UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

Commission file number 001-33761

PZENA INVESTMENT MANAGEMENT, INC.

(Exact Name of Registrant as Specified in its Charter)

Registrant’s telephone number, including area code: (212) 355-1600

Not Applicable

(Former name, former address, and former fiscal year if changed since last report)

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-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.

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

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

As of May 8 2009, there were 55,559,751 outstanding shares of the registrant’s Class B common stock, par value $0.000001 per share.

PZENA INVESTMENT MANAGEMENT, INC.

FORM 10-Q

TABLE OF CONTENTS

i

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

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

Forward-looking statements are subject to known and unknown risks and uncertainties and are based on potentially inaccurate assumptions that could cause actual results to differ materially from those expected or implied by the forward-looking statements.  Our actual results could differ materially from those anticipated in forward-looking statements for many reasons, including the factors described in Item 1A, “Risk Factors” in Part I of our Annual Report on Form 10-K for our fiscal year ended December 31, 2008.  Accordingly, you should not unduly rely on these forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q.  We undertake no obligation to publicly revise any forward-looking statements to reflect circumstances or events after the date of this Quarterly Report on Form 10-Q, or to reflect the occurrence of unanticipated events.  You should, however, review the factors and risks we describe in the reports we will file from time to time with the Securities and Exchange Commission, or SEC, after the date of this Quarterly Report on Form 10-Q.

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

·                  our anticipated future results of operations and operating cash flows;

·                  our business strategies and investment policies;

·                  our financing plans and the availability of short- or long-term borrowing, or equity financing;

·                  our competitive position and the effects of competition on our business;

·                  potential growth opportunities available to us;

·                  the recruitment and retention of our employees;

·                  our expected levels of compensation for our employees;

·                  our potential operating performance, achievements, efficiency and cost reduction efforts;

·                  our expected tax rate;

·                  changes in interest rates;

·                  our expectation with respect to the economy, capital markets, the market for asset management services and other industry trends; and

·                  the impact of future legislation and regulation, and changes in existing legislation and regulation, on our business.

The reports that we file with the SEC, accessible on the SEC’s website at www.sec.gov, identify additional factors that can affect forward-looking statements.

ii

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)

See accompanying notes to consolidated financial statements

1

PZENA INVESTMENT MANAGEMENT, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

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

See accompanying notes to consolidated financial statements

2

PZENA INVESTMENT MANAGEMENT, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

See accompanying notes to consolidated financial statements

3

PZENA INVESTMENT MANAGEMENT, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

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

See accompanying notes to consolidated financial statements

4

Pzena Investment Management, Inc.

Unaudited Notes to the Consolidated Financial Statements

Note 1—Organization

Pzena Investment Management, Inc. (the “Company”) functions as the holding company through which the business of its operating company, Pzena Investment Management, LLC, is conducted. The Company was incorporated in the State of Delaware on May 8, 2007.  Concurrently with the consummation of the Company’s initial public offering, on October 30, 2007, the Operating Agreement of Pzena Investment Management, LLC (the “Operating Agreement”) was amended and restated such that, among other things, the Company became the sole managing member of Pzena Investment Management, LLC.  The acquisition of the operating company’s membership interests by the Company was treated as a reorganization of entities under common control pursuant to the guidance set forth in Financial Accounting Standards Board Technical Bulletin No. 85-5, Issues Relating to Accounting for Business Combinations (“FTB 85-5”).  As a result of these transactions, as of and subsequent to October 30, 2007, (i) the Company has consolidated the financial results of Pzena Investment Management, LLC with its own and reflected the membership interest in it that it does not own as a non-controlling interest in its consolidated financial statements, and (ii) the Company recognizes income generated from its economic interest in Pzena Investment Management, LLC’s net income.

Pzena Investment Management, LLC is an investment adviser which is registered under the Investment Advisers Act of 1940 and is headquartered in New York, New York.  As of March 31, 2009, the Company managed assets in a variety of value-oriented investment strategies across a wide range of market capitalizations in both U.S. and international capital markets.

The Company, through its investment in its operating company, has consolidated the results of operations and financial condition of the following private investment partnerships as of March 31, 2009:

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

Note 2—Significant Accounting Policies

Basis of Presentation:

The consolidated financial statements are prepared in conformity with U.S. generally accepted accounting principles and related Securities and Exchange Commission rules and regulations.  The Company’s policy is to consolidate all majority-owned subsidiaries in which it has a controlling financial interest and variable interest entities where the Company is deemed to be the primary beneficiary (“Consolidated Subsidiaries”).  Pursuant to the guidance of Emerging Issues Task Force Issue No. 04-5, Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights (“EITF 04-5”), the Company also consolidates non-variable-interest entities in which it acts as the general partner or managing member.  All of these entities represent private investment partnerships over which the Company exercises or exercised control.  Non-controlling interests recorded on the consolidated financial statements of the Company include the non-controlling interests of the outside investors in each of these entities, as well as those of the operating company.  All significant inter-company transactions and balances have been eliminated.

The Pzena International Value Service and the Pzena Global Value Service are limited liability companies whose managing members are or were members of the executive committee of the operating company or the operating company itself.  Neither of these entities are considered variable-interest entities, as the managing members have substantive interests in the partnerships.  Each of these limited liability companies are considered entities “similar” to limited partnerships and thus subject to the guidance of EITF 04-5.  Under each of their respective operating agreements, none of these entities’ non-managing members have the ability to remove the managing member under any circumstance, nor do they have any participating rights.  As a result, nothing substantive exists to overcome the presumption of control by the managing member

5

Pzena Investment Management, Inc.

Unaudited Notes to the Consolidated Financial Statements (Continued)

Note 2—Significant Accounting Policies (continued)

laid out by EITF 04-5.  As the managing members of these entities are, or were, either the operating company or one of the controlling persons of the operating company, their results of operations and financial position have been consolidated.

During 2008, the decision was made to close the Pzena Large Cap Value Fund II, the Pzena Emerging Markets Value Service, the Pzena Mega Cap Value Fund and Pzena Value Partners.  The results of operations and financial position of each of these entities were consolidated until the dates of their respective liquidations.

All of the consolidated investment partnerships are, or were, investment companies under the American Institute of Certified Public Accountants Audit and Accounting Guide for Investment Companies (the “AICPA Guide”).  The Company has retained the specialized accounting for these partnerships pursuant to Emerging Issues Task Force Issue No. 85-12, Retention of Specialized Accounting for Investments in Consolidation (“EITF 85-12”).  Thus, the Company reports the investment partnerships’ investments in marketable securities at fair value, with net realized and unrealized gains and losses reported in earnings in the consolidated statements of operations.

The Company records in its own equity its pro rata share of transactions that impact the operating company’s net equity, including equity and option issuances and adjustments to accumulated other comprehensive income.  The operating company’s pro rata share of such transactions are recorded as adjustments to additional paid-in capital or non-controlling interests, as applicable, on the consolidated statements of financial position.  As discussed further in Note 13, the Company did not initially record a non-controlling interest associated with the acquisition of its operating company, as the post offering net equity of the operating company was less than zero.  Pursuant to the guidance in Emerging Issues Task Force Issue No. 95-7, Implementation Issues Related to the Treatment of Minority Interest in Certain Real Estate Trusts (“EITF 95-7”), an operating company non-controlling interest was recorded after the initial deficit that existed at acquisition was extinguished in 2008.

The Company acts as the investment manager for four trusts and one offshore investment company, each of which are considered variable-interest entities.  All of these entities are vehicles through which the Company offers its Global Value and/or International Value strategies.  The Company is not considered the primary beneficiary of any of these entities.  Correspondingly, their results of operations and financial condition are not consolidated by the Company.  The total net assets of these variable-interest entities were approximately $351.1 million and $446.0 million at March 31, 2009 and December 31, 2008, respectively.  The Company is not exposed to losses as a result of its involvement with these entities because it has no direct investment in them.

Management’s Use of Estimates:

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

Fair Values of Financial Instruments:

The carrying amount of all financial instruments in the consolidated statements of financial condition, including investments in marketable securities, approximates their fair values.

Revenue Recognition:

Revenue, comprised of advisory fee income, is recognized over the period in which investment management services are provided.  Advisory fee income includes management fees that are calculated based on percentages of assets under management, generally billed quarterly, either in arrears or advance, depending on their contractual terms.  Advisory fee income also includes incentive fees that may be earned by the Company depending on the investment return of the assets under management.  Incentive fee arrangements generally entitle the Company to participate, on a fixed-percentage basis, in any returns generated in excess of an agreed-upon benchmark.  The Company’s participation percentage in such return differentials is then multiplied by assets under management to determine the incentive fees earned.  Returns are calculated on an annualized basis over the contract’s measurement period, which may extend up to three years.  Incentive fees are generally payable annually.  Pursuant to the preferred accounting method under Emerging Issues Task Force Issue D-96, Accounting

6

Pzena Investment Management, Inc.

Unaudited Notes to the Consolidated Financial Statements (Continued)

Note 2—Significant Accounting Policies (continued)

 for Management Fees Based on a Formula (“EITF D-96”), such incentive fee income is recorded at the conclusion of the contractual performance period, when all contingencies are resolved.  The Company recognized no such incentive fees for the three months ended March 31, 2009 and 2008.

Earnings per Share:

Basic earnings per share is computed by dividing the Company’s net income or loss attributable to the Company’s common stockholders by the weighted-average number of shares outstanding during the reporting period.  Diluted earnings per share adjusts this calculation to reflect the impact of all outstanding operating company membership units, as well as outstanding operating company options and phantom units, to the extent that they would have a dilutive effect on net income per share for the reporting period.  Net income for diluted earnings per share generally assumes all operating company membership units are converted into Company stock at the beginning of the reporting period and the resulting change to Company net income associated with its increased interest in the operating company is taxed at the Company’s effective tax rate.  For the three months ended March 31, 2009, 3,153,122 options to purchase operating company units and 153,829 phantom operating company units were excluded from the calculation of diluted net income per share, as their inclusion would have had an antidilutive effect for the period.  For the three months ended March 31, 2008, 954,310 options to purchase operating company units and 89,826 phantom units were excluded from the calculation of diluted net income per share, as their inclusion would have had an antidilutive effect.

For the three months ended March 31, 2009 and 2008, the Company’s basic and diluted earnings per share attributable to the Company’s common stockholders were determined as follows (in thousands, except for share and per-share amounts):

7

Pzena Investment Management, Inc.

Unaudited Notes to the Consolidated Financial Statements (Continued)

Note 2—Significant Accounting Policies (continued)

Cash and Cash Equivalents:

The Company considers all highly-liquid debt instruments with an original maturity of three months or less at the time of purchase to be cash equivalents.  The Company maintains its cash in bank deposits and other accounts, the majority of which are held at two financial institutions.  These balances, at times, exceed federally insured limits.

Interest on cash and cash equivalents is recorded as interest income on an accrual basis on the consolidated statements of operations.

Due to/from Broker:

Due to/from broker consists primarily of cash balances and amounts receivable/payable for unsettled securities transactions held/initiated at the clearing brokers of the Company’s consolidated investment partnerships.

Investments in Securities:

Investments in marketable securities represent primarily the securities held by the Company’s consolidated investment partnerships.  All such securities are recorded at fair value, with net realized and unrealized gains and losses reported in earnings in the consolidated statements of operations.

The Company adopted the provisions of Statement of Financial Accounting Standard No.157, Fair Value Measurements (“FAS 157”), on January 1, 2008.  FAS 157 defines fair value as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date.  FAS 157 also establishes a framework for measuring fair value and a valuation hierarchy based upon the transparency of inputs used in the valuation of an asset or liability.  Classification within the hierarchy is based upon the lowest level of input that is significant to the fair value measurement.  The valuation hierarchy contains three levels: (i) valuation inputs are unadjusted quoted market prices for identical assets or liabilities in active markets (Level 1); (ii) valuation inputs are quoted prices for identical assets or liabilities in markets that are not active, quoted market prices for similar assets and liabilities in active markets and other observable inputs directly or indirectly related to the asset or liability being measured (Level 2); and (iii) valuation inputs are unobservable and significant to the fair value measurement (Level 3).

The Company’s fair value measurements relate to its interest rate swap, as well as its investments in marketable securities, which are primarily exchange-traded securities with quoted prices in active markets.  The fair value measurement of the interest rate swap has been determined primarily based upon the market prices for interest rate swaps with similar provisions and the use of forward interest rate curves.  The interest rate swap has been classified as Level 2 and recorded in other liabilities on the consolidated statement of financial condition.  The fair value measurements of the securities have been classified as Level 1.

The following table presents these instruments’ fair value at March 31, 2009 (in thousands):

8

Pzena Investment Management, Inc.

Unaudited Notes to the Consolidated Financial Statements (Continued)

Note 2—Significant Accounting Policies (continued)

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

Securities Valuation:

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

The net realized gain or loss on sales of securities is determined on a specific identification basis and is included in realized and unrealized loss, net on marketable securities in the consolidated statements of operations.

Concentrations of Credit Risk:

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents, amounts due from brokers and advisory fees receivable.  The Company maintains its cash and temporary cash investments in bank deposits and other accounts whose balances, at times, exceed federally insured limits.

The concentration of credit risk with respect to advisory fees receivable is generally limited due to the short payment terms extended to clients by the Company.  On a periodic basis, the Company evaluates its advisory fees receivable and establishes an allowance for doubtful accounts, if necessary, based on a history of past write-offs and collections and current credit conditions.  For the three months ended March 31, 2009 and 2008, approximately 12.2% and 15.7%, respectively, of the Company’s advisory fees were generated from an advisory agreement with one client.  At March 31, 2009 and December 31, 2008, no allowance for doubtful accounts has been deemed necessary.

Financial Instruments:

On February 28, 2008, the operating company entered into an interest rate swap agreement to manage its exposure to changes in interest rates associated with the credit agreement (the “Credit Agreement”) discussed in Note 9.  The counterparty to this agreement is a major financial institution.  The Company designated the interest rate swap agreement as a cash flow hedge of the Credit Agreement effective February 28, 2008.  Pursuant to Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Certain Hedging Activities (“FAS 133”), the Company recorded the cash flow hedge at fair value on the consolidated statement of financial condition.  Additionally, the Company’s pro rata share of the changes in the fair value of this agreement were recorded as 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 flow hedge to a trading derivative, as a significant portion of the cash flows associated with the original forecasted transaction were probable to not occur due to amortization payments required be made pursuant to the terms of its amended Credit Agreement.  Accordingly, the Company reclassified the cumulative changes in fair value related to this swap from accumulated other comprehensive income to other expense.  The Company records all subsequent changes to the swap’s fair value as a component of other expense.  For the three months ended March 31, 2009, the Company recognized less than $0.1 million in other income related to such changes.  For the three months ended March 31, 2008, the Company recognized approximately $0.0 million in other accumulated comprehensive loss associated with the change in fair value of  this swap agreement.

9

Pzena Investment Management, Inc.

Unaudited Notes to the Consolidated Financial Statements (Continued)

Note 2—Significant Accounting Policies (continued)

At March 31, 2009 and December 31, 2008, the approximate fair value of the liability associated with the swap agreement was $0.4 million and $0.6 million, respectively, and has been included in other liabilities on the statements of financial condition.

The following table summarizes the impact of the Company’s derivative financial instruments on its results of operations for the three months ended March 31, 2009 and 2008 (in thousands):

The following table summarizes the impact of the Company’s derivative financial instruments on its financial position as of March 31, 2009 (in thousands):

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

Property and Equipment:

Property and equipment is carried at cost, less accumulated depreciation and amortization.  Depreciation is provided on a straight-line basis over the estimated useful lives of the respective assets, which range from three to seven years.  Leasehold improvements are amortized on a straight-line basis over the shorter of the useful life of the improvements or the remaining lease term.

Business Segments:

The Company views its operations 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 its operating company.  The operating company is a limited liability company that has elected to be treated as a partnership for tax purposes.  It has not made a provision for federal or state income taxes because it is the responsibility of each of the operating company’s members (including the Company) to separately report their proportionate share of the operating company’s taxable income or loss.  Similarly, the income of the Company’s consolidated investment partnerships is not subject to income taxes, as it is allocated to each partnership’s

10

Pzena Investment Management, Inc.

Unaudited Notes to the Consolidated Financial Statements (Continued)

Note 2—Significant Accounting Policies (continued)

individual partners.  The operating company has made a provision for New York City Unincorporated Business Tax, (“UBT”).

The Company and its consolidated subsidiaries account for all state, local and federal taxation pursuant to the asset and liability method, which requires deferred income tax assets and liabilities to be recorded for temporary differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future, based on enacted tax laws and rates applicable to the periods in which the temporary differences are expected to affect taxable income.  Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount more likely than not to be realized.  At March 31, 2009 and December 31, 2008, the Company had a $64.3 million and a $62.7 million valuation allowance, respectively, against the deferred tax asset recorded as part of the Company’s acquisition of operating company membership units in conjunction with the offering and the March 3, 2009 unit conversions.  These valuation allowances represent approximately 94% and 95% of the total value of such deferred tax assets as of March 31, 2009 and December 31, 2008, respectively.  The income tax provision, or credit, is the tax payable or refundable for the period, plus or minus the change during the period in deferred tax assets and liabilities.  The Company records its deferred tax liabilities as a component of other liabilities on the consolidated statements of financial condition.

Foreign Currency:

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

The Company does not isolate that portion of the results of its operations resulting from changes in foreign exchange rates on investments from the fluctuations arising from changes in market prices of securities held.  Such fluctuations are included in the net realized and unrealized loss, net on marketable securities in the consolidated statements of operations.

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

New Accounting Pronouncements:

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51 (“FAS 160”).  FAS 160 amends ARB No. 51 and establishes accounting and reporting standards that require non-controlling interests (previously referred to as minority interest) to be reported as a component of equity, changes in a parent’s ownership interest while the parent retains its controlling interest be accounted for as equity transactions, and upon a loss of control, retained ownership interest will be remeasured at fair value, with any gain or loss recognized in earnings.  FAS 160 was adopted by the Company on January 1, 2009.  The adoption of FAS 160 only impacted the Company’s presentation of its consolidated financial statements.

In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, Disclosures about Derivative Instruments and Hedging Activities (“FAS 161”).  FAS 161 is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows.  It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008.  As FAS 161 only affects financial statement disclosure, the impact of adoption and January 1, 2009 was limited to additional financial statement disclosure.

In June 2008, the FASB issued EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities (“EITF 03-6-1”).  The EITF release states that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method.  EITF 03-6-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those

11

Pzena Investment Management, Inc.

Unaudited Notes to the Consolidated Financial Statements (Continued)

Note 2—Significant Accounting Policies (continued)

years.  The adoption of EITF 03-6-1 on January 1, 2009 did not have a material impact on the Company’s consolidated financial statements.

On January 1, 2009, the Company adopted the remaining provisions of  Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“FAS No. 157”), as permitted by the FASB Staff Position 157-2, “Effective Date of FASB Statement No. 157” (“FSP 157-2”), which delayed the effective date of SFAS No. 157 for nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). These nonfinancial items include, for example, reporting units required to be measured at fair value for annual goodwill impairment testing purposes and nonfinancial assets acquired and liabilities assumed in a business combination. The Company did not have any impairments or business combinations during the first quarter of 2009, therefore the adoption of FAS 157 for nonfinancial assets did not impact the Company’s consolidated financial statements.

Note 3—Property and Equipment

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

Depreciation is included in general and administrative expenses and totaled $0.1 million for each of the three months ended March 31, 2009 and 2008.

Note 4—Related Party Transactions

For the three months ended March 31, 2009 and 2008, the Company earned $0.9 million and $1.8 million, respectively, in investment advisory fees from unconsolidated entities for which it acts as the investment manager.

At March 31, 2009 and December 31, 2008, the Company had advanced $0.1 million and $0.1 million, respectively, to an international investment company for organization and start-up costs, which are included in receivable from related parties on the consolidated statements of financial condition.  The Company is the sponsor and investment manager of this entity.

At March 31, 2009 and December 31, 2008, receivable from related parties included $0.1 million and $0.1 million of loans to employees.  These loans are in the form of forgivable promissory notes which are amortized through compensation expense pursuant to their terms.

Employees of the Company who are considered accredited investors have the ability to open separately-managed accounts, or invest in certain of the Company’s consolidated investment partnerships, without being assessed advisory fees.  Investments by employees in separately-managed accounts are permitted only at the discretion of the Executive Committee of the Company, but are generally not subject to the same minimum investment levels that are required of outside investors.  Some of the investment advisory fees that are waived on separately managed accounts for employees are for strategies that typically have account fee minimums, which vary by strategy, but typically average approximately $50,000 per account per year.

During the quarter ended June 30, 2008, an unaffiliated shareholder who held more than 10% of the Company’s outstanding shares sold shares in transactions deemed to be short-swing sales.  Under Section 16(b) of the Securities Exchange Act of 1934, the shareholder was required to disgorge to the Company the $0.2 million in profits realized from these stock sales.  The Company recognized these proceeds as a capital contribution from a shareholder and reflected a corresponding increase to additional paid-in capital in its consolidated statements of changes in equity.  Proceeds from these transactions did not affect the Company’s consolidated statements of operations.

As discussed in Note 9, on October 28, 2008, the operating company issued an aggregate of $16.0 million principal amount of Senior Subordinated Notes to entities established by Richard S. Pzena, the Company’s Chief Executive Officer, for the benefit of certain of his family members, an entity controlled by a Company Director, and 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 of business, the Company enters into agreements that include indemnities in favor of third parties, such as engagement letters with advisors and consultants.  In certain cases, the Company may have recourse against third parties with respect to these indemnities.  The Company maintains insurance policies that may provide coverage against certain claims under these indemnities.  FASB issued Interpretation No.  45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (“FIN 45”), providing accounting and disclosure requirements for certain guarantees.  The Company has had no claims or payments pursuant to these agreements, and it believes the likelihood of a claim being made is remote.  Utilizing the methodology in FIN 45, the Company’s estimate of the value of such guarantees is de minimis, and, therefore, an accrual has not been made in the consolidated financial statements.

The Company may be subject to various legal and administrative proceedings in the normal course of business.  On November 21, 2007 and January 16, 2008, substantively identical putative class action lawsuits were commenced in the United States District Court for the Southern District of New York against the Company and Richard S. Pzena, the Company’s chief executive officer, seeking remedies under Section 11 of the Securities Act of 1933, as amended.  The Court consolidated the lawsuits and appointed co-lead plaintiffs, who filed a consolidated amended complaint.  The consolidated amended complaint named as defendants the Company, Richard S. Pzena, and two of the underwriters of the Company’s initial public offering, Goldman Sachs & Co, Inc. and UBS Securities LLC.  Plaintiffs sought to represent a class of all persons who purchased or otherwise acquired Class A common stock issued pursuant or traceable to the Company’s initial public offering.  The consolidated amended complaint alleged that the registration statement and prospectus relating to the initial public offering of the Company’s Class A common stock contained material misstatements and omissions and wrongfully failed to disclose net redemptions in the John Hancock Classic Value Fund, for which the Company acts as sub-investment advisor.  The consolidated amended complaint sought damages in an unspecified amount including rescission or rescissory damages.  The Court granted Company’s motion to dismiss the consolidated amended complaint and, on September 4, 2008, the Court entered a judgment in favor of the Company.  Plaintiffs have filed a Notice of Appeal of the Court’s judgment to the United States Court of Appeals for the Second Circuit.  The Company believes that the allegations and claims are without merit and will continue to contest these claims vigorously.

The Company leases office space under two non-cancelable operating lease agreements which expire on October 31, 2015.  The Company reflects lease expense on a straight-line basis over the lease term.  Lease expenses totaled $0.6 million for each of the three months ended March 31, 2009 and 2008.

Note 6—Retirement Plan

The Company maintains a defined contribution pension plan which covers substantially all members and employees.  The Company may make contributions to the plan at the discretion of management.  Under the terms of the plan, all such contributions vest immediately.  The Company recognized $0.5 million in expense associated with this plan for the three months ended March 31, 2008.  These expenses are included in compensation and benefits expense in the consolidated statements of operations.  No such expenses were incurred during the three months ended March 31, 2009

Note 7—Compensation and Benefits

Compensation and benefits expense to employees and members is comprised of the following:

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Note 7—Compensation and Benefits (continued)

For the three months ended March 31, 2008, the operating company granted 446,000 options to purchase units pursuant to the Pzena Investment Management, LLC 2006 Equity Incentive Plan.  For the three months ended March 31, 2009, the operating company granted no options to purchase such units.  The options had varying vesting schedules and were issued at strike prices equal to the assessed fair market value per unit at the time of award issuance.  The Company determined that the total grant-date fair value of the options awarded during the three months ended March 31, 2008 was approximately $1.2 million.  For the three months ended March 31, 2009 and 2008, the Company recognized approximately $0.1 million and $0.1 million, respectively, in compensation and benefits expense associated with the amortization of these awards.

For the three months ended March 31, 2009 and 2008, the Company granted  30,000 and 13,000 restricted Class B units to certain members pursuant to the Pzena Investment Management, LLC 2006 Equity Incentive Plan.  These unit grants each vest ratably over a four-year period commencing January 1, 2009 and 2008, respectively.  The amortization of these awards was not material for the three months ended March 31, 2009 and 2008.

Pursuant to the operating company’s bonus plan, which became effective January 1, 2007, eligible employees whose cash compensation is in excess of certain thresholds have a portion of that excess mandatorily deferred.  Amounts deferred may be credited to an investment account or take the form of phantom Class B units, at the employee’s discretion, and vest ratably over four years.  At March 31, 2009 and December 31, 2008, no such compensation was deferred.  At March 31, 2009 and December 31, 2008, the liability associated with such investment accounts was approximately $0.1 million and $0.3 million, respectively, and has been included as a component of other liabilities on the consolidated statements of financial condition.  For the three months ended March 31, 2009 and 2008, the Company recognized approximately $0.2 million and $0.3 million, respectively, in compensation and benefits expense associated with the amortization of all deferred compensation awards.

Note 8—Short Term Borrowings

Simultaneously with the Credit Agreement described below, on July 23, 2007, the operating company obtained a $20.0 million revolving credit facility, expiring on July 23, 2010, in order to finance its short term working capital needs.  This facility carries a commitment fee of 0.2% on any unused amounts, and the Company’s approximately $1.8 million letter of credit reduces the amounts otherwise available to be used.  On February 11, 2008, the operating company entered into Amendment No. 1 to its Credit Agreement.  The amendment changed a number of Credit Agreement provisions, including reducing the capacity of the revolving credit facility from $20.0 million to $5.0 million.  On September 19, 2008, the operating company entered into Amendment No. 2 to its Credit Agreement.  The amendment reduced the capacity of the revolving credit facility from $5.0 million to $3.0 million and extended its maturity to July 23, 2011.  On October 28, 2008, the operating company entered into Amendment No. 3 to its Credit Agreement, which reduced the capacity of the revolving credit facility to the value of its letter of credit, approximately $1.8 million.  As of and for the periods ended March 31, 2009 and December 31, 2008, no balance was outstanding against the facility.

Note 9—Debt

On July 23, 2007, the operating company entered into a $60.0 million, three-year Credit Agreement, the proceeds of which were used to finance a one-time distribution to its members.  The principal amount borrowed bore interest at a variable rate based, at the Company’s option, on (i) the one, two, three, nine or twelve-month LIBOR rate plus 1.00%, or (ii) the higher of the lender’s prime rate and the Federal Funds Rate.  The principal amount was payable in full at the end of the three-year term, with no penalty for prepayment.  Approximately $0.1 million in debt issuance costs were incurred in association with this loan.  Such costs have been recorded in prepaid expenses and other assets on the consolidated statements of financial condition and are being amortized over the term of the loan.

On February 11, 2008, the operating company entered into Amendment No. 1 to the Credit Agreement.  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 amended agreement, term loan amortization was required beginning in any period when assets under management were less than $20.0 billion and ending when assets under management was greater than $21.5 billion.  Further, a 50% excess cash flow sweep was required if assets

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Unaudited Notes to the Consolidated Financial Statements (Continued)

Note 9—Debt (continued)

under management were below $17.5 billion.  Additionally, the LIBOR interest rate option was increased to LIBOR plus 1.50%.  For the period from February 11, 2008 through July 23, 2008, the interest rate in effect was 6.91%, which was equal to the twelve-month LIBOR rate in effect at the time of the closing of the agreement of 5.41%, plus 1.50%.  During the quarter ended June 30, 2008, the Company’s assets under management fell below $20 billion.  On June 30, 2008, the Company made a required amortization payment of $3.0 million.

On September 19, 2008, the operating company entered into Amendment No. 2 to its Credit Agreement.  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 was eliminated.  The excess cash flow sweep was also increased to 75% of excess cash flow.  On September 22, 2008, the Company made a required amortization payment of $5.0 million as a condition precedent to the effectiveness of this amendment.  On September 30, 2008, the Company made a quarterly amortization payment of $5.0 million.

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

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

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 the operating company of an aggregate of $16.0 million principal amount of Senior Subordinated Notes (collectively, the “Notes”) to entities established by Richard S. Pzena, the Company’s Chief Executive Officer, for the benefit of certain of his family members, an entity controlled by a Company director, and a former employee.  The issuance of these Notes was approved by the three independent members of the Company’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 a restricted payments covenant (including dividends), a prohibition on incurring indebtedness which is not subordinated to the Notes, and events of default based on failure to make payments, bankruptcy, change of control and acceleration of material indebtedness.  In addition, the Notes are subordinated to the repayment in full of the loans under the Credit Agreement.

As discussed above, subsequent to Amendment No. 2 and Amendment No. 3 to the Company’s Credit Agreement in 2008, the minimum EBITDA and minimum AUM covenants were eliminated.  The Company was in compliance with these covenants as of and for all 2008 periods in which they were in effect.

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Unaudited Notes to the Consolidated Financial Statements (Continued)

Note 9—Debt (continued)

Pursuant to the Credit Agreement and the Senior Subordinated Notes, the operating company would be in default if it ever failed to pay required interest and amortization payments in a timely fashion.  Further, the Credit Agreement stipulates that the operating company would be in default thereunder if it defaults on its Senior Subordinated Notes.  Such events of default would permit the lender under the applicable debt agreement to accelerate the debt thereunder.  No such occurrence of acceleration occurred during the three months ended March 31, 2009 and 2008.

On January 23, 2009, the Company repaid $8.0 million of the principal amount outstanding under the Credit Agreement.

Note 10—Interest Rate Swap

The Company manages its exposure to changes in market rates of interest.  The Company’s use of derivative instruments is limited to an interest rate swap used to manage the interest rate exposure related to its Credit Agreement.  The Company monitors its position and the credit rating of the counterparty and does not anticipate non-performance by such counterparty.

On February 28, 2008, the operating company entered into a $60.0 million notional amount interest rate swap agreement that commenced on July 23, 2008.  The swap, which expires July 23, 2010, obligates the operating company to pay a 2.825% fixed rate of interest on the notional amount and requires the counterparty to pay the operating company a floating interest rate based on the monthly LIBOR interest rate.  The spread on the Credit Agreement is in addition to these amounts.  As discussed in Note 9, on September 19, 2008, the maturity of amounts outstanding under the Company’s Credit Agreement was extended to July 23, 2011.  The Company has not entered into any agreements to manage its exposure to fluctuations in interest rates from July 23, 2010 through July 23, 2011.

During the quarter ended September 30, 2008, the Company changed the designation of its swap agreement from a cash flow hedge to a trading derivative, as a significant portion of the cash flows associated with the original forecasted transaction were probable to not occur due to the amortization payments required to be made pursuant to the terms of its amended agreement.  Accordingly, the Company reclassified the cumulative changes in fair value related to this swap from accumulated other comprehensive income to other expense.  The Company records all changes to the swap’s fair value as a component of other expense.  For the three months ended March 31, 2009, the Company recognized approximately $0.1 million in other expense related to such changes.  For the three months ended March 31, 2008, the Company recognized approximately $0.5 million in other accumulated comprehensive loss associated with the change in fair value of  this swap agreement.

Concurrently with the reductions in principal outstanding under the Credit Agreement in 2008, the Company reduced the notional amount of its interest rate swap to $22.0 million.  The amounts paid to the counterparty in exchange for these 2008 reductions were approximately $0.1 million.  During the three months ended March 31, 2009, the Company reduced the notional amount of its interest rate swap to $14.0 million.  The amounts paid to the counterparty in exchange for this reduction was approximately $0.2 million.

Note 11—Income Taxes

The operating company is a limited liability company that has elected to be treated as a partnership for tax purposes.  Neither it nor the Company’s other consolidated subsidiaries has made a provision for federal or state income taxes because it is the personal responsibility of each of these entities’ members (including the Company) to separately report their proportionate share of the respective entity’s taxable income or loss.  The operating company has made a provision for New York City UBT.  Subsequent to the offering and reorganization on October 30, 2007, the Company, as a “C” corporation under the Internal Revenue Code, is liable for federal, state and local taxes on the income derived from its economic interest in its operating company, which is net of UBT.  Correspondingly, in its consolidated financial statements, the Company reports both the operating company’s provision for UBT as well as its provision for federal, state and local corporate taxes.

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Note 11—Income Taxes (continued)

For the three months ended March 31, 2009 and 2008, the Company’s taxable income was determined as follows:

In September 2006, the Financial Accounting Standards Board issued Interpretation No.48, Accounting for Uncertainty in Income Taxes (“FIN 48”).  FIN 48 establishes the minimum threshold for recognizing, and a system for measuring, the benefits of tax return positions in financial statements.  It is the Company’s policy to recognize accrued interest and penalties associated with uncertain tax positions as part of the tax provision.  For the three months ended March 31, 2009 and 2008, no such expenses were recognized.  As of March 31, 2009 and December 31, 2008, no accruals were recorded.

The Company and the operating company are generally no longer subject to U. S federal, or state and local income tax examinations by tax authorities for any year prior to 2005.  All tax years subsequent to this date are considered open and subject to examination by tax authorities.

The components of the provision for income taxes are as follows (in thousands):

Prior to October 30, 2007, the operating company was a cash basis taxpayer.  As the result of the Company’s acquisition of membership units in conjunction with the offering, the operating company was required to become an accrual basis taxpayer.  Pursuant to Section 481 of the Internal Revenue Code, the cumulative difference between the two methods of taxpaying are amortizable over four years.  These differences generated approximately $0.4 million and $0.4 million in deferred tax liabilities as of March 31, 2009 and December 31, 2008, respectively.  Such amounts are recorded in other liabilities in the consolidated statements of financial condition.

The acquisition of the operating company membership units noted above has allowed the Company to make an election under Section 754 of the Internal Revenue Code (“Section 754”) to step up its tax basis in the net assets acquired. 

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Unaudited Notes to the Consolidated Financial Statements (Continued)

Note 11—Income Taxes (continued)

This step up is deductible for tax purposes over a 15-year period.  Based on the net proceeds 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 $68.7 million.

Pursuant to a Tax Receivable Agreement signed between the members of the operating company and the Company, 85% of the cash savings generated by this election will be distributed to the selling shareholders upon this benefit’s realization.

In September 2008, the Company evaluated the asset associated with this election after the decline in its AUM brought, for the first time, revenue projections below the point at which the Company would generate sufficient full-year taxable income to fully utilize this deferred tax asset.  Other negative evidence it reviewed included (i) the general uncertain economic environment, which has been reflected in declining stock markets and had a corresponding impact on AUM and revenue levels; (ii) the accelerating negative trends affecting the asset management industry in particular; and (iii) the difficulty of projecting AUM in the current volatile environment.  These factors were moderated by (i) the Company’s ability to control its compensation costs, which is its single largest expense; (ii) management’s experience in the asset management industry and minimal turnover of key personnel; and (iii) the ability of the Company to utilize tax losses generated by this asset over a longer time horizon.  In conducting its analysis, the Company believed that the inherent difficulty in projecting future income was exacerbated by the economic environment.  It correspondingly limited its projections to three years.  Over this time period, the Company projected taxable income assuming no AUM growth and modest reductions in its cost structure.

The Company determined that, after weighing both the positive and negative evidence discussed above, a portion of benefits associated with this deferred tax asset were more likely than not to go unrealized due to estimates of future taxable income.  As a result, the Company established a $62.7 million valuation allowance to reduce the net deferred tax asset to an amount more likely than not to be realized on September 30, 2008.  This deferred tax asset remains available to the Company and can be used to reduce taxable income in future years.  The Company similarly reduced the associated liability to selling and converting shareholders to reflect this change in the estimated realization of the asset.  The Company recorded an approximate $53.3 million increase to other income associated with this reduction in the liability to selling and converting shareholders on September 30, 2008.

In October 2008, the selling unitholders agreed to waive any payments that the Company is or will be required to make to them for the 2008 and 2009 tax years pursuant to the Tax Receivable Agreement.  During the quarter ended December 31, 2008, the Company recognized approximately $2.9 million in other income associated with this waiver.

As discussed further in Note 15 below, on March 3, 2009 certain of the operating company’s members exchanged an aggregate of 2,445,973 of their Class B units for an equivalent number of shares of Company Class A common stock.   The Company elected to step up its tax basis in the incremental assets acquired in accordance with Section 754.  Based on the exchange-date fair value of the Company’s common stock and the tax basis of the operating company, this election gave rise to a $2.5 million deferred tax asset and a corresponding $2.2 million liability to selling and converting shareholders under the Tax Receivable Agreement.  Using the methodology described above, the Company assessed the realizability of the deferred tax asset associated with this exchange and determined that a portion of its benefits would go unutilized.  Consequently, the Company established a $2.4 million valuation allowance to reduce the incremental deferred tax asset to an amount more likely than not to be realized.  This deferred tax asset remains available to the Company and can be used to reduce taxable income in future years.  The Company similarly reduced the associated liability to selling and converting shareholders to reflect this change in the estimated realization of the asset.  Pursuant to the guidance of Emerging Issues Task Force Issue No. 94-10, Accounting by a Company for the Income Tax Effects of Transactions among or with Its Shareholders under FASB Statement No.109 (“EITF 94-10”), the Company recorded the effects of these transactions in equity.

During the first quarter of 2009, the Company reduced its valuation allowance by approximately $0.8 million due to revised estimates of future taxable income, primarily related to lower expense projections.   The Company correspondingly increased its liability to selling and converting shareholders by $0.6 million to reflect this change in the estimated realization of the asset.  The effects of these changes to the deferred tax asset and liability to selling and converting shareholders were recorded as a component of the provision for income taxes and other expense, respectively, on the consolidated statements of operations.  As of March 31, 2009 and December 31, 2008, the net value of all deferred tax assets was approximately $4.2 million and $3.4 million, respectively.  As of March 31, 2009 and December 31, 2008, the liability to selling and converting shareholders was approximately $2.5 million and $1.8 million, respectively.

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Unaudited Notes to the Consolidated Financial Statements (Continued)

Note 11—Income Taxes (continued)

The change in the Company’s net deferred tax assets for the three months ended March 31, 2009 is summarized as follows (in thousands):

Note 12—Investments in Marketable Securities

Investments in marketable securities consisted of the following at March 31, 2009:

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