UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2007

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to

JEFFERIES GROUP, INC.

(Exact name of registrant as specified in its charter)

Delaware		95-4719745
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)
520 Madison Avenue, 12th Floor, New York, New York		10022
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (212) 284-2550

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 þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer þ      Accelerated filer o      Non-accelerated filer o

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

Indicate the number of shares outstanding of the registrant’s class of common stock, as of the latest practicable date. 125,431,975 shares as of the close of business May 7, 2007.

 

 

JEFFERIES GROUP, INC. AND SUBSIDIARIES
INDEX TO QUARTERLY REPORT ON FORM 10-Q
MARCH 31, 2007

		Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Financial Condition (unaudited) — March 31, 2007 and December 31, 2006			3
Consolidated Statements of Earnings (unaudited) — Three Months Ended March 31, 2007 and 2006			4
Consolidated Statement of Changes in Stockholders’ Equity (unaudited) — Three Months Ended March 31, 2007 and Year Ended December 31, 2006			5
Consolidated Statements of Cash Flows (unaudited) — Three Months Ended March 31, 2007 and 2006			6
Notes to Consolidated Financial Statements (unaudited)			8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			39
Item 3. Quantitative and Qualitative Disclosures About Market Risk			50
Item 4. Controls and Procedures			54
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 54
Item 1A. Risk Factors			54
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			54
Item 6. Exhibits			55
Signature			56
EXHIBIT 10.2
EXHIBIT 10.3
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32

PART I. FINANCIAL INFORMATION

		March 31,				December 31,
		2007				2006
ASSETS
Cash and cash equivalents		$	216,577			$	513,041
Cash and securities segregated and on deposit for regulatory purposes or deposited with clearing and depository organizations			692,941				508,303
Investments			135,087				125,533
Investments in managed funds			431,365				372,869
Securities borrowed			14,953,164				9,711,894
Securities purchased under agreements to resell			257,212				226,176
Receivable from brokers, dealers and clearing organizations			725,631				254,580
Receivable from customers			528,082				663,552
Financial instruments owned, including securities pledged to creditors of $2,770,321 and $1,481,098 in 2007 and 2006, respectively			6,839,631				4,606,223
Premises and equipment			100,349				91,375
Goodwill			261,401				257,321
Other assets			554,047				494,590
Total Assets		$	25,695,487			$	17,825,457
LIABILITIES AND STOCKHOLDERS’ EQUITY
Bank loans and current portion of long-term debt		$	331,915			$	99,981
Securities loaned			10,076,504				6,794,554
Securities sold under agreements to repurchase			4,688,989				2,092,838
Payable to brokers, dealers and clearing organizations			984,981				669,196
Payable to customers			1,217,691				1,010,486
Financial instruments sold, not yet purchased			4,940,261				3,600,869
Accrued expenses and other liabilities			444,283				650,974
			22,684,624				14,918,898
Long-term debt			1,169,278				1,168,562
Mandatorily redeemable convertible preferred stock			125,000				125,000
Minority interest			27,426				31,910
Total Liabilities			24,006,328				16,244,370
STOCKHOLDERS’ EQUITY
Common stock, $.0001 par value. Authorized 500,000,000 shares; issued 150,912,711 shares in 2007 and 145,628,024 shares in 2006			15				14
Additional paid-in capital			951,880				876,393
Retained earnings			997,906				952,263
Less:
Treasury stock, at cost, 26,674,469 shares in 2007 and 26,081,110 shares in 2006			(271,162	)			(254,437	)
Accumulated other comprehensive gain (loss):
Currency translation adjustments			13,430				9,764
Additional minimum pension liability			(2,910	)			(2,910	)
Total accumulated other comprehensive gain (loss)			10,520				6,854
Total stockholders’ equity			1,689,159				1,581,087
Total Liabilities and Stockholders’ Equity		$	25,695,487			$	17,825,457

See accompanying unaudited notes to consolidated financial statements.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

		Three Months Ended
		Mar. 31,				Mar. 31,
		2007				2006
Revenues:
Commissions		$	77,032			$	69,002
Principal transactions			144,449				159,980
Investment banking			170,115				127,734
Asset management fees and investment income from managed funds			22,485				40,822
Interest			201,162				113,760
Other			8,041				12,779
Total revenues			623,284				524,077
Interest expense			204,475				108,663
Revenues, net of interest expense			418,809				415,414
Non-interest expenses:
Compensation and benefits			227,666				232,734
Floor brokerage and clearing fees			14,582				13,933
Technology and communications			22,157				19,245
Occupancy and equipment rental			18,171				15,172
Business development			13,109				12,603
Other			19,631				24,320
Total non-interest expenses			315,316				318,007
Earnings before income taxes, minority interest and cumulative effect of change in accounting principle			103,493				97,407
Income taxes			40,658				38,432
Earnings before minority interest and cumulative effect of change in accounting principle			62,835				58,975
Minority interest in earnings of consolidated subsidiaries, net			576				2,134
Earnings before cumulative effect of change in accounting principle, net			62,259				56,841
Cumulative effect of change in accounting principle, net			¾				1,606
Net earnings		$	62,259			$	58,447
Earnings per basic share:
Basic-
Earnings before cumulative effect of change in accounting principle, net		$	0.44			$	0.44
Cumulative effect of change in accounting principle, net			—				0.01
Net earnings		$	0.44			$	0.45
Diluted-
Earnings before cumulative effect of change in accounting principle, net		$	0.42			$	0.40
Cumulative effect of change in accounting principle, net			—				0.01
Net earnings		$	0.42			$	0.41
Weighted average shares:
Basic			140,897				130,358
Diluted			152,058				142,942
Fixed charge coverage ratio			5.0X				5.3X

See accompanying unaudited notes to consolidated financial statements.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited)

THREE MONTHS ENDED MARCH 31, 2007 AND YEAR ENDED DECEMBER 31, 2006
(Dollars in thousands, except per share amounts)

		2007				2006
Common stock, par value $.0001 per share
Balance, beginning of year		$	14			$	7
Issued stock			1				7
Balance, end of period		$	15			$	14
Additional paid in capital
Balance, beginning of year		$	876,393			$	709,447
Benefit plan share activity (1)			13,713				33,360
Amortization expense			29,158				83,137
Proceeds from exercise of stock options			1,720				17,543
Tax benefits			30,896				32,906
Balance, end of period		$	951,880			$	876,393
Retained earnings
Balance, beginning of year, as previously reported		$	952,263			$	803,262
Cumulative effect of adjustment from adoption of FIN 48			(410	)			—
Net earnings			62,259				205,750
Dividends			(16,206	)			(56,749	)
Balance, end of period		$	997,906			$	952,263
Treasury stock, at cost
Balance, beginning of year		$	(254,437	)		$	(220,703	)
Purchases			(16,657	)			(23,972	)
Returns / forfeitures			(68	)			(9,762	)
Balance, end of period		$	(271,162	)		$	(254,437	)
Accumulated other comprehensive income (loss)
Balance, beginning of year		$	6,854			$	(5,163	)
Currency adjustment			3,666				8,802
Pension adjustment			—				3,215
Balance, end of period		$	10,520			$	6,854
Total stockholders’ equity		$	1,689,159			$	1,581,087
Comprehensive income
Net earnings		$	62,259			$	205,750
Other comprehensive income			3,666				12,017
Total comprehensive income		$	65,925			$	217,767

See accompanying unaudited notes to consolidated financial statements.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

		Three Months Ended
		Mar. 31,				Mar. 31,
		2007				2006
Cash flows from operating activities:
Net earnings		$	62,259			$	58,447
Adjustments to reconcile net earnings to net cash used in operating activities:
Cumulative effect of accounting change, net			—				1,606
Depreciation and amortization			5,693				5,273
Accruals related to various benefit plans, stock issuances, net of forfeitures			42,804				22,851
(Increase) decrease in cash and securities segregated and on deposit for regulatory purposes or deposited with clearing and depository organizations			(184,458	)			150,052
(Increase) decrease in receivables:
Securities borrowed			(5,241,270	)			(1,537,046	)
Brokers, dealers and clearing organizations			(468,817	)			(174,859	)
Customers			136,652				(113,171	)
Increase in financial instruments owned			(2,233,765	)			(926,661	)
Increase in securities purchased under agreements to resell			(31,036	)			—
Increase in other assets			(58,156	)			(146,519	)
Increase in operating payables:
Securities loaned			3,281,950				1,142,060
Securities sold under agreements to repurchase			2,596,151				—
Brokers, dealers and clearing organizations			313,719				325,696
Customers			207,233				77,881
Increase in financial instruments sold, not yet purchased			1,339,392				952,670
Decrease in accrued expenses and other liabilities			(196,884	)			(16,276	)
Decrease increase in minority interest			(4,484	)			(3,874	)
Net cash used in operating activities			(433,017	)			(181,870	)

Continued on next page.

JEFFERIES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS — CONTINUED (Unaudited)
(Dollars in thousands)

		Three Months Ended
		Mar. 31,				Mar. 31,
		2007				2006
Cash flows from investing activities:
Decrease in short term bond funds			—				7,037
Increase in investments			(9,545	)			(5,626	)
Increase in investments in managed funds			(58,496	)			(3,383	)
Business acquisitions, net of cash received			(14,567	)			(19,944	)
Purchase of premises and equipment			(14,236	)			(6,426	)
Net cash used in investing activities			(96,844	)			(28,342	)
Cash flows from financing activities
Tax benefit from the issuance of stock based awards			30,896				14,053
Net proceeds from (payments on):
Bank loans			231,927				1,927
Issuance of senior notes			—				492,155
Issuance of mandatorily redeemable convertible preferred stock			—				125,000
Repurchase of treasury stock			(16,657	)			(3,418	)
Dividends			(16,206	)			(9,547	)
Exercise of stock options, not including tax benefits			1,720				2,873
Net cash provided by financing activities			231,680				623,043
Effect of foreign currency translation on cash and cash equivalents			1,717				169
Net (decrease) increase in cash and cash equivalents			(296,464	)			413,000
Cash and cash equivalents – beginning of period			513,041				255,933
Cash and cash equivalents – end of period		$	216,577			$	668,933
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest		$	212,192			$	116,633
Income taxes		$	7,104			$	42,785

See accompanying unaudited notes to consolidated financial statements.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

Index

				Page
Note 1.		Organization and Summary of Significant Accounting Policies			9
Note 2.		Asset Management Fees and Investment Income From Managed Funds			17
Note 3.		Cash, Cash Equivalents, and Short-Term Investments			19
Note 4.		Financial Instruments			19
Note 5.		Short-Term Borrowings			21
Note 6.		Long-Term Debt			21
Note 7.		Mandatorily Redeemable Convertible Preferred Stock			22
Note 8.		Income Taxes			22
Note 9.		Benefit Plans			23
Note 10.		Minority Interest			23
Note 11.		Earnings Per Share			24
Note 12.		Derivative Financial Instruments			25
Note 13.		Other Comprehensive Gain (Loss)			28
Note 14.		Net Capital Requirements			28
Note 15.		Commitments, Contingencies and Guarantees			29
Note 16.		Segment Reporting			30
Note 17.		Goodwill			32
Note 18.		Quarterly Dividends			32
Note 19.		Variable Interest Entities (“VIEs”)			32
Note 20.		Related Party Disclosures			33
Note 21.		Stock Based Compensation			34
Note 22.		Subsequent Events			38

JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
(Unaudited)

Note 1. Organization and Summary of Significant Accounting Policies

Organization

The accompanying unaudited consolidated financial statements include the accounts of Jefferies Group, Inc. and all its subsidiaries (together, “we” or “us”), including Jefferies & Company, Inc. (“Jefferies”), Jefferies Execution Services, Inc., (“Jefferies Execution”), Jefferies International Limited, Jefferies Asset Management, LLC, Jefferies Financial Products, LLC and all other entities in which we have a controlling financial interest or are the “primary beneficiary”, including Jefferies Employees Opportunity Fund, LLC (“JEOF”). The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the U.S. for complete financial statements. In the opinion of our management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three-month period ended March 31, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007. These unaudited consolidated financial statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2006.

Reclassifications

Certain reclassifications have been made to previously reported balances to conform to the current presentation. These reclassifications had no effect on the Consolidated Statements of Earnings.

Starting in 2006, we included contingent consideration paid in subsequent periods relating to prior business combinations as investing activities in the Consolidated Statements of Cash Flows included in this report and accordingly have corrected the March 31, 2006 period to be consistent with the current presentation. The cash payments related to the contingent consideration are primarily paid during the first quarter. For the quarter ended March 31, 2006, this correction had the effect of reducing net cash used in operating activities and increasing net cash used in investing activities by $19.9 million from that previously reported. The amounts involved are immaterial to the Consolidated Financial Statements. In addition, the change only affects the presentation within the Consolidated Statements of Cash Flows and does not impact the Consolidated Statements of Financial Condition or the Consolidated Statements of Earnings, debt balances or compliance with debt covenants.

Common Stock

On April 18, 2006, we declared a 2-for-1 split of all outstanding shares of our common stock, payable May 15, 2006 to stockholders of record as of April 28, 2006. The stock split was effected as a stock dividend of one share for each one share outstanding on the record date. All share, share price and per share information included in this quarterly report, including the consolidated financial statements and the notes thereto, have been restated to retroactively reflect the effect of the two-for-one stock split.

JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
(Unaudited)

Summary of Significant Accounting Policies

Principles of Consolidation

Our policy is to consolidate all entities in which we own more than 50% of the outstanding voting stock and have control. In addition, in accordance with Financial Accounting Standards Board (“FASB”) Interpretation No. 46(R), Consolidation of Variable Interest Entities (“FIN 46(R)”), as revised, we consolidate entities which lack characteristics of an operating entity or business for which we are the primary beneficiary. Under FIN 46(R), the primary beneficiary is the party that absorbs a majority of the entity’s expected losses, receives a majority of its expected residual returns, or both, as a result of holding variable interests, direct or implied. In situations where we have significant influence but not control of an entity that does not qualify as a variable interest entity, we apply the equity method of accounting. If we do not consolidate an entity or apply the equity method of accounting, we account for our investment at fair value. We also have formed nonconsolidated investment vehicles with third-party investors that are typically organized as limited partnerships. We act as general partner for these investment vehicles and have generally provided the third-party investors with termination or “kick-out” rights as defined by EITF 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.

All material intercompany accounts and transactions are eliminated in consolidation.

Revenue Recognition Policies

Commissions. All customer securities transactions are reported on the Consolidated Statement of Financial Condition on a settlement date basis with related income reported on a trade-date basis. Under clearing agreements, we clear trades for unaffiliated correspondent brokers and retain a portion of commissions as a fee for our services. Correspondent clearing revenues are included in other revenue. We permit institutional customers to allocate a portion of their gross commissions to pay for research products and other services provided by third parties. The amounts allocated for those purposes are commonly referred to as soft dollar arrangements. Soft dollar expenses amounted to $7.7 million and $8.0 million for the period ended March 31, 2007 and 2006, respectively. We are accounting for the cost of these arrangements on an accrual basis. Our accounting for commission revenues includes the guidance contained in Emerging Issues Task Force (“EITF”) Issue No. 99-19, Reporting Revenues Gross versus Net, because we are not the primary obligor of such arrangements, and accordingly, expenses relating to soft dollars are netted against the commission revenues.

Principal Transactions. Financial instruments owned, securities pledged and financial instruments sold, but not yet purchased (all of which are recorded on a trade-date basis) and investments are carried at fair value, as appropriate, with unrealized gains and losses reflected in principal transactions in the Consolidated Statement of Earnings on a trade date basis.

Investment Banking. Underwriting revenues and fees from mergers and acquisitions, restructuring and other investment banking advisory assignments are recorded when the services related to the underlying transaction are completed under the terms of the assignment or engagement. Expenses associated with such transactions are deferred until reimbursed by the client, the related revenue is recognized or the engagement is otherwise concluded. Expenses are recorded net of client reimbursements. Revenues are presented net of related unreimbursed expenses. Unreimbursed expenses with no related revenues are included in business development in the Consolidated Statement of Earnings. Reimbursed expenses totaled approximately $2.2 million and $3.6 million for the period ended March 31, 2007 and 2006, respectively.

JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
(Unaudited)

Asset Management Fees and Investment Income From Managed Funds. Asset management fees and investment income from managed funds include revenues we receive from management, administrative and performance fees from funds managed by us, revenues from management and performance fees we receive from third-party managed funds, and investment income from our investments in these funds. We receive fees in connection with management and investment advisory services performed for various funds and managed accounts, including two Jefferies Partners Opportunity funds, Jefferies Paragon Fund, Jefferies RTS Fund, Victoria Falls CLO, Summit Lake CLO, Clear Lake CLO, Diamond Lake CLO and certain third-party managed funds. These fees are based on the value of assets under management and may include performance fees based upon the performance of the funds. Management and administrative fees are generally recognized over the period that the related service is provided based upon the beginning or ending Net Asset Value of the relevant period. Generally, performance fees are earned when the return on assets under management exceeds certain benchmark returns, “high-water marks”, or other performance targets. Performance fees are accrued on a monthly basis and are not subject to adjustment once the measurement period ends (annually) and performance fees have been realized.

Interest Revenue and Expense. We recognize contractual interest on financial instruments owned and financial instruments sold, but not yet purchased on an accrual basis as a component of interest revenue and interest expense, respectively. Interest flows on derivative transactions and dividends are included as part of the mark-to-market valuation of these contracts in principal transactions in the Consolidated Statements of Earnings and are not recognized as a component of interest revenue or expense. We account for our short-term and long-term borrowings on an accrual basis with related interest recorded as interest expense.

Cash Equivalents

Cash equivalents include highly liquid investments not held for resale with original maturities of three months or less.

Cash and Securities Segregated and on Deposit for Regulatory Purposes or Deposited With Clearing and Depository Organizations

In accordance with Rule 15c3-3 of the Securities Exchange Act of 1934, Jefferies & Company, Inc., as a broker-dealer carrying client accounts, is subject to requirements related to maintaining cash or qualified securities in a segregated reserve account for the exclusive benefit of its clients. In addition, certain financial instruments used for initial and variation margin purposes with clearing and depository organizations are recorded in this caption.

Foreign Currency Translation

Assets and liabilities of foreign subsidiaries having non-U.S. dollar functional currencies are translated at exchange rates at the end of a period. Revenues and expenses are translated at average exchange rates during the period. The gains or losses resulting from translating foreign currency financial statements into U.S. dollars, net of hedging gains or losses and taxes, if any, are included in accumulated other comprehensive income, a component of stockholders’ equity. Gains or losses resulting from foreign currency transactions are included in the Consolidated Statements of Earnings.

Investments

Investments include direct investments in limited liability companies and partnerships that make investments in private equity companies, strategic investments in financial service entities and other investments. With the adoption of FASB No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115 (“FASB 159”), we apply fair value accounting on positions that are risk-managed on a fair value basis. Factors considered in valuing investments at fair value include, without limitation, available market prices, reported net asset values, type of security, purchase price, purchases of the same or similar securities by other investors, marketability, restrictions on disposition, current financial position and operating results of the issuer and other pertinent information. For strategic investments in financial services entities we apply the equity method of accounting. Investment gains and losses are included in principal transactions in the Consolidated Statements of Earnings.

JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
(Unaudited)

Investments in Managed Funds

Investments in managed funds includes our investments in funds managed by us and our investments in third-party managed funds in which we are entitled to a portion of the management and/or performance fees. Investments in managed funds are accounted for on the equity method.

Receivable from, and Payable to, Customers

Receivable from, and payable to, customers includes amounts receivable and payable on cash and margin transactions. Securities owned by customers and held as collateral for these receivables are not reflected in the accompanying consolidated financial statements. Receivable from officers and directors represents balances arising from their individual security transactions. These transactions are subject to the same regulations as customer transactions and are provided on substantially the same terms.

Fair Value of Financial Instruments

Substantially all of our financial instruments are carried at fair value or amounts approximating fair value. Assets, including cash and cash equivalents, securities borrowed or purchased under agreements to sell, and certain receivables, are carried at fair value or contracted amounts, which approximate fair value due to the short period to maturity. Similarly, liabilities, including bank loans, securities loaned or sold under agreements to repurchase and certain payables, are carried at amounts approximating fair value. Debt is carried at face value less unamortized discount, except for the $200.0 million aggregate principal amount of unsecured 7³/4% senior notes due March 15, 2012 hedged by interest rate swaps. The fair value of a financial instrument is the amount 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 (the exit price). Financial instruments owned and financial instruments sold, not yet purchased, are valued at quoted market prices, if available. For financial instruments that do not have readily determinable fair values through quoted market prices, the determination of fair value is based upon consideration of available information, including types of financial instruments, current financial information, restrictions on dispositions, fair values of underlying financial instruments and quotations for similar instruments.

In addition to the interest rate swaps mentioned above, we have derivative financial instrument positions in exchange traded and over-the-counter option contracts, foreign exchange forward contracts, index futures contracts, commodities swap and option contracts and commodities futures contracts, which are measured at fair value with gains and losses recognized in principal transactions. The gross contracted or notional amount of these contracts is not reflected in the Consolidated Statements of Financial Condition. We follow FIN No. 39, Offsetting Amounts Related to Certain Contracts (“FIN 39”), and offset assets and liabilities in the Consolidated Statements of Financial Condition provided that the legal right of offset exists under a master netting agreement. This includes the offsetting of payables or receivables relating to the fair value of cash collateral received or paid associated with its derivative inventory, on a counterparty basis.

Prior to the adoption of FASB No. 157, Fair Value Measurements (“FASB 157”), we followed Emerging issues Task Force Statement No. 02-3, Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities (“EITF 02-3”). This guidance generally prohibited recognizing profit at the inception of a derivative contract unless the fair value of the derivative was obtained from a quoted market price in an active market or was otherwise evidenced by comparison to other observable current market transactions or based on a valuation technique that incorporates observable market data. Subsequent to the transaction date, we recognized trading profits deferred at inception of the derivative transaction in the period in which the valuation of an instrument became observable. With the adoption of FASB 157, we are no longer applying the revenue recognition criteria of EITF 02-3. However, FASB 157 requires that a fair value measurement reflect the assumptions market participants would use in pricing an asset or liability based on the best information available.

JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
(Unaudited)

Securities Borrowed and Securities Loaned

In connection with both trading and brokerage activities, we borrow securities to cover short sales and to complete transactions in which customers have failed to deliver securities by the required settlement date, and lend securities to other brokers and dealers for similar purposes. We have an active securities borrowed and lending matched book business (“Matched Book”), in which we borrow securities from one party and lend them to another party. When we borrow securities, we generally provide cash to the lender as collateral, which is reflected in our Consolidated Statements of Financial Condition as securities borrowed. We earn interest revenues on this cash collateral. Similarly, when we lend securities to another party, that party provides cash to us as collateral, which is reflected in our Consolidated Statements of Financial Condition as securities loaned. We pay interest expense on the cash collateral received from the party borrowing the securities. A substantial portion of our interest revenues and interest expenses results from the Matched Book activity. The initial collateral advanced or received approximates or is greater than, the fair value of the securities borrowed or loaned. We monitor the fair value of the securities borrowed and loaned on a daily basis and request additional collateral or return excess collateral, as appropriate.

Securities Purchased Under Agreements to Resell and Securities Sold Under Agreements to Repurchase

Securities purchased under agreements to resell and securities sold under agreements to repurchase (“repos”) are treated as collateralized financing transactions and are recorded at their contracted repurchase amount.

We monitor the fair value of the repos daily versus the related receivable or payable balances. Should the fair value of the repos decline or increase, additional collateral is requested or excess collateral is returned, as appropriate.

We carry repos on a net basis when permitted under the provisions of FASB Interpretation No. 41, Offsetting of Amounts Related to Certain Repurchase and Reverse Repurchase Agreements (“FIN 41”).

Premises and Equipment

Premises and equipment are depreciated using the straight-line method over the estimated useful lives of the related assets (generally three to ten years). Leasehold improvements are amortized using the straight-line method over the term of related leases or the estimated useful lives of the assets, whichever is shorter.

Goodwill

In accordance with FASB No. 142, Goodwill and Other Intangible Assets, goodwill is not amortized; instead, it is reviewed, on at least an annual basis, for impairment. Goodwill is impaired when the carrying amount of the reporting unit exceeds the implied fair value of the reporting unit. While goodwill is no longer amortized, it is tested for impairment annually as of the third quarter or at the time of a triggering event requiring re-evaluation, if one were to occur. No triggering events occurred during the first quarter of 2007 that required a re-evaluation of goodwill for impairment purposes.

JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
(Unaudited)

Income Taxes

We file a consolidated U.S. Federal income tax return, which includes all of our qualifying subsidiaries. Amounts provided for income taxes are based on income reported for financial statement purposes and do not necessarily represent amounts currently payable. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred income taxes are provided for temporary differences in reporting certain items, principally deferred compensation, unrealized gains and losses on investments, and tax amortization on intangible assets. Tax credits are recorded as a reduction of income taxes when realized.

Legal Reserves

We recognize a liability for a contingency when it is probable that a liability has been incurred and when the amount of loss can be reasonably estimated. When a range of probable loss can be estimated, we accrue the most likely amount of such loss, and if such amount is not determinable, then we accrue the minimum of the range of probable loss.

We record reserves related to legal proceedings in accrued expenses and other liabilities. Such reserves are established and maintained in accordance with FASB No. 5, Accounting for Contingencies, and FASB Interpretation No. 14, Reasonable Estimation of the Amount of a Loss an Interpretation of FASB Statement No. 5. The determination of these reserve amounts requires significant judgment on the part of management. Our management considers many factors including, but not limited to: the amount of the claim; the basis and validity of the claim; previous results in similar cases; and legal precedents and case law. Each legal proceeding is reviewed with counsel in each accounting period and the reserve is adjusted as deemed appropriate by management.

Stock Based Compensation

Under FASB No. 123, Accounting for Stock-Based Compensation, we defined the service period (over which compensation cost should be recognized) to generally include the year prior to the grant and the subsequent vesting period. With the adoption of FASB 123R on January 1, 2006, our policy regarding the timing of expense recognition for non-retirement eligible employees changed to recognize compensation cost over the period from the service inception date, which is the grant date, through the date the employee is no longer required to provide service to earn the award.

In addition, with the adoption of FASB 123R on January 1, 2006, the awards granted to retirement eligible employees where the award does not contain future service requirements must be either expensed on the date of grant or, in certain circumstances, may be accrued in the periods prior to the grant date. Subsequent to the adoption of FASB 123R, we made certain changes to the terms of certain new grants which effectively eliminated accelerated expense recognition upon retirement and/or increased the retirement eligibility age and years of service from those generally provided for in prior grants. During the period ended March 31, 2007, we granted stock-based awards with a fair value of $8.7 million which require accelerated expense recognition upon retirement under FASB 123R.

Earnings per Common Share

Basic earnings per share of common stock are computed by dividing net earnings by the average number of shares outstanding and certain other shares committed to be, but not yet issued. Basic earnings per share include restricted stock and RSUs for which no future service is required. Diluted earnings per share of common stock are computed by dividing net earnings plus dividends on mandatorily redeemable convertible preferred stock divided by the average number of shares outstanding of common stock and all dilutive common stock equivalents outstanding during the period. Diluted earnings per share include the dilutive effects of restricted stock and RSUs for which future service is required.

JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
(Unaudited)

Accounting and Regulatory Developments

EITF Issue No. 04-5. In June 2005, the FASB ratified the consensus reached by the Emerging Issues Task Force on Issue 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”). EITF 04-5 presumes that a general partner controls a limited partnership, and should therefore consolidate a limited partnership, unless the limited partners have the substantive ability to remove the general partner without cause based on a simple majority vote or can otherwise dissolve the limited partnership, or unless the limited partners have substantive participating rights over decision making. This guidance became effective upon ratification by the FASB on June 29, 2005 for all newly formed limited partnerships and for existing limited partnerships for which the partnership agreements have been modified. For all other limited partnerships, the guidance is effective no later than the beginning of the first reporting period in fiscal years beginning after December 15, 2005. As of March 31, 2007 we have generally provided limited partners with rights to remove us as general partner or rights to terminate the partnership, and therefore, the impact of adopting EITF Issue No. 04-5 was not material.

FASB Interpretation No. 48. In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The transition adjustment to beginning retained earnings was a reduction of approximately $410 thousand.

FASB No. 157. In September 2006, the FASB issued FASB No. 157, Fair Value Measurements (“FASB 157”). FASB 157 clarifies that fair value is the amount that would be exchanged to sell an asset or transfer a liability, in an orderly transaction between market participants. FASB 157 reverses the consensus reached in EITF Issue No. 02-3 prohibiting the recognition of day one gain or loss on derivative contracts where we cannot verify all of the significant model inputs to observable market data and verify the model to market transactions. However, FASB 157 requires that a fair value measurement technique include an adjustment for risks inherent in a particular valuation technique (such as a pricing model) and/or the risks inherent in the inputs to the model, if market participants would also include such an adjustment. In addition, FASB 157 prohibits the recognition of “block discounts” for large holdings of unrestricted financial instruments where quoted prices are readily and regularly available in an active market. The provisions of FASB 157 are to be applied prospectively, except for changes in fair value measurements that result from the initial application of FASB 157 to existing derivative financial instruments measured under EITF Issue No. 02-3 and block discounts, which are to be recorded as an adjustment to opening retained earnings in the year of adoption. FASB 157 is effective for fiscal years beginning after November 15, 2007. We adopted FASB No. 157 as of the beginning of 2007. To determine the transition adjustment to opening retained earnings, we performed an analysis of existing derivative instruments measured under EITF Issue 02-3 and block discounts, and determined that there was no transition adjustment to opening retained earnings first quarter of 2007.

JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
(Unaudited)

FASB No. 158. In September 2006, the FASB issued Statement No. 158, Accounting for Uncertainty in Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R) (“FASB 158”). FASB 158 improves financial reporting by requiring an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. This Statement also improves financial reporting by requiring an employer to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. An employer with publicly traded equity securities is required to initially recognize the funded status of a defined benefit postretirement plan and to provide the required disclosures as of the end of the fiscal year ending after December 15, 2006. The requirement to measure plan assets and benefit obligations as of the date of the employer’s fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008. On December 31, 2006, we adopted the recognition and disclosure provisions of FASB 158. FASB 158 required us to recognize the funded status (i.e., the difference between the fair value of plan assets and the projected benefit obligations) of our benefit plan on our December 31, 2006 Consolidated Statement of Financial Condition, with a corresponding adjustment to accumulated other comprehensive income, net of tax. As a result of the pension plan being frozen, the projected benefit obligation was equal to the accumulated benefit obligation. Consequently, no additional adjustment to accumulated other comprehensive income was necessary.

FASB No. 159. In February 2007, the FASB issued FASB No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115 (“FASB 159”). This standard permits an entity to measure financial instruments and certain other items at estimated fair value. Most of the provisions of FASB No. 159 are elective; however, the amendment to FASB No. 115, Accounting for Certain Investments in Debt and Equity Securities, applies to all entities that own trading and available-for-sale securities. The fair value option created by FASB 159 permits an entity to measure eligible items at fair value as of specified election dates. The fair value option (a) may generally be applied instrument by instrument, (b) is irrevocable unless a new election date occurs, and (c) must be applied to the entire instrument and not to only a portion of the instrument. FASB 159 allows for a one-time election for existing positions upon adoption, with the transition adjustment recorded to opening retained earnings. FASB 159 is effective as of the beginning of the first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of the previous fiscal year provided that the entity (i) makes that choice in the first 120 days of that year, (ii) has not yet issued financial statements for any interim period of such year, and (iii) elects to apply the provisions of FASB 157. We adopted FASB 159 as of the beginning of 2007. We elected to apply the fair value option on loans and loan commitments made in connection with our investment banking activities (“loans and loan commitments”). Loans and loan commitments are included in financial instruments owned on the Consolidated Statement of Financial Condition. At the time of adoption, we did not have such loans and loan commitments outstanding, therefore there was no transition adjustment recorded to opening retained earnings. In addition, we elected to apply the fair value option on certain investments held by subsidiaries that are not registered broker-dealers as defined in the AICPA Audit and Accounting Guide, Brokers and Dealers in Securities. These investments had been accounted for by us at fair value prior to the adoption of FASB 159; therefore, there was no transition adjustment recorded to opening retained earnings related to these investments. The fair value option was elected for loans and loan commitments and investments held by subsidiaries that are not registered broker-dealers because they are risk managed by us on a fair value basis.

Use of Estimates

Our management has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these financial statements in conformity with U.S. generally accepted accounting principles. Actual results could differ from those estimates.

JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
(Unaudited)

Note 2. Asset Management Fees and Investment Income From Managed Funds

Period end assets under management by predominant asset strategy were as follows (in millions of dollars):

		March 31,				March 31,
		2007				2006
Assets under management:
Fixed Income (1)		$	1,838			$	981
Equities (2)			388				469
Convertibles (3)			2,715				1,681
Real Assets (4)			—				136
			4,941				3,267
Assets under management by third parties (5):
Equities, Convertibles and Fixed Income			291				261
Private Equity			600				720
			891				981
Total		$	5,832			$	4,248

The following summarizes revenues from asset management fees and investment income from managed funds relating to funds managed by us and funds managed by third parties for the three-month period ended March 31, 2007 and 2006 (in thousands of dollars):

		Three Months Ended
		Mar. 31,				Mar. 31,
		2007				2006
Asset management fees:
Fixed Income (1)		$	4,440			$	5,042
Equities (2)			2,180				17,130
Convertibles (3)			2,831				1,643
Real Assets (4)			—				2,194
			9,451				26,009
Investment income from managed funds			13,034				14,813
Total		$	22,485			$	40,822

JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
(Unaudited)

The following tables detail our average investment in managed funds, investment income from managed funds, investment income from managed funds — minority interest portion and net investment income from managed funds relating to funds managed by us and funds managed by third parties for the three months ended March 31, 2007 and 2006 (in millions of dollars):

Three Months Ended March 31, 2007

										Investment				Net
						Investment				Income from				Investment
						Income from				Managed Funds –				Income from
		Average				Managed				Minority Interest				Managed
		Investment (5)				Funds				Portion				Funds
Fixed Income (1)		$	274.7			$	7.4			$	0.4			$	7.0
Equities (2)			161.7				5.1				0.1				5.0
Convertibles (3)			33.5				0.5				—				0.5
Real Assets (4)			—				—				—				—
Total		$	469.9			$	13.0			$	0.5			$	12.5

Three Months Ended March 31, 2006

										Investment				Net
						Investment				Income from				Investment
						Income from				Managed Funds –				Income from
		Average				Managed				Minority Interest				Managed
		Investment (5)				Funds				Portion				Funds
Fixed Income (1)		$	154.8			$	7.4			$	1.7			$	5.7
Equities (2)			75.1				5.9				¾				5.9
Convertibles (3)			12.3				0.8				¾				0.8
Real Assets (4)			11.1				0.7				¾				0.7
Total		$	253.3			$	14.8			$	1.7			$	13.1

Included in investments in managed funds as of March 31, 2007 and December 31, 2006 is $58,285,000 and $69,691,000, respectively, relating to our interest in the unconsolidated high yield funds that we manage. Included in investment income from managed funds for the periods ended March 31, 2007, and 2006 is $1,399,000, and $2,639,000, respectively, relating to the associated income from our interest in those high yield funds.

JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
(Unaudited)

Note 3. Cash, Cash Equivalents, and Short-Term Investments

We generally invest our excess cash in money market funds and other short-term investments. Cash equivalents include highly liquid investments not held for resale with original maturities of three months or less. The following are financial instruments that are cash and cash equivalents or are deemed by our management to be generally readily convertible into cash as of March 31, 2007 and December 31, 2006 (in thousands of dollars):

		March 31, 2007				December 31, 2006
Cash and cash equivalents:
Cash in banks		$	156,934			$	107,488
Money market investments			59,643				405,553
Total cash and cash equivalents			216,577				513,041
Cash and securities segregated (1)			692,941				508,303
Mortgage-backed securities (2)			4,512				43,151
Asset-backed securities (2)			4,095				28,009
		$	918,125			$	1,092,504

Note 4. Financial Instruments

The following is a summary of the fair value of major categories of financial instruments owned and financial instruments sold, not yet purchased, as of March 31, 2007 and December 31, 2006 (in thousands of dollars):

		March 31, 2007								December 31, 2006
						Financial								Financial
						Instruments								Instruments
		Financial				Sold,				Financial				Sold,
		Instruments				Not Yet				Instruments				Not Yet
		Owned				Purchased				Owned				Purchased
Corporate equity securities		$	3,461,161			$	2,958,762			$	1,737,174			$	1,835,046
High-yield securities			176,491				60,798				166,616				62,115
Corporate debt securities			1,948,836				1,090,610				1,752,213				1,123,285
U.S. Government and agency obligations			773,392				492,567				634,263				339,891
Mortgage-backed securities			4,512				—				43,151				—
Asset-backed securities			4,095				—				28,009				—
Derivatives			463,974				337,220				234,646				240,231
Other			7,170				304				10,151				301
		$	6,839,631			$	4,940,261			$	4,606,223			$	3,600,869

JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
(Unaudited)

Financial instruments owned includes securities pledged to creditors. The following is a summary of the fair value of major categories of securities pledged to creditors as of March 31, 2007 and December 31, 2006 (in thousands of dollars):

		March 31, 2007				December 31, 2006
Corporate equity securities		$	2,441,605			$	1,068,498
Corporate debt securities			313,452				404,167
High-yield securities			15,264				8,433
		$	2,770,321			$	1,481,098

At March 31, 2007 and December 31, 2006, the approximate fair value of collateral received by us that may be sold or repledged by us, excluding amounts netted in accordance with FIN 39 and FIN 41, was $14.9 billion and $9.8 billion, respectively. This collateral was received in connection with resale agreements and securities borrowings. At March 31, 2007 and December 31, 2006, a substantial portion of this collateral received by us had been sold or repledged.

FASB 157 establishes a fair value hierarchy to prioritize the inputs used in valuation techniques. The three broad levels to the fair value hierarchy of inputs are:

		Level 1:		Inputs that reflect unadjusted quoted prices at the measurement date for identical assets or liabilities in active markets;
		Level 2:		Inputs other than quoted prices included in Level 1 that are either directly or indirectly observable for the asset or liability at the measurement date;
		Level 3:		Inputs that are unobservable at the measurement date.

The following is a summary of our financial assets and liabilities that are accounted for at fair value as of March 31, 2007 by level within the fair value hierarchy (in thousands of dollars):

														Counterparty
														and Cash
														Collateral
		Level 1				Level 2				Level 3				Netting				Total
Assets:
Financial instruments owned:
Non-derivative instruments		$	1,980,759			$	4,234,521			$	160,377			$	—			$	6,375,657
Derivative instruments			549,890				160,444				—				(246,360	)			463,974
Total financial instruments owned			2,530,649				4,394,965				160,377				(246,360	)			6,839,631
Investments (1)			—				—				97,653				—				97,653
Other assets (2)			—				8,155				—				—				8,155
Liabilities:
Financial instruments sold, not yet purchased:
Non-derivative instruments			3,092,863				1,510,178				—				—				4,603,041
Derivative instruments			375,605				408,148				—				(446,533	)			337,220
Total financial instruments sold, not yet purchased			3,468,468				1,918,326				—				(446,533	)			4,940,261

JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
(Unaudited)

The following is a summary of changes in fair value of our financial assets and liabilities that have been classified as Level 3 at March 31, 2007 (in thousands of dollars):

		Non-derivative
		instruments –
		Assets				Investments
Balance, December 31, 2006		$	205,278			$	97,289
Total gains/ (losses) (realized and unrealized) (1)			(3,043	)			5,354
Purchases, sales, settlements, and Issuances			(27,422	)			(4,990	)
Net transfers in and/or out of Level 3			(14,436	)			—
Balance, March 31, 2007		$	160,377			$	97,653
Change in unrealized gains/ (losses) relating to instruments still held at March 31, 2007 (1)		$	(3,620	)		$	5,354

Note 5. Short-Term Borrowings

Bank loans represent short-term borrowings that are payable on demand and generally bear interest at a spread over the Fed Funds rate. We had $110.0 million and $0 of outstanding secured bank loans as of March 31, 2007 and December 31, 2006, respectively. Unsecured bank loans are typically overnight loans used to finance securities owned or clearing related balances. We had $121.9 million and $0 of outstanding unsecured bank loans as of March 31, 2007 and December 31, 2006, respectively. Average daily bank loans for the quarter ended March 31, 2007 and year ended December 31, 2006 were $171.4 million and $12.4 million, respectively.

In addition, the current portion of our long-term debt maturing within one year of the financial statement date is classified with bank loans on the Consolidated Statement of Financial Condition. As of March 31, 2007 and December 31, 2006, the outstanding balance of our 7¹/2% Senior Notes, due in the third quarter of 2007, was $100.0 million and $100.0 million, respectively.

Note 6. Long-Term Debt

The following summarizes long-term debt outstanding at March 31, 2007 and December 31, 2006 (in thousands of dollars):

		March 31, 2007				December 31, 2006
73/4% Senior Notes, due 2012, net of unamortized discount of $4,504 (2007)			328,651				328,003
51/2% Senior Notes, due 2016, net of unamortized discount of $1,635 (2007)			348,365				348,320
61/4% Senior Notes, due 2036, net of unamortized discount of $7,738 (2007)			492,262				492,239
		$	1,169,278			$	1,168,562

JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
(Unaudited)

We previously entered into a fair value hedge with no ineffectiveness using interest rate swaps in order to convert $200 million aggregate principal amount of unsecured 7³/4% senior notes due March 15, 2012 into floating rates based upon LIBOR. The effective interest rate on the $200 million aggregate principal amount of unsecured 7³/4% senior notes, after giving effect to the swaps, is 7.5%. The fair value of the swaps was $8.2 million as of March 31, 2007, which was recorded as an increase in the book value of the debt and an increase in other assets.

In January 2006, we sold in a registered public offering $500 million aggregate principal amount of our unsecured 6.25% 30-year senior debentures due January 15, 2036.

Note 7. Mandatorily Redeemable Convertible Preferred Stock

In February 2006, Massachusetts Mutual Life Insurance Company (“MassMutual”) purchased in a private placement $125 million of our Series A convertible preferred stock. Our Series A convertible preferred stock has a 3.25% annual, cumulative cash dividend and is currently convertible into 4,060,369 shares of our common stock at an effective conversion price of approximately $30.79 per share. The preferred stock is callable beginning in 2016 and will mature in 2036. The dividend is recorded as a component of interest expense as the Series A convertible preferred stock is treated as debt in accordance with FASB 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. The dividend is not deductible for tax purposes because the Series A convertible preferred stock is considered “equity” for tax purposes. As of March 31, 2007, 10,000,000 shares of preferred stock were authorized and 125,000 shares of preferred stock were issued and outstanding.

Note 8. Income Taxes

We adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), as of January 1, 2007. As a result of adoption, we recognized a $.4 million increase to reserves for uncertain tax positions. This increase was accounted for as an adjustment to the beginning balance of retained earnings on the Consolidated Statement of Financial Condition. As of March 31, 2007 and January 1, 2007, we had approximately $5.4 million and $3.3 million, respectively, of total gross unrecognized tax benefits. These totals also represent the amount of unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in any future periods.

We are subject to U.S. federal income tax as well as income tax in multiple state and foreign jurisdictions. We have concluded all U.S federal income tax matters for the years through 2000. Substantially all material state and local, and foreign income tax matters have been concluded for the years through 1998. New York State and New York City income tax returns for the years 2001 through 2004 and 2000 through 2003, respectively, are currently under examination. The final outcome of these examinations is not yet determinable. However, management anticipates that adjustments to the unrecognized tax benefits, if any, will not result in a material change to the results of operations or financial condition.

We recognize interest accrued related to unrecognized tax benefits in interest expense. Penalties, if any, are recognized in other expenses. As of March 31, 2007 and January 1, 2007, we had accrued interest and penalties related to unrecognized tax benefits of approximately $1.4 million and $1.0 million, respectively.

JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
(Unaudited)

Note 9. Benefit Plans

The following summarizes the net periodic pension cost for the three-month periods ended March 31, 2007 and 2006 (in thousands of dollars):

		Three Months Ended
		Mar. 31,				Mar. 31,
		2007				2006
Net pension cost included the following components:
Service cost — benefits earned during the period		$	69			$	—
Interest cost on projected benefit obligation			590				638
Expected return on plan assets			(628	)			(560	)
Amortization of prior service cost			—				—
Amortization of net loss			141				255
Net periodic pension cost		$	172			$	333

We have not contributed to our pension plan during 2007. We anticipate contributing between approximately $2.0 million and $4.0 million during the remainder of 2007. Effective December 31, 2005, benefits under the pension plan have been frozen. There will be no further benefit accruals for service after December 31, 2005.

Note 10. Minority Interest

Minority interest primarily represents the minority equity holders’ proportionate share of the equity of JEOF. At March 31, 2007, we controlled and owned approximately 44% of JEOF.

JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
(Unaudited)

Note 11. Earnings Per Share

The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations for the three-month period ended March 31, 2007 and 2006 (in thousands, except per share amounts):

		Three Months Ended
		March 31,				March 31,
		2007				2006
Earnings before cumulative effect of change in accounting principle, net		$	62,259			$	56,841
Cumulative effect of change in accounting principle, net			—				1,606
Net earnings		$	62,259			$	58,447
Add: Convertible preferred stock dividends			1,016				463
Net earnings for diluted earnings per share		$	63,275			$	58,910
Shares:
Average shares used in basic computation			140,897				130,358
Unvested restricted stock / restricted stock units			6,457				9,110
Stock options			647				1,547
Convertible preferred stock			4,057				1,927
Average shares used in diluted computation			152,058				142,942
Earnings per share:
Basic-
Earnings before cumulative effect of change in accounting principle, net		$	0.44			$	0.44
Cumulative effect of change in accounting principle, net			—				0.01
Net earnings		$	0.44			$	0.45
Diluted-
Earnings before cumulative effect of change in accounting principle, net		$	0.42			$	0.40
Cumulative effect of change in accounting principle, net			—				0.01
Net earnings		$	0.42			$	0.41

JEFFERIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
(Unaudited)

Note 12. Derivative Financial Instruments

Off- Balance Sheet Risk

We have contractual commitments arising in the ordinary course of business for securities loaned or purchased under agreements to sell, financial instruments sold but not yet purchased, repurchase agreements, future purchases and sales of foreign currencies, securities transactions on a when-issued basis, options contracts, futures index contracts, commodities futures contracts and underwriting. Each of these financial instruments and activities contains varying degrees of off-balance sheet risk whereby the fair values of the securities underlying the financial instruments may be in excess of, or less than, the contract amount. The settlement of these transactions is not expected to have a material effect upon our consolidated financial statements.

Jefferies Financial Products

Jefferies Financial Products, LLC (“JFP”), a wholly-owned subsidiary of ours, was formed as a limited liability company in November 2003. JFP is a market maker in commodity index products and a trader in commodities futures and options. JFP offers customers exposure to over-the-counter commodity indices and other commodity baskets in the form of fixed-for-floating swaps (“swaps”) and options, where the return is based on a specific commodity or basket of commodities (e.g., Jefferies Commodity Performance Index (“JCPI”)). The primary end users in this market are creditworthy institutional investors, such as pension funds, mutual funds, foundations, endowments, and insurance companies. These investors generally seek exposure to commodities in order to diversify their existing stock and bond portfolios. Generally, JFP will enter into swaps whereby JFP receives a stream of fixed cash flows against paying the return of a given commodity or index plus a spread or fee (“fee”). The fee is meant to compensate JFP for the costs of replicating the commodity or index exposure in the underlying exchange traded futures markets. The floating return can be either the total return on the index (inclusive of implied collateral yield), or the excess return. JFP also enters into swap, forward and option transactions on foreign exchange, individual commodities and commodity indices.

Generally, the swap and option contract tenors range from 1 month to 2 years, and in some transactions both parties may settle the changes in the mark-to-market value of the transaction on a monthly basis. Where appropriate, JFP utilizes various credit enhancements, including guarantees, collateral and margin agreements to mitigate the credit exposure relating to these swaps and options. JFP establishes credit limits based on, among other things, the creditworthiness of the counterparties, the transaction’s size and tenor, and estimated potential exposure. In addition, swap and option transactions are generally documented under International Swaps and Derivatives Association Master Agreements. We believe that such agreements provide for legally enforceable set-off and close-out netting of exposures to specific counterparties. Under such agreements, in connection with an early termination of a transaction, JFP is permitted to set-off its receivables from a counterparty against its payables to the same counterparty arising out of all included transactions. As a result, the fair value represents the net sum of estimated fair values after the application of such netting. JFP has determined that the fair value of its swaps and options (inclusive of counterparty netting and exclusive of cash collateral netting) approximated $(136.7) million and $(92.6) million, respectively at March 31, 2007 and $156.1 million and $(125.4) million, respectively at December 31, 2006.

The following table sets forth the fair value of JFP’s outstanding OTC positions and exchange-traded futures and options by remaining contractual maturity as of March 31, 2007:

		0 – 12				1 – 5				5 – 10
(in millions)		Months				Years				Years				Total
Swaps		$	(136.8	)		$	0.1			$	—			$	(136.7	)
Options			(24.5	)			(68.1	)			—				(92.6	)
FX forwards			1.3				—				—				1.3
Exchange-traded futures			222.0				2.4				—				224.4
Total		$	62.0			$	(65.6	)		$	—			$	(3.6	)

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In July 2004, JFP entered into a credit intermediation facility with an AA-rated European bank (the “Bank”). This facility allows JFP customers that require a counterparty with a high credit rating for commodity index transactions to transact with the Bank. The Bank simultaneously enters into a back-to-back transaction with JFP and receives a fee from JFP for providing credit support. Subject to the terms of the agreement between JFP and the Bank, JFP is generally responsible to the Bank for the performance of JFP’s customers. We guarantee the performance of JFP to the Bank under the credit intermediation facility. JFP also provides commodity index pricing to the Bank’s customers and JFP earns revenue from the Bank’s hedging of its customer transactions with JFP.

At March 31, 2007 and December 31, 2006, the counterparty credit quality with respect to the fair value of commodities and foreign exchange futures, options and swap portfolios were as follows:

		Fair Value
(in millions)		March 31, 2007				December 31, 2006
Counterparty credit quality:
A or higher		$	(238.1	)		$	37.5
Exchange-traded futures and options (1)			234.5				13.4
Total		$	(3.6	)		$	50.9

At March 31, 2007 and December 31, 2006 the counterparty breakdown by industry with respect to the fair value of JFP’s commodities and foreign exchange futures, options and swap portfolio was as follows:

		Fair Value
(in millions)		March 31, 2007				December 31, 2006
Foundations, trusts and endowments		$	64.0			$	(6.4	)
Financial services			(278.8	)			4.7
Collective investment vehicles (including pension plans, mutual funds and other institutional counterparties)			(23.3	)			39.2
Exchanges (1)			234.5				13.4
Total		$	(3.6	)		$	50.9

Derivative Financial Instruments

Our derivative activities are recorded at fair value in the Consolidated Statement of Financial Condition. Acting in a trading capacity, we may enter into derivative transactions to satisfy the needs of our clients and to manage our own exposure to market and credit risks resulting from our trading activities.

Derivatives are subject to various risks similar to other financial instruments, including market, credit and operational risk. In addition, we may be exposed to legal risks related to derivative activities. The risks of derivatives should not be viewed in isolation, but rather should be considered on an aggregate basis along with our other trading-related activities. We manage the risks associated with derivatives on an aggregate basis along with the risks associated with proprietary trading as part of our firmwide risk management policies.

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We record trading derivative contracts at fair value with realized and unrealized gains and losses recognized in principal transactions in the Consolidated Statement of Earnings on a trade date basis and as a component of cash flows from operating activities in the Consolidated Statements of Cash Flows.

We have also entered into a fair value hedge with no ineffectiveness using interest rate swaps in order to convert $200.0 million aggregate principal amount of unsecured 7³/4% senior notes due March 15, 2012 into floating rates based upon LIBOR. The effective interest rate on the $200.0 million aggregate principal amount of unsecured 7³/4% senior notes, after giving effect to the swaps, is 7.5%. The fair value of the swaps was positive $8.2 million as of March 31, 2007, which was recorded as an increase in the book value of the debt and an increase in derivative assets classified as part of other assets.

The following table presents the fair value of derivatives at March 31, 2007 and December 31, 2006. The fair value of assets/liabilities related to derivative contracts at March 31, 2007 and December 31, 2006 represent our receivable/payable for derivative financial instruments:

		March 31, 2007								December 31, 2006
(in thousands)		Assets				Liabilities				Assets				Liabilities
Derivative instruments included in financial instruments owned and financial instruments sold, not yet purchased:
Exchange traded futures		$	225,797			$	9,414			$	19,724			$	2,116
Commodity related swaps (1)			59,820				¾				61,741				¾
Option contracts			177,039				327,806				152,361				238,115
Foreign exchange forward contracts			1,318				¾				820				¾
Total		$	463,974			$	337,220			$	234,646			$	240,231
Derivative instruments included in other assets:
Interest rate swaps		$	8,155				¾				7,690				¾

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Note 13. Other Comprehensive Gain (Loss)

The following summarizes other comprehensive income and accumulated other comprehensive income (loss) at March 31, 2007 and for the three months then ended (in thousands of dollars):

						Minimum				Accumulated
		Currency				Pension				Other
		Translation				Liability				Comprehensive
		Adjustments				Adjustment				Gain
Beginning at December 31, 2006		$	9,764			$	(2,910	)		$	6,854
Change in first quarter of 2007			3,666				¾				3,666
Ending at March 31, 2007		$	13,430			$	(2,910	)		$	10,520

The following summarizes other comprehensive income and accumulated other comprehensive income (loss) at March 31, 2006 and for the three months then ended (in thousands of dollars):

						Minimum				Accumulated
		Currency				Pension				Other
		Translation				Liability				Comprehensive
		Adjustments				Adjustment				Loss
Beginning at December 31, 2005		$	962			$	(6,125	)		$	(5,163	)
Change in first quarter of 2006			453				¾				453
Ending at March 31, 2006		$	1,415			$	(6,125	)		$	(4,710	)

Comprehensive income for the three months ended March 31, 2007 and 2006 was as follows (in thousands of dollars):

		March 31,				March 31,
		2007				2006
Net earnings		$	62,259			$	58,447
Other comprehensive gain (loss)			3,666				453
Comprehensive income		$	65,925			$	58,900

Note 14. Net Capital Requirements

As registered broker-dealers, Jefferies and Jefferies Execution are subject to the Securities and Exchange Commission Uniform Net Capital Rule (Rule 15c3-1), which requires the maintenance of minimum net capital. Jefferies and Jefferies Execution have elected to use the alternative method permitted by the Rule, which requires that they each maintain minimum net capital.

As of March 31, 2007, Jefferies’ and Jefferies Execution’s net capital and excess net capital were as follows (in thousands of dollars):

		Net Capital				Excess Net Capital
Jefferies		$	254,882			$	236,599
Jefferies Execution		$	25,216			$	24,966

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Note 15. Commitments, Contingencies and Guarantees

The following table summarizes other commitments and guarantees at March 31, 2007:

						Maturity Date
														2009				2011				2013
		Notional / Maximum												and				and				and
		Payout				2007				2008				2010				2012				Later
		(Dollars in Millions)
Standby letters of credit		$	264.3			$	264.3				—				—				—				—
Bank credit		$	60.2			$	60.2				—				—				—				—
Equity commitments		$	266.8				—				—				—			$	1.7			$	265.1
Derivative contracts		$	751.6			$	751.6				—				—				—				—

Standby Letters of Credit. In the normal course of business, we had letters of credit outstanding aggregating $264.3 million at March 31, 2007, mostly to satisfy various collateral requirements in lieu of depositing cash or securities. These letters of credit have a current carrying amount of $0. As of March 31, 2007, there were no draw downs on these letters of credit.

Bank Credit. As of March 31, 2007, we had outstanding guarantees of $56.0 million relating to bank credit obligations ($47.5 million of which is undrawn) of associated investment vehicles in which we have an interest.

Equity Commitments. On October 7, 2004, we entered into an agreement with Babson Capital and MassMutual to form Jefferies Finance LLC, a joint venture entity created for the purpose of offering senior loans to middle market and growth companies. In February 2006, we and MassMutual reached an agreement to double our equity commitments to Jefferies Finance LLC. With an incremental $125 million from each partner, the new total committed equity capitalization of Jefferies Finance LLC is $500 million. Loans are expected to be originated primarily through the investment banking efforts of Jefferies & Company, Inc. with Babson Capital providing primary credit analytics and portfolio management services. As of March 31, 2007, we have funded $35.0 million of our aggregate commitment leaving $215.0 million unfunded.

As of March 31, 2007, we have an aggregate commitment to invest in Jefferies Capital Partners IV L.P. and its related parallel fund of approximately $39.4 million.

As of March 31, 2007, we had other equity commitments to invest up to $12.4 million in various other investments.

Derivative Contracts. In accordance with FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (“FIN 45”), we disclose certain derivative contracts meeting the FIN 45 definition of a guarantee. Such derivative contracts include written equity put options. At March 31, 2007, the maximum payout value of derivative contracts deemed to meet the FIN 45 definition of a guarantee was approximately $751.6 million. For purposes of determining maximum payout, notional values are used; however, we believe the fair value of these contracts is a more relevant measure of these obligations because we believe the notional amounts greatly overstate our expected payout. At March 31, 2007, the fair value of such derivative contracts approximated $14.2 million. In addition, the derivative contracts deemed to meet the FIN 45 definition of a guarantee are before consideration of hedging transactions. We substantially mitigate our risk on these contracts through hedges, such as other derivative contracts and/or cash instruments. We manage risk associated with derivative guarantees consistent with our risk management policies.

High Yield Loan Commitments. From time to time we make commitments to extend credit to investment-banking clients in loan syndication and acquisition-finance transactions. These commitments and any related drawdowns of these facilities typically have fixed maturity dates and are contingent on certain representations, warranties and contractual conditions applicable to the borrower. We define high yield (non-investment grade) as debt securities or loan commitments to companies rated BB+ or lower or equivalent ratings by recognized credit rating agencies, as well as non-rated securities or loans that, in management’s opinion, are non-investment grade. We did not have any commitments outstanding to non-investment grade borrowers as of March 31, 2007.

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Jefferies Financial Products, LLC. In July 2004, JFP entered into a credit intermediation facility with an “AA”-rated European bank (the “Bank”). This facility allows JFP customers that require a counterparty with a high credit rating for commodity index transactions to transact with the Bank. The Bank simultaneously enters into a back-to-back transaction with JFP and receives a fee from JFP for providing credit support. Subject to the terms of the agreement between JFP and the Bank, JFP is responsible to the Bank for the performance of JFP’s customers. We guarantee the performance of JFP to the Bank under the credit intermediation facility. JFP will also provide commodity index pricing to the Bank’s customers and JFP will earn revenue from the Bank’s hedging of its customer transactions with JFP. Also, we guarantee the performance of JFP to its trading counterparties and various banks and other entities, which provide clearing and credit services to JFP.

Other Guarantees. In the normal course of business we provide guarantees to securities clearinghouses and exchanges. These guarantees generally are required under the standard membership agreements, such that members are required to guarantee the performance of other members. To mitigate these performance risks, the exchanges and clearinghouses often require members to post collateral. Our obligations under such guarantees could exceed the collateral amounts posted; however, the potential for us to be required to make payments under such guarantees is deemed remote. Also, we have guaranteed obligations of Jefferies International Limited (“JIL”) to various banks which provide clearing and credit services to JIL and to counterparties of JIL. Also, we have provided a guarantee to a third-party bank in connection with the bank’s extension of 500 million Japanese yen (approximately $4.2 million) to Jefferies (Japan) Limited.

Note 16. Segment Reporting

We currently report two business segments, Capital Markets and Asset Management. The Capital Markets reportable segment includes our traditional securities brokerage and investment banking activities. The Capital Markets reportable segment is managed as a single operating segment that provides the sales, trading and origination effort for various fixed income, equity and advisory products and services. The Capital Markets segment comprises many divisions, with interactions among each. In addition, we choose to voluntarily disclose the Asset Management segment even though it is currently an “immaterial non-reportable” segment as defined by FASB 131, Disclosures about Segments of an Enterprise and Related Information. The Asset Management segment is primarily comprised of operating activities related to our non-integrated asset management businesses including Clear Lake CLO, Victoria Falls CLO, Summit Lake CLO, Diamond Lake CLO, Jefferies RTS Fund, Jefferies Paragon Fund and the Jefferies Buckeye Fund.

Our reportable business segment information is prepared using the following methodologies:

•

Net revenues and expenses directly associated with each reportable business segment are included in determining earnings before taxes.

•

Net revenues and expenses not directly associated with specific reportable business segments are allocated based on the most relevant measures applicable, including each reportable business segment’s net revenues, headcount and other factors.

•

Reportable business segment assets include an allocation of indirect corporate assets that have been fully allocated to our reportable business segments, generally based on each reportable business segment’s capital utilization.

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Our net revenues, expenses, income before income taxes and total assets by segment are summarized below (amounts in millions):

		Capital				Asset
		Markets				Management				Total
Three months ended March 31, 2007
Net revenues		$	404.2			$	14.6			$	418.8
Expenses			307.2				8.1				315.3
Earnings before income taxes, minority interest and cumulative effect of change in accounting principle		$	97.0			$	6.5			$	103.5
Segment assets		$	25,502.1			$	193.4			$	25,695.5
Three months ended March 31, 2006
Net revenues		$	385.7			$	29.7			$	415.4
Expenses			291.0				27.0				318.0
Earnings before income taxes, minority interest and cumulative effect of change in accounting principle		$	94.7			$	2.7			$	97.4
Segment assets		$	15,881.7			$	63.2			$	15,944.9

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Note 17. Goodwill

The following is a summary of goodwill activity for the year ended March 31, 2007 (in thousands of dollars):

		Three Months Ended
		March 31, 2007
Balance, at December 31, 2006		$	257,321
Add: Contingent consideration			4,080
Balance, at March 31, 2007		$	261,401

The acquisitions of Helix Associates, Randall & Dewey, Bonds Direct Securities LLC, Broadview International LLC and Quarterdeck Investment Partners, LLC all contained a five-year contingency for additional consideration to the selling owners, based on future revenues. This additional consideration is paid in cash annually. There is no contractual dollar limit to the potential of additional consideration. During the quarter ended March 31, 2006, the Bonds Direct contingency for additional consideration was terminated pursuant to the terms of the acquisition agreement. The additional contingent consideration paid for Broadview International LLC, Randall & Dewey and Quarterdeck Investment Partners, LLC mostly represents additional consideration based on operating net revenue.

None of the acquisitions listed above were considered material based on the small percentage they represent of our total assets, equity, revenues and net earnings.

Note 18. Quarterly Dividends

The only restrictions on our present ability to pay dividends on our common stock are the dividend preference terms of our Series A convertible preferred stock and the governing provisions of the Delaware General Corporation Law.

Dividends per Common Share (declared and paid):

		1st Quarter
2007		$	0.125
2006		$	0.075

On April 18, 2006, we declared a 2-for-1 stock split of all outstanding shares of common stock. The stock split was paid May 15, 2006 to stockholders of record as of April 28, 2006 and was effected as a stock dividend of one share of common stock for each one share outstanding on the record date. We also announced an increase to our quarterly dividend to $0.125 per post-split share, which represented a 67% increase from the previous dividend of $0.075 per post split share.

Note 19. Variable Interest Entities (“VIEs”)

Under the provisions of FIN 46(R) we determined that the Jefferies Employees Opportunity Fund (“JEOF”) meets the definition of a VIE. We and our employees (related parties) are the primary beneficiary of JEOF, one of the three high yield funds that we manage. Therefore, we consolidate JEOF.

We also own significant variable interests in Clear Lake CLO, Summit Lake CLO, Victoria Falls CLO and Diamond Lake CLO for which we are not the primary beneficiary and therefore do not consolidate these entities. In aggregate, these variable interest entities have assets approximating $1.4 billion as of March 31, 2007. Our exposure to loss is limited to our capital contributions. The carrying value of our aggregate investment in these variable interest entities is $17.3 million at March 31, 2007 and is included in Investments in managed funds on our Consolidated Statement of Financial Condition.

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Note 20. Related Party Disclosures

High Yield Funds

In January 2000, we created three broker-dealer entities that employ a trading and investment strategy substantially similar to that historically employed by our High Yield division. Although we refer to these three broker-dealer entities as funds, they are registered with the SEC as broker-dealers. Two of these funds, the Jefferies Partners Opportunity Fund and the Jefferies Partners Opportunity Fund II, are principally capitalized with equity contributions from institutional and high net worth investors. The third fund, Jefferies Employees Opportunity Fund (and collectively with the two Jefferies Partners Opportunity Funds, referred to as the “High Yield Funds”), is principally capitalized with equity investments from our employees and is therefore consolidated into our consolidated financial statements. Our senior management (including our Chief Executive Officer, Chief Financial Officer, Chairman, Executive Committee, General Counsel and Controller) and certain of our employees have direct investments in these funds on terms identical to other fund participants. We have an 18% aggregate interest in the funds, senior management has a 3% interest and all employees (exclusive of senior management) have a 5% interest. The High Yield division and each of the funds share gains or losses on trading and investment activities of the High Yield division on the basis of a pre-established sharing arrangement related to the amount of capital each has committed. The sharing arrangement is modified from time to time to reflect changes in the respective amounts of committed capital. As of March 31, 2007, on a combined basis, the High Yield division had in excess of $1,024.8 million of combined pari passu capital available (including unfunded commitments and availability under a revolving credit facility) to deploy and execute the division’s investment and trading strategy. The High Yield Funds are managed by a team led by Richard Handler, our Chief Executive Officer. On January 15, 2007, the manager of the High Yield Funds and a majority of the funds’ member interests elected to extend the funds’ term until January 18, 2008. On April 2, 2007, we formed Jefferies High Yield Trading, LLC (“JHYT”) to conduct the secondary market trading activities previously performed by the High Yield division of Jefferies and our High Yield Funds. The activities of JHYT are overseen by our CEO, and the same long-standing team that was previously responsible for these trading activities. For more information on JHYT, see Note 22 “Subsequent Events”.

Jefferies Capital Partners

In July 2005, we entered into a Share and Membership Interest Purchase Agreement (“Purchase Agreement”) with Brian P. Friedman (one of our directors and an executive officer), 2055 Partners L.P. (an affiliate of Mr. Friedman), James L. Luikart, and the manager and general partner of Jefferies Capital Partners IV L.P. Jefferies Capital Partners IV L.P., together with its related parallel funds (“Fund IV”), is a private equity fund managed by a team led by Messrs. Friedman and Luikart. We agreed to purchase a 49% interest in the manager of Fund IV and an amount, not less than 20% and not more than the percentage allocated to Mr. Friedman, of the carried interest attributed to Fund IV. In addition, we have the right, subject to certain conditions, to receive similar interests from future private equity funds overseen by Mr. Friedman. With the final closing of Fund IV during the second quarter of 2006, we are obligated to issue 1,040,000 shares of common stock (post 2-for-1 stock split) to Mr. Friedman. The shares of common stock to be issued are subject to clawback provisions based upon the size of a subsequent fund as well as certain other conditions.

As of March 31, 2007, our aggregate commitment in Fund IV was approximately $39.4 million. We have also guaranteed certain of the obligations of an employee parallel fund to Fund IV, including a guarantee of up to an aggregate of approximately $36.0 million in third party bank loans committed to such employee fund as of March 31, 2007.

We have guaranteed the obligations of one other private equity fund managed by entities controlled by Mr. Friedman. These obligations may arise under a $20 million credit facility provided by a third party to these funds.

JEFFERIES GROUP, INC. AND SUBSIDIARIES
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