boards and shareholders of the SEC-registeredfunds that we sub-advise.  An assignment,actual or constructive, would trigger these termination and consent provisionsand, unless the necessary approvals and consents are obtained, could adversely 

 

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affect our ability to continue managingclient accounts, resulting in the loss of AUM and a corresponding loss ofrevenue.

 

***Our failure to comply withguidelines set by our clients could result in damage awards against us and aloss of AUM, either of which would cause our earnings to decline or affect ourability to remain in business.***

 

As an investment adviser, wehave a fiduciary duty to our clients. When clients retain us to manage assets on their behalf, they mayspecify certain guidelines regarding investment allocation and strategy that weare required to observe in the management of their portfolios.  Our failure to comply with these guidelinesand other limitations could result in losses to a client account that theclient could seek to recover from us and could result in the client withdrawingits assets from our management or terminating our investment advisory agreementwith them.  Any of these events couldcause our earnings to decline or affect our ability to remain in business.

 

***Extensive regulation of our businesslimits our activities and exposes us to the potential for significantpenalties, including fines or limitations on our ability to conduct ourbusiness.***

 

We are subject to extensiveregulation of our investment management business and operations.  As a registered investment adviser, the SECoversees our activities pursuant to its regulatory authority under theInvestment Advisers Act.  In addition, wemust comply with certain requirements under the Investment Company Act withrespect to the SEC-registered funds for which we act as sub-investmentadviser.  We are also subject toregulation by the Department of Labor under ERISA.  Each of the regulatory bodies withjurisdiction over us has regulatory powers dealing with many aspects offinancial services, including the authority to grant, and in specificcircumstances to cancel, permissions to carry on particular businesses.  A failure to comply with the obligationsimposed by the Investment Advisers Act on investment advisers, includingrecord-keeping, advertising and operating requirements, disclosure obligationsand prohibitions on fraudulent activities, could result in investigations,sanctions and reputational damage.  Ourfailure to comply with applicable laws or regulations could result in fines,censure, suspensions of personnel or other sanctions, including revocation ofour registration as an investment adviser. Even if a sanction imposed against us or our personnel is small inmonetary amount, the adverse publicity arising from the imposition of sanctionsagainst us by regulators could harm our reputation, result in withdrawal by ourclients from our investment strategies and impede our ability to retain clientsand develop new client relationships, which may reduce our revenues.

 

We face the risk ofsignificant intervention by regulatory authorities, including extendedinvestigation and surveillance activity, adoption of costly or restrictive newregulations and judicial or administrative proceedings that may result insubstantial penalties.  Among otherthings, we could be fined or be prohibited from engaging in some of ourbusiness activities.  The requirementsimposed by our regulators are designed to ensure the integrity of the financialmarkets and to protect customers and other third parties who deal with us, andare not designed to protect our stockholders. Consequently, these regulationsoften serve to limit our activities, including through net capital, customerprotection and market conduct requirements.

 

In addition, the regulatoryenvironment in which we operate is subject to modifications and furtherregulation.  New laws or regulations, orchanges in the enforcement of existing laws or regulations, applicable to usand our clients also may adversely affect our business, and our ability tofunction in this environment will depend on our ability to constantly monitorand react to these changes.  Forinvestment management firms in general, there have been a number of highlypublicized regulatory inquiries that focus on the mutual fund industry.  These inquiries already have resulted inincreased scrutiny in the industry and new rules and regulations formutual funds and their investment managers. This regulatory scrutiny may limit our ability to engage in certainactivities.

 

Specific regulatory changesalso may have a direct impact on our revenue. In addition to regulatoryscrutiny and potential fines and sanctions, regulators continue to examinedifferent aspects of the asset management industry.  New regulation regarding the annual approvalprocess for mutual fund sub-investment advisory agreements may result in thereduction of fees or possible terminations of these agreements.  These regulatory changes and other proposedor potential changes may result in a reduction of revenue associated with theseactivities.

 

***Operational risks may disrupt ourbusiness, result in losses or limit our growth.***

 

We rely heavily on ourfinancial, accounting, trading, compliance and other data processingsystems.  Any failure or interruption ofthese systems, whether caused by fire, other natural disaster, power ortelecommunications failure, act of terrorism or war or otherwise, could resultin a disruption of our business, liability to clients, regulatory interventionor reputational damage, and thus materially adversely affect our business.  Although we have back-up systems in place,our back-up procedures and capabilities in the event of a failure orinterruption may not be adequate.  Theinability of our systems to accommodate an increasing volume of transactionsalso could constrain our ability to expand our businesses.  In recent years, we have substantiallyupgraded and expanded the capabilities of our data processing systems and otheroperating technology, and we expect that we will need to continue to upgrade andexpand these capabilities in the future to avoid disruption of, or constraintson, our operations.

 

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Furthermore, we depend onour headquarters in New York City for the continued operation of ourbusiness.  A disaster or a disruption inthe infrastructure that supports our business, or directly affecting ourheadquarters, may have a material adverse impact on our ability to continue tooperate our business without interruption. Although we have disaster recovery programs in place, there can be noassurance that these will be sufficient to mitigate the harm that may resultfrom such a disaster or disruption. In addition, insurance and other safeguardsmight only partially reimburse us for our losses.

 

***The investment management industryfaces substantial litigation risks which could materially adversely affect ourbusiness, financial condition or results of operations or cause significant reputationalharm to us.***

 

We depend to a large extenton our relationships with our clients and our reputation for integrity andhigh-caliber professional services to attract and retain clients.  As a result, if a client is not satisfiedwith our services, such dissatisfaction may be more damaging to our businessthan to other types of businesses.  Wemake investment decisions on behalf of our clients which could result insubstantial losses to them.  In order forour classic value investment strategies to yield attractive returns, we expectto have to hold securities for multi-year periods and, therefore, ourinvestment strategies may not perform well in the short term.  If our clients suffer significant losses, orare otherwise dissatisfied with our services, we could be subject to the riskof legal liabilities or actions alleging negligent misconduct, breach offiduciary duty or breach of contract. These risks are often difficult to assessor quantify and their existence and magnitude often remain unknown forsubstantial periods of time.  We mayincur significant legal expenses in defending against litigation.  Substantial legal liability or significantregulatory action against us could materially adversely affect our business,financial condition or results of operations or cause significant reputationalharm to us.  For information on ourcurrent legal proceedings, see “Item 1—Legal Proceedings.”

 

***Fulfilling our public companyfinancial reporting and other regulatory obligations has been and will beexpensive and time consuming.***

 

Since becoming a publiccompany, we have been required to implement specific corporate governancepractices and adhere to a variety of reporting requirements and complexaccounting rules under the Sarbanes-Oxley Act of 2002 and the related rules andregulations of the SEC, as well as the rules of the New York StockExchange (the “NYSE”).  Compliance withthese requirements has and will increase our legal and accounting compliancecosts and place significant additional demands on our accounting and financestaff, and on our accounting, financial and information systems.  We have hired, and may need to hire,additional accounting and finance staff with appropriate public companyfinancial reporting experience and technical accounting knowledge, which hasand may increase our compensation expense.

 

Beginning with the fiscalyear ended December 31, 2008, our management was required to conduct anannual assessment of the effectiveness of our internal controls over financialreporting and include a report on our internal controls in our annual reportson Form 10-K pursuant to Section 404 of the Sarbanes-Oxley Act of2002.  In addition, we are required tohave our independent registered public accounting firm attest to and report onthe effectiveness of our internal controls over financial reporting.  We will continue to incur costs in order tomaintain our internal control over financial reporting and comply with Section 404of the Sarbanes-Oxley Act of 2002, including necessary auditing and legal fees,and costs associated with accounting, internal audit, information technology,compliance and administrative staff.

 

***The historical consolidatedfinancial information included in this quarterly report and our previouslyfiled public company reports may not necessarily be indicative of our futurefinancial results.***

 

The historical consolidatedfinancial information included in this quarterly report and our previouslyfiled public company reports may not necessarily be indicative of our futurefinancial results.  We do not expect ourAUM or revenue to grow at the same rate as they grew in the five years ended December 31,2007.  As mentioned above, we experienceddeclines in AUM, revenue, and profitability from the quarter ended September 30,2007, through the quarter ended March 31, 2009, and there can be noassurance that there will not be similar or more severe declines in our AUM,revenue and profitability in the future. Although in 2007 we re-opened the Large Cap Value, Value Service, SmallCap Value, Mid Cap Value and All Cap Value strategies, in the future, we mayclose these or other strategies at any time. In addition, the historical consolidated financial information includedin this quarterly report and our previously filed public company reports withrespect to the periods prior to the consummation of the reorganization of ouroperating company and the concurrent initial public offering of our Class Acommon stock on October 30, 2007 do not reflect all the added costs thatwe have incurred and continue to expect to incur as a public company.  For example, because we operated through alimited liability company prior to October 30, 2007 and paid little or notaxes on our profits, our historical consolidated financial information priorto October 30, 2007 does not reflect the tax impact of our adoption of acorporate holding company structure.

 

See “Part I,Item 2—Management’s Discussion and Analysis of Financial Condition andResults of Operations” and the historical financial statements includedelsewhere in this report.

 

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**Risks Related to OurInvestment Strategies**

 

*Ourresults of operations depend on the performance of our investmentstrategies.  Poor performance of ourinvestment strategies will reduce or minimize the value of our assets undermanagement, on which our advisory fees are based. Since advisory fees compriseall of our operating revenues, poor performance of our investment strategieswill have a material adverse impact on our results of operations.  In addition, poor performance will make itdifficult for us to retain or attract clients and to grow our business.  The performance of our strategies is subjectto some or all of the following risks.*

 

***Our classic value investments inconcentrated portfolios subject the performance of our investment strategies tothe risk that the companies in which we invest may not achieve the level ofearnings recovery that we initially expect, or at all.***

 

We generally invest incompanies after they have experienced a shortfall in their historic earnings,due to an adverse business development, management error, accounting scandal orother disruption, and before there is clear evidence of earnings recovery orbusiness momentum.  While very fewinvestors are willing to invest when companies lack earnings visibility, ourclassic value investment approach seeks to capture the return that can beobtained by investing in a company before the market has a level of confidencein its ability to achieve earnings recovery. However, our investment approach entails the risk that the companiesincluded in our portfolios are not able to execute the turnaround that we hadexpected when we originally invested in them, thereby reducing the performanceof our strategies.  Our strategy ofconstructing concentrated portfolios, generally ranging from 30 to 60 holdings,of companies underperforming their historical earnings power, is subject to ahigher risk of underperformance relative to benchmarks than the investmentapproaches of some of our competitors. Further, since our positions in these investments are often substantial,there is the risk that we may be unable to find willing purchasers for ourinvestments when we decide to sell them.

 

Since we apply the sameinvestment process across all of our investment strategies, utilizing one team,and given the overlapping universes of many of our investment strategies, wecould have common positions and industry or sector concentrations across manyof our investment strategies at the same time. As such, factors leading one of our investment strategies tounderperform may lead other strategies to underperform simultaneously.

 

***Our investment strategies may notobtain attractive returns in certain periods or during certain marketconditions.***

 

Our products are best suitedfor investors with long-term investment horizons.  In order for our classic value investmentapproach to yield attractive returns, we must typically hold securities for anaverage of over three years. Our investment strategies may not perform wellduring certain periods of time.  Inaddition, our strategies may not perform well during points in the economiccycle when value-oriented stocks are relatively less attractive.  For instance, during the late stages of aneconomic cycle, investors may purchase relatively expensive stocks in order toobtain access to above average growth, as was the case in the late 1990s.  Value-oriented strategies may also experienceweakness during periods when the markets are focused on one investment thesisor sector. In 2006, 2007 and 2008, our investment strategies underperformedtheir respective benchmarks, and there can be no assurance that suchunderperformance will not continue.

 

***Our investment approach mayunderperform other investment approaches, which may result in significantwithdrawals of client assets or client departures or a reduction in our AUM.***

 

Even when securities pricesare rising generally, portfolio performance can be affected by our investmentapproach. We employ a classic value investment approach in all of ourinvestment strategies.  This investmentapproach has outperformed the market in some economic and market environmentsand underperformed it in others. In particular, a prolonged period in which thegrowth style of investing outperforms the value style may cause our investmentstrategy to go out of favor with some clients, consultants or third-partyintermediaries.  Poor performancerelative to peers, coupled with changes in personnel, extensive periods inparticular market environments, or other difficulties may result in significantwithdrawals of client assets, client departures or a reduction in our AUM.

 

We experienced declines inAUM from the quarter ended September 30, 2007, through the quarter ended March 31,2009, and declines in revenue and profitability from the quarter ended December 31,2007 through the quarter ended March 31, 2009.  There can be no assurance that there will notbe declines in our AUM, revenue and profitability in the future.

 

***The recessionary environment has,and may continue to, negatively affect the companies in which we invest.Despite recent governmental efforts to stimulate the economy, the recessionaryenvironment may continue.***

 

The recent disruption in theglobal credit markets and the deterioration of the economy and the financialmarkets has created difficult conditions for most companies, including many ofthose in which we invest.  Therecessionary environment that the United States and the world face as a resultof these factors has had the effect of pushing the prices of equity securitiesin which we invest lower than their historical levels.  In addition, the recessionary environment hashad the effect of reducing the funds available to our clients to invest.  Both of these trends could continue to reduceour AUM, which is the main driver of our revenues and profitability.

 

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The federal government hasimplemented a host of programs intended to stimulate the economy and unclogcredit markets.  The ultimate effect ofthese governmental programs is unknown at this time and, despite theirenactment and implementation, the recessionary environment may not improve forsome time, or may deteriorate, either of which could materially adverselyaffect the companies in which we invest, the economy in general and ourbusiness, financial condition and results of operations, as well as the tradingprice of our common stock.

 

***Our investment process requires usto conduct extensive fundamental research on any company before investing init, which may result in missed investment opportunities and reduce theperformance of our investment strategies.***

 

We take a considerableamount of time to complete the in-depth research projects that our investmentprocess requires before adding any security to our portfolio.  Our process requires that we take this timein order to understand the company and the business well enough to make aninformed decision as to whether we are willing to own a significant position ina company whose current earnings are below its historic norms and that does notyet have earnings visibility.  However,the time we take to make this judgment may cause us to miss the opportunity toinvest in a company that has a sharp and rapid earnings recovery.  Any such missed investment opportunities couldadversely impact the performance of our investment strategies.

 

***Our Global Value strategies andEurope, Australasia, and Far East (EAFE) Value strategies consist primarily ofinvestments in the securities of issuers located outside of the United States, whichmay involve foreign currency exchange, political, social and economicuncertainties and risks.***

 

Our Global Value strategiesand EAFE Value strategies which together represented $4.0 billion and$2.2 billion of our AUM as of September 30, 2009 and December 31,2008, respectively, and may comprise a larger portion of our AUM in the future,are primarily invested in securities of companies located outside the UnitedStates.  Fluctuations in foreign currencyexchange rates could negatively impact the portfolios of our clients who areinvested in these strategies. In addition, foreign currency fluctuations mayaffect the levels of our AUM from one reporting period to another.  An increase in the value of the U.S. dollarrelative to non-U.S. currencies may result in a decrease in the dollar value ofour AUM, which, in turn, would result in lower U.S.-dollar denominatedrevenue.  We do not currently engage inany hedging activities for these portfolios and continue to market theseproducts as unhedged.

 

Investments in non-U.S.issuers may also be affected by political, social and economic uncertaintyaffecting a country or region in which we are invested.  Many non-U.S. financial markets are not asdeveloped, or as efficient, as the U.S. financial market, and, as a result,liquidity may be reduced and price volatility may be higher.  The legal and regulatory environments,including financial accounting standards and practices, may also be different,and there may be less publicly available information in respect of suchcompanies.  These risks could adverselyimpact the performance of our strategies that are invested in securities ofnon-U.S. issuers.

 

**Risks Related to OurStructure**

 

***We are dependent upon distributionsfrom our operating company to make distributions to our Class Astockholders, and to pay taxes and other expenses.***

 

We are a holding company andhave no material assets other than our ownership of membership units of ouroperating company.  We have noindependent means of generating revenue and cash flow. Our operating company istreated as a partnership for U.S. federal income tax purposes and, as such, isnot itself subject to U.S. federal income tax. Instead, its taxable income isallocated to its members, including us, pro-rata according to the number ofmembership units each owns.  Accordingly,we incur income taxes on our proportionate share of any net taxable income ofour operating company and also incur expenses related to our operations.  We intend to cause our operating company todistribute cash to its members in an amount at least equal to that necessary tocover their tax liabilities, if any, with respect to the earnings of ouroperating company.  To the extent that weneed funds to pay our tax or other liabilities or to fund our operations, andour operating company is restricted from making distributions to us underapplicable laws or regulations, or loan agreements, or does not have sufficientearnings to make these distributions, we may have to borrow funds to meet theseobligations and run our business and, thus, our liquidity and financialcondition could be materially adversely affected.  There can be no assurance that funds will beavailable to borrow under such circumstances on terms acceptable to us, or atall.

 

***We are required to pay the twocurrent members and one former member of our operating company who sold to usan aggregate of 6.1 million membership units of our operating company in October 2007and the other holders of Class B units of our operating company whosubsequently have and will exchange their Class B units for shares of our Class Acommon stock most of the tax benefit of any depreciation or amortizationdeductions we may claim as a result of the tax basis step up we receive inconnection with these sales of membership units and any future exchanges of Class Bunits.***

 

We used the net proceeds ofour October 2007 initial public offering to purchase an aggregate of6.1 million membership units of our operating company from three of itsmembers, or the selling members.  Thesepurchases have and are expected to result in

 

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increases in our share of the tax basis inthe tangible and intangible assets of our operating company that otherwisewould not have been available. Subsequent exchanges of Class B units of our operating company forshares of our Class A common stock have and are expected to result inincreases in our share of the tax basis in the tangible and intangible assetsof our operating company that otherwise would not have been available.  These increases in tax basis have and areexpected to reduce the amount of tax that we would otherwise be required to payin the future, although the Internal Revenue Service, or IRS, might challengeall or part of this tax basis increase, and a court might sustain such achallenge.

 

Pursuant to a tax receivableagreement dated October 30, 2007, among the selling members, all holders ofClass B units after our October 2007 initial public offering and us,we are required to pay the selling members and any holders of Class Bunits who elect to exchange their Class B units for shares of our Class Acommon stock 85% of the amount of the cash savings, if any, in U.S. federal,state and local income tax that we realize as a result of the increases in taxbasis due to the sale to us of 6.1 million membership units in October 2007and the subsequent exchanges of Class B units for shares of our Class Acommon stock.  The actual increase in taxbasis, as well as the amount and timing of any payments under this agreement,will vary depending upon a number of factors, including the timing ofexchanges, the price of our Class A common stock at the time of theexchange, the extent to which such exchanges are taxable, the amount and timingof our income and the tax rates then applicable.  We expect that, as a result of the size andincreases in our share of the tax basis in the tangible and intangible assetsof our operating company attributable to our interest therein, the paymentsthat we may make to these members likely will be substantial. In October 2008,each of the selling members agreed with us to waive any payments that we are ormay be required to make to them with respect to the 2008 and 2009 tax years, asa result of their sale to us of an aggregate of 6.1 million membershipunits in October 2007.  There can beno assurance that any of the selling members would grant us similar waivers inthe future or that any holder of Class B units would grant us such awaiver related to any exchanges or future exchanges.

 

Were the IRS to successfullychallenge the tax basis increases described above, we would not be reimbursedfor any payments made under the tax receivable agreement.  As a result, in certain circumstances, wecould be required to make payments under the tax receivable agreement in excessof our cash tax savings.

 

***If we are deemed an investmentcompany under the Investment Company Act, our business would be subject toapplicable restrictions under that Act, which could make it impracticable forus to continue our business as contemplated.***

 

We believe our company isnot an investment company under Section 3(b) (1) of theInvestment Company Act because we are primarily engaged in a non-investmentcompany business.  We conduct ouroperations so that we will not be deemed an investment company.  However, if we were to be deemed aninvestment company, restrictions imposed by the Investment Company Act,including limitations on our capital structure and our ability to transact withaffiliates, could make it impractical for us to continue our business ascontemplated.

 

**Risks Related to Our Class A Common Stock**

 

***The market price and trading volumeof our Class A common stock may be volatile, which could result in rapidand substantial losses for our stockholders.***

 

The market price of our Class Acommon stock may be highly volatile and could be subject to widefluctuations.  In addition, the tradingvolume in our Class A common stock may fluctuate and cause significantprice variations to occur.  If the marketprice of our Class A common stock declines significantly, you may beunable to resell your shares of Class A common stock at or above yourpurchase price, if at all.  We cannotassure you that the market price of our Class A common stock will notfluctuate or decline significantly in the future. Some of the factors thatcould negatively affect the price of our Class A common stock, or resultin fluctuations in the price or trading volume of our Class A commonstock, include:

 

·                  decreases inour assets under management;

 

·                  variations inour quarterly operating results;

 

·                  failure to meetour earnings estimates;

 

·                  publication ofresearch reports about us or the investment management industry;

 

·                  additions ordepartures of our managing principals and other key personnel;

 

·                  adverse marketreaction to any indebtedness we may incur or securities we may issue in thefuture;

 

·                  actions bystockholders;

 

·                  changes inmarket valuations of similar companies;

 

·                  changes orproposed changes in laws or regulations, or differing interpretations thereof,affecting our business, or enforcement of these laws and regulations, orannouncements relating to these matters;

 

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·                  adversepublicity about the asset management industry, generally, or individualscandals, specifically; and

 

·                  general marketand economic conditions.

 

***The market price of our Class Acommon stock could decline due to the large number of shares of our Class Acommon stock eligible for future sale upon the exchange of Class B unitsof our operating company.***

 

Pursuant to the operatingagreement of our operating company, on at least one date designated by us eachyear (or, if we do not designate a date by September 30th of anyyear, on October 30th), each holder of Class B units may exchange upto 15% of its Class B units for an equivalent number of shares of our Class Acommon stock, subject to certain restrictions set forth in the operatingagreement.  Pursuant to the resale andregistration rights agreement, dated October 30, 2007, among the holdersof Class B units and us, (i) on at least one date designated by useach year (or, if we do not designate a date by September 30th of anyyear, on a date that is three business days after October 30th) theseholders may resell the shares of Class A common stock issued to them uponthe exchange of up to 15% of their Class B units, and (ii) until October 30,2011, they may only resell these shares in the manner determined by us.

 

We filed a Form S-3registration statement, which became effective in February 2009, in orderto register our issuance to these holders of the total number of shares of Class Acommon stock issuable upon exchange of all Class B units outstandingimmediately after the consummation of our operating company’sreorganization.  We designated March 3,2009 as the 2009 exchange date. Certain executive officers and employeeselected to exchange an aggregate of 2,445,973 Class B units for anequivalent number of shares of our Class A common stock, which, with theexception of those held by our executive officers, are freely tradable.  The market price of our Class A commonstock could decline as a result of sales pursuant to the Form S-3registration statement, or the perception that such sales could occur.  These sales, or the possibility that thesesales may occur, also might make it more difficult for us to raise additionalcapital by selling equity securities in the future, at a time and price that wedeem appropriate.  None of the members ofthe Executive Committee of Pzena Investment Management, LLC, who beneficiallyown a substantial majority of the Class B units currently outstanding,have any present plans to sell any shares of Class A common stock.

 

***Control by our Class Bstockholders, which include our managing principals, 28 of our other employees,certain unaffiliated investors and two former employees, of 97.0% of thecombined voting power of our common stock may give rise to conflicts ofinterest.***

 

Our Class Bstockholders collectively hold approximately 97.0% of the combined voting powerof our common stock.  These stockholdersconsist of our managing principals, 28 of our other employees, certainunaffiliated investors and two former employees.  Holders of shares of our Class B commonstock have entered into a Class B stockholders’ agreement with respect toall shares of Class B common stock then held by them and any additionalshares of Class B common stock they may acquire in the future.  Pursuant to this agreement, they will votethese shares of Class B common stock together on all matters submitted toa vote of our common stockholders.  Tothe extent that we cause our operating company to issue additional Class Bunits, which may be granted, subject to vesting, to our employees pursuant tothe PIM LLC 2006 Equity Incentive Plan, these employees will be entitledto receive an equivalent number of shares of our Class B common stock,subject to the condition that they agree to enter into this Class Bstockholders’ agreement.  Each share ofour Class B common stock entitles its holder to five votes per share forso long as the Class B stockholders collectively hold 20% of the totalnumber of shares of our common stock outstanding.  When a Class B unit is exchanged for ashare of our Class A common stock, an unvested Class B unit isforfeited due to the employee holder’s failure to satisfy the conditions of theaward agreement pursuant to which it was granted, or any Class B unit isforfeited as result of a breach of any restrictive covenants contained in ouroperating company’s amended and restated operating agreement, a correspondingshare of our Class B common stock will automatically be redeemed byus.  For so long as our Class Bstockholders hold at least 20% of the total number of shares of our commonstock outstanding, they will be able to elect all of the members of our boardof directors and thereby control our management and affairs, includingdeterminations with respect to acquisitions, dispositions, borrowings,issuances of securities, and the declaration and payment of dividends.  In addition, they will be able to determinethe outcome of all matters requiring approval of stockholders, and will be ableto cause or prevent a change of control of our company or a change in thecomposition of our board of directors, and could preclude any unsolicitedacquisition of our company.  Our Class Bstockholders have the ability to prevent the consummation of mergers, takeoversor other transactions that may be in the best interests of our Class Astockholders.  In particular, thisconcentration of voting power could deprive Class A stockholders of anopportunity to receive a premium for their shares of Class A common stockas part of a sale of our company, and could ultimately affect the market priceof our Class A common stock.

 

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***Anti-takeover provisions in our amended and restated certificate ofincorporation and bylaws could discourage a change of control that our stockholdersmay favor, which could also adversely affect the market price of our Class Acommon stock.***

 

Provisions in our amendedand restated certificate of incorporation and bylaws may make it more difficultand expensive for a third party to acquire control of us, even if a change ofcontrol would be beneficial to our stockholders. For example, our amended andrestated certificate of incorporation authorizes our board of directors toissue up to 200,000,000 shares of our preferred stock and to designate therights, preferences, privileges and restrictions of unissued series of ourpreferred stock, each without any vote or action by our stockholders.  We could issue a series of preferred stock toimpede the consummation of a merger, tender offer or other takeoverattempt.  The anti-takeover provisions inour amended and restated certificate of incorporation and bylaws may impedetakeover attempts, or other transactions, that may be in the best interests ofour stockholders and, in particular, our Class A stockholders.  In addition, the market price of our Class Acommon stock could be adversely affected to the extent that provisions of ouramended and restated certificate of incorporation and bylaws discouragepotential takeover attempts, or other transactions, that our stockholders mayfavor.

 

***Under the terms of our seniorsubordinated notes, we are prohibited from paying regular dividends to ourstockholders, and any future payments are subject to the discretion of ourboard of directors and may be limited by our holding company structure andapplicable provisions of Delaware law.***

 

In the future, if and when we are no longerprohibited by the terms of the senior subordinated notes, our board ofdirectors may, in its discretion, reinstate the dividend at an amount to bedetermined by it.  However, the abilityof our operating company to make distributions to us so that we are able tomake a dividend distribution to our shareholders is subject to its operatingresults, debt agreements to which it may be a party, cash requirements andfinancial condition and applicable Delaware laws (which may limit the amount offunds available for distribution to its members).  If, as a consequence of these variouslimitations and restrictions, we are unable to generate sufficientdistributions from our business, we may not be able to make, or may have toreduce or eliminate, the payment of future dividends on our Class A commonstock.

 

***The disparity in the voting rightsamong the classes of our common stock may have a potential adverse effect onthe price of our Class A common stock.***

 

Each share of our Class Acommon stock entitles its holder to one vote on all matters to be voted on bystockholders generally, while each share of our Class B common stockentitles its holder to five votes for so long as the number of shares of Class Bcommon stock represents 20% of the total number of shares of our common stockoutstanding.  The difference in votingrights could adversely affect the value of our Class A common stock to theextent that investors view, or any potential future purchaser of our companyviews, the superior voting rights of the Class B common stock to havevalue.

 

**Item 2.  Unregistered Sales of Equity Securities andUse of Proceeds.**

 

None.

 

**Item 3. Defaults Upon Senior Securities.**

 

None.

 

**Item 4. Submission of Matters to a Vote of Security Holders.**

 

None.

 

**Item 5. Other Information.**

 

None.

 

**Item 6. Exhibits.**

 
| **Exhibit** | ** ** | **Description of Exhibit**                                                                                                                                    |
|-------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1        |       | Pzena  Investment Management, Inc. Non-Employee Director Deferred Compensation  Plan                                                                     |
| 31.1        |       | Certification  of Chief Executive Officer pursuant to Exchange Act  Rule 13a-14(a)/15(d)-14(a)                                                           |
| 31.2        |       | Certification  of Chief Financial Officer pursuant to Exchange Act  Rule 13a-14(a)/15(d)-14(a)                                                           |
| 32.1        |       | Certification  of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| 32.2        |       | Certification  of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |

 

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**SIGNATURES**

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

 

Dated: November 9, 2009

 
|   | PZENA INVESTMENT MANAGEMENT, INC. |
|--------|----------------------------------------|
|   |                                   |
|   |                                   |
|   | By:                                    | /s/ RICHARD S. PZENA |
|   |                                   | Name: | Richard S. Pzena |
|   |                                   | Title: | *Chief Executive Officer* |
|   |                                   |   |
|   |                                   |   |
|   | By:                                    | /s/ GREGORY S. MARTIN |
|   |                                   | Name: | Gregory S. Martin |
|   |                                   | Title: | *Chief Financial Officer* |

 

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