Jefferies Corporation

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K


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

For the fiscal year ended December 31, 2006


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

For the transition period from _______________ to _______________

Commission File Number: 1-14947

JEFFERIES GROUP, INC.

(Exact name of registrant as specified in its charter)


Delaware (State or other jurisdiction of incorporation or organization)		95-4719745 (I.R.S. Employer Identification No.)

520 Madison Avenue, 12^th Floor New York, New York (Address of principal executive offices)		10022 (Zip Code)

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

Securities registered pursuant to Section 12(b) of the Act:


Title of each class:		Name of each exchange on which registered:
Common Stock, $.0001 par value		New York Stock Exchange

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No o

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o No þ

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K, or any amendment to this Form 10-K. þ

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

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. $3,392,154,283 as of June 30, 2006.

Indicate the number of shares outstanding of the registrant’s class of common stock, as of the latest practicable date. 123,745,551 shares as of the close of business February 15, 2007.

DOCUMENTS INCORPORATED BY REFERENCE

Information from the Registrant’s Definitive Proxy Statement with respect to the 2007 Annual Meeting of Stockholders to be held on May 21, 2007 to be filed with the SEC is incorporated by reference into Part III of this Form 10-K.

LOCATION OF EXHIBIT INDEX

The index of exhibits is contained in Part IV herein on page 85.

PART I

Item 1. Business.

Introduction

Jefferies Group, Inc. and its subsidiaries (“we”, “us” or “our”) operate as a full-service global investment bank and institutional securities firm focused on growth and middle-market companies and their investors. We offer these companies capital raising, merger and acquisition, restructuring and other financial advisory services, and provide investors fundamental research and trade execution in equity, equity-linked, high yield and investment grade fixed income securities, as well as commodities and derivatives. We also provide asset management services and products to institutions and other investors.

Our principal operating subsidiary, Jefferies & Company, Inc. (“Jefferies”), was founded in 1962. Since 2000, we have pursued a strategy of continuing growth and diversification, whereby we have sought to increase our market share in each of the markets we serve and the products and services we offer, while at the same time expanding the breadth of our activities in an effort to mitigate the cyclical nature of the financial markets in which we operate. Our growth plan has been achieved through internal growth supported by the ongoing addition of experienced personnel in targeted areas, as well as the acquisition from time to time of complementary businesses. More recently, we have increased our global focus on serving companies and investors in Europe, the Middle East, Latin America and Asia.

As of December 31, 2006, we had 2,254 employees. We maintain offices throughout the world and have our executive offices located at 520 Madison Avenue, New York, New York 10022. Our telephone number is (212) 284-2550 and our Internet address is www.jefferies.com.

We make available free of charge on our Internet website the following documents and reports, including amendments (the reports are made available as soon as reasonably practicable after such materials are filed with or furnished to the SEC pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934):

	•		Code of Ethics;

	•		Reportable waivers, if any, from our Code of Ethics by our executive officers;

	•		Board of Directors Corporate Governance Guidelines;

	•		Charter of the Audit Committee of the Board of Directors;

	•		Charter of the Corporate Governance and Nominating Committee of the Board of Directors;

	•		Charter of the Compensation Committee of the Board of Directors;

	•		Annual reports on Form 10-K;

	•		Quarterly reports on Form 10-Q;

	•		Current reports on Form 8-K; and

	•		Beneficial ownership reports on Forms 3, 4 and 5.

Shareholders may also obtain free of charge a printed copy of any of these documents or reports by sending a request to Investor Relations, Jefferies & Company, Inc., 520 Madison Avenue, 12th Floor, New York, NY 10022, by calling 203-708-5975 or by sending an email to info@jefferies.com.

Business Segments

We currently operate in two business segments, Capital Markets and Asset Management. Our Capital Markets reportable segment includes our traditional securities and investment banking activities. The Capital Markets reportable segment is managed as a single operating segment that provides the research, sales, trading and investment banking effort for various fixed income, equity and advisory products and services. The Capital Markets segment comprises many divisions, with extensive interactions among each. In addition, we voluntarily choose to disclose our 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 asset management businesses including Victoria Falls CLO, Summit Lake CLO, Diamond Lake CLO, Jefferies RTS Fund, Jefferies Paragon Fund and Jefferies Buckeye Fund. This segment does not include activity associated with our high yield or international asset management as they are managed by the respective desk managers and included as an integrated component of the Capital Markets reportable segment.

Financial information regarding our reportable business segments as of December 31, 2006, December 31, 2005, and December 31, 2004 is set forth in note 18 of the Notes to Consolidated Financial Statements, titled “Segment Reporting” and is incorporated herein by reference.

Jefferies Businesses

Capital Markets

Our Capital Markets activity includes our securities execution activities, including sales, trading and research in equity, equity derivatives, convertible, high yield and investment grade fixed income securities, and prime brokerage, and our investment banking activities which include capital market transactions, mergers and acquisitions and other advisory transactions. In addition, our Capital Markets activities include securities lending and commodity-related trading. We are primarily focused on serving corporations and institutional investors.

Investment Banking

Our Investment Banking Division offers our clients, primarily growing and mid-sized companies, a full range of financial advisory services, as well as debt, equity, and convertible capital raising services.

Underwriting

Equity and Equity-Linked Financing — We offer expertise in direct placements, private equity, private placements, initial public offerings, and follow-on offerings of equity and equity-linked convertible securities.

Leveraged Finance — We offer a full range of debt financing for growing and middle market companies and sponsors. We focus on structuring and distributing public and private debt in leveraged finance transactions, including leveraged buy-outs, acquisitions, growth capital financings, recapitalizations, and Chapter 11 exit financings. We specialize in high yield debt, fixed- and floating-rate senior and subordinated debt. Our joint venture loan finance company, Jefferies Finance, has the ability to commit capital for transactions that range between $50 million and $500 million.

Advisory Services

Mergers & Acquisitions — We advise buyers and sellers on sales, divestitures, acquisitions, mergers, tender offers, joint ventures, strategic alliances and takeover defenses. With extensive experience facilitating and financing acquisitions and recapitalizations, we execute both buy-side and sell-side mandates. We provide dedicated senior banker focus to clients throughout the merger and acquisition (“M&A”) process, which leverages our industry knowledge, extensive relationships, and capital markets and restructuring expertise.

Restructuring & Recapitalization - We specialize in exchange offers, consent solicitations, capital raising, recapitalization, restructuring and distressed M&A activity. We provide advice and support in the structuring, valuation and placement of securities issued in recapitalizations and restructurings. We represent issuers, bondholders and creditors, as well as buyers and sellers of assets.

Fund Placement - Helix Associates, our fund placement group, is a leading placement agent serving private equity fund sponsors and sophisticated investors throughout North America, Europe, the Middle East, Japan and Australia.

Our over 430 investment banking professionals operate throughout the United States, Europe and Asia, and are organized into industry, product and geographic coverage groups in order to maximize our extensive network of relationships and deep product and industry knowledge in particular areas. Industry coverage groups include Jefferies Quarterdeck for Aerospace and Defense, CleanTech, Jefferies Randall & Dewey for Energy, Financial & Business Services, Gaming and Leisure, Healthcare, Industrial, Media & Communications, Private Equity and Venture Capital Sponsors, Retail & Consumer, Jefferies Broadview for Technology, and Transportation, Oil Service & Infrastructure. The division has experienced substantial growth over the last five years both organically and through acquisitions.

Equities

Our Equities Division consists of equity research, sales and trading, electronic execution services, equity derivatives, securities lending and prime brokerage.

Equity Sales and Trading

Our equity research, sales and trading unit is one of the primary foundations of our platform. We have an over forty-year history in equity trading and one of the largest, most experienced institutional sales forces on Wall Street, providing a major source of liquidity for institutional investors. Our equity sales representatives connect a network of more than 2,000 institutional investors around the globe and excel at providing seamless execution with a focus on minimal market impact. We specialize in listed block trades, NASDAQ market making, bulletin board trading, capital markets/origination, risk arbitrage, statistical arbitrage, special situations, pair trades, relative value, and portfolio and electronic trading, as well as American Depository Receipts and Ordinary Shares. We consistently rank highly versus our peers as a trader of equity securities and are often the number one trader of the stocks in which we make a market.

Our clients include domestic and international investors such as investment advisors, banks, mutual funds, insurance companies, hedge funds, and pension and profit sharing plans. These investors normally purchase and sell securities in block transactions, the execution of which requires focused marketing and trading expertise. We are one of the leading firms in the execution of equity block transactions and believe that our institutional customers are attracted by the quality of our execution (measured by volume, timing and price) and our competitive commission rates, which are negotiated on the basis of market conditions, the size of the particular transaction and other factors. We have a small, but growing Private Client Services group that focuses on serving smaller institutions, family offices and high net worth individuals.

Execution

Through our Jefferies Execution subsidiary, we provide agency-only execution services for stocks and options listed on the NYSE, AMEX, and all other major exchanges, as well as OTC. In 2006, the firm traded over 25 billion shares utilizing its execution platform which includes floor brokerage, electronic connectivity, direct access and listed options trading. Jefferies Execution is one of the largest execution services providers on the New York Stock Exchange. In addition, we offer a suite of quantitative and algorithmic trading solutions as well as access to liquidity in order to access the global markets. We leverage our portfolio management systems, analysis and benchmark auto-trading strategies to deliver our execution services to our institutional customers.

Research

Encompassed within equity sales and trading is research and research sales. We have built and expanded our research platform over the last ten years and now employ over 130 equity and convertible research professionals covering over 950 companies worldwide, and nearly 70 dedicated equity research sales professionals. We provide long- and short-term investment ideas, utilizing the latest technologies to deliver a product that is differentiated and tailored to customers. Our analysts use a variety of quantitative and qualitative tools, integrating field analysis, proprietary channel checks and ongoing dialogue with the managements of the companies they cover.

Equity Derivatives

We offer equity derivatives for investors seeking to manage risk and optimize returns within the equities market. Our experienced professionals have deep expertise in listed and over-the-counter transactions and products. We focus on serving the diverse needs of our institutional, corporate and private client base across multiple product lines, offering listed options, ETFs and OTC options and swaps.

Securities Lending

In connection with both our 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. In addition, we have an active matched book business whereby we borrow securities from one party and lend them to another party. When we borrow securities, we provide cash to the lender as collateral, which is reflected in our financial statements as receivable from brokers and dealers. 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 financial statements as payable to brokers and dealers. We incur 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 our matched book activities. 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. In 2006, we expanded our securities lending focus internationally, with additional professionals in London and New York.

Prime Brokerage

We offer prime brokerage services to hedge funds, money managers, and registered investment advisors. Our clients receive an integrated, one-firm, service-based approach by receiving securities lending, competitive financing and technology support and access to our research and capital markets platform. In 2006, we enhanced our prime brokerage unit and expanded our overall commitment to being a significant provider of prime brokerage services.

Fixed Income and Commodities

Our Fixed Income and Commodities division consists of our high yield department, convertibles department, investment grade fixed income department, research and our commodity trading group.

High Yield

We are a recognized leader in high yield trading and financing, with a team of more than 50 professionals encompassing integrated sales, trading, research and capital markets capabilities in the U.S. and London. We are a top trader in the secondary high yield and distressed markets, trading in more than 1,500 cusip / issues with over 600 institutions globally in 2006. Our high yield professionals have long term relationships with institutional high yield, distressed, and levered debt investor bases with focus on secondary trading and new issues.

In January 2000, we created three broker-dealer entities that employ a trading and investment strategy substantially similar to that historically employed by the Jefferies High Yield division. Although we often 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 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 and Chief Financial Officer) and certain of our employees have direct investments in these funds on terms identical to other fund participants. We have a 18% aggregate interest in these 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 December 31, 2006, 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 the fund revolving credit facility) to deploy and execute the division’s investment and trading strategy. The High Yield Funds are managed by Richard Handler, our Chief Executive Officer.

On January 15, 2007, the manager of the Funds along with a majority of the Funds’ member interests elected to extend the term of the High Yield Funds until January 18, 2008; thereafter, the High Yield Funds can be further extended for up to two successive one-year terms subject to approval by a majority of the member interests and the manager. We anticipate that we may establish a successor entity to these Funds during 2007. Additional information is set forth in note 25 of the Notes to Consolidated Financial Statements, titled “Subsequent Events.”

Convertibles

We commit dedicated personnel in the U.S., London, Tokyo, and Zurich to serve the geographically diverse global convertible markets. We offer expertise in the sales, trading and analysis of U.S. domestic and international convertible bonds, convertible preferred shares, closed-end funds, warrants and structured products, with a focus on minimizing transaction costs and maximizing liquidity. Globally, we trade in more than 750 issues and maintain active relationships with more than 450 institutional and corporate clients.

Investment Grade Fixed Income

We provide fixed income transaction execution for institutions acting as principal, through a combination of professional sales and trading coverage, and a technology platform that enables true on-line real-time trading. The division has more than 80 professionals who are active traders of corporate bonds, U.S. government agency securities, mortgage-backed securities, municipal bonds and emerging markets debt. We serve more than 2,000 mid-sized institutional clients and trade in more than 3,800 individual issues.

Research

We have expanded our research platform over the last few years and have over 15 fixed income research professionals covering over 380 companies worldwide and have 11 dedicated fixed income sales professionals. Our fixed income research supports our investment banking and sales and trading activities. We provide long- and short-term investment ideas, utilizing the latest technologies to deliver a product that is differentiated and tailored to each customer. Our analysts use a variety of quantitative and qualitative tools, integrating field analysis, proprietary channel checks and ongoing dialogue with the managements of the companies they cover.

Commodities

Our commodities group, Jefferies Financial Products, LLC (“JFP”), offers swaps, options and other derivatives typically linked to various commodity indexes and is a significant provider of liquidity in exchange-traded commodity index contracts. JFP’s team of experienced professionals provide innovative financial products and commodity index expertise to pension funds, mutual funds, sovereigns, foundations, endowments and other institutional investors seeking exposure to commodities as an asset class. In 2005, JFP worked with Reuters to modify the benchmark CRB Index, now renamed the Reuters Jefferies CRB Index. In addition, JFP offers proprietary commodity indexes, such as the Jefferies Commodity Performance Index, which are designed to outperform standard benchmark indexes.

Asset Management

We provide investment management services and products to various private investment funds through Jefferies Asset Management (“JAM”). JAM is registered as an investment adviser with the SEC. Our private fund products consist of long-short equity funds that focus on specific strategies.

Our Asset Management business is primarily comprised of operating activities related to our private investment funds including Victoria Falls CLO, Summit Lake CLO, Diamond Lake CLO, Jefferies RTS Fund, Jefferies Paragon Fund and Jefferies Buckeye Fund.

In Europe, we offer investment solutions for long-only strategies in global convertible bonds to pension funds, insurance companies and private banking clients in Switzerland, France and Germany. These funds are not registered under federal or state securities laws, are made available only to certain sophisticated investors and are not offered or sold to the general public.

Our Sources of Revenues

Commissions

A substantial portion of our revenues is derived from customer commissions and commission equivalents. We charge fees for assisting our domestic and international clients with purchasing and selling equity, debt and convertible securities as well as ADRs, options, preferred stocks, financial futures and other similar products.

Principal Transactions

In the regular course of our business, we take securities positions as a market maker to facilitate customer transactions and for proprietary risk trading. Trading profits or losses and changes in market prices of our proprietary investments are also recorded as principal transaction revenues.

Investment Banking

Investment banking revenues are generated by fees from capital markets activities which include debt, equity, and convertible underwriting and placement services and fees from financial advisory activities including M&A and restructuring services.

Interest

We derive a substantial portion of our interest revenues in connection with our securities borrowed / securities lending activity. We also earn interest on our securities portfolio, on our operating and segregated balances, on our margin lending activity and on certain of our investments, including our investment in short-term bond funds.

Competition

As a global investment bank and securities firm, all aspects of our business are intensely competitive. We compete directly with numerous domestic and international competitors, including firms included on the AMEX Securities Broker/Dealer Index and with other brokers and dealers, investment banking firms, investment advisors, mutual funds, hedge funds and commercial banks. Many of our competitors have substantially greater capital and resources than we do and offer a broader range of financial products. In addition to competition from firms currently in the securities business, there has been increasing competition from others offering financial services. These developments and others have resulted, and may continue to result, in significant additional competition for us. We believe that the principal factors affecting competition involve market focus, reputation, the abilities of professional personnel, the relative price of the service and products being offered and the quality of service.

Regulation

The securities industry in the United States is subject to extensive regulation under both federal and state laws. The Securities and Exchange Commission is the federal agency responsible for the administration of federal securities laws. In addition, self-regulatory organizations, principally NASD and the securities exchanges, are actively involved in the regulation of broker-dealers. These self-regulatory organizations conduct periodic examinations of member broker-dealers in accordance with rules they have adopted and amended from time to time, subject to approval by the SEC. Securities firms are also subject to regulation by foreign regulatory bodies, state securities commissions and state attorneys general in those jurisdictions and states in which they do business.

Broker-dealers are subject to regulations which cover all aspects of the securities business, including sales methods, trade practices among broker-dealers, use and safekeeping of customers’ funds and securities, capital structure of securities firms, anti-money laundering, record-keeping and the conduct of directors, officers and employees. Additional legislation, changes in rules promulgated by the SEC and self-regulatory organizations, or changes in the interpretation or enforcement of existing laws and rules, may directly affect the mode of operation and profitability of broker-dealers. Broker-dealers that engage in commodities and futures transactions are also subject to regulation by the Commodity Futures Trading Commission (“CFTC”) and the National Futures Association (“NFA”). The SEC, self-regulatory organizations, state securities commissions, state attorneys general, the CFTC and the NFA may conduct administrative proceedings which can result in censure, fine, suspension, expulsion of a broker-dealer, its officers or employees, or revocation of broker-dealer licenses. The principal purpose of regulation and discipline of broker-dealers is the protection of customers and the securities markets, rather than protection of creditors and stockholders of broker-dealers.

As registered broker-dealers, Jefferies and Jefferies Execution are required by law to belong to the Securities Investor Protection Corporation (“SIPC”). In the event of a member’s insolvency, the SIPC fund provides protection for customer accounts up to $500,000 per customer, with a limitation of $100,000 on claims for cash balances. We carry an excess policy that provides additional protection for securities of up to $24.5 million per customer with an aggregate limit of $100 million.

Net Capital Requirements. U.S. registered broker-dealers doing business with the public are subject to the SEC’s Uniform Net Capital Rule (the “Rule”), which specifies minimum net capital requirements. Jefferies Group, Inc. is not a registered broker-dealer and is therefore not subject to the Rule; however, its United States broker-dealer subsidiaries are registered and are subject to the Rule.

The Rule provides that a broker-dealer doing business with the public shall not permit its aggregate indebtedness to exceed 15 times its adjusted net capital (the “basic method”) or, alternatively, that it not permit its adjusted net capital to be less than 2% of its aggregate debit balances (primarily receivables from customers and broker-dealers) computed in accordance with such Rule (the “alternative method”). Jefferies and Jefferies Execution use the alternative method of calculation.

Compliance with applicable net capital rules could limit operations of Jefferies, such as underwriting and trading activities, that require the use of significant amounts of capital, and may also restrict loans, advances, dividends and other payments by Jefferies or Jefferies Execution to us.

As of December 31, 2006, Jefferies’, and Jefferies Execution’s net capital and excess net capital were as follows (in thousands of dollars):


	Net Capital		Excess Net Capital
Jefferies	$	191,830	$	174,597
Jefferies Execution		21,477		21,227

NYSE Regulations. Our common stock is listed on the New York Stock Exchange. As a listed company, we are required to comply with the NYSE’s rules and regulations, including rules pertaining to corporate governance matters. As required by the NYSE on an annual basis, in 2006 our Chief Executive Officer, Richard Handler, certified to the NYSE that he was not aware of any violation by us of the NYSE’s corporate governance listing standards.

Regulation Outside the United States. We are an active participant in the international fixed income and equity markets. Many of our principal subsidiaries that participate in these markets are subject to comprehensive regulations in the United States and elsewhere that include some form of capital adequacy rules and other customer protection rules. We provide investment services in and from the United Kingdom under the regulation of the Financial Services Authority.

Business Risks

As a global investment bank and securities firm, risk is an inherent part of our businesses. Capital markets, by their nature, are prone to uncertainty and subject participants to a variety of risks. We have developed policies and procedures designed to identify, measure and monitor each of the risks involved in our trading, brokerage and investment banking activities on a global basis. Our principal risks are market, credit, operational, legal and compliance and new business risks. Risk management is considered to be of paramount importance to our day-to-day operations. Consequently, we devote significant resources (including investments in personnel and technology) to the measurement, analysis and management of risk.

We seek to reduce risk through the diversification of our businesses, counterparties and activities. We accomplish this objective by monitoring the usage of capital to each of our businesses, establishing trading limits and setting credit limits for individual counterparties. We seek to achieve adequate returns from each of our businesses commensurate with the risks assumed. Nonetheless, the effectiveness of our policies and procedures for managing risk exposure can never be completely or accurately predicted or fully assured. For example, unexpectedly large or rapid movements or disruptions in one or more markets or other unforeseen developments can have an adverse effect on our results of operations and financial condition. The consequences of these developments can include losses due to adverse changes in inventory values, decreases in the liquidity of trading positions, higher volatility in our earnings, increases in our credit exposure to customers and counterparties and increases in general systemic risk. If any of our strategies used to hedge or otherwise mitigate exposures to the various types of risks described above are not effective, we could incur losses. Additionally, business continuity plans have been developed and are periodically tested for critical processes and systems, and controls have been implemented to provide oversight of the activities.

Margin Risk

Customers’ transactions are executed on either a cash or margin basis. In a margin transaction, we extend credit to the customer, collateralized by securities and cash in the customer’s account, for a portion of the purchase price, and receive income from interest charged on such extensions of credit. In permitting a customer to purchase securities on margin, we are subject to the risk that a market decline could reduce the value of its collateral below the amount of the customer’s indebtedness and that the customer might otherwise be unable to repay the indebtedness.

In addition to monitoring the creditworthiness of our customers, we also consider the trading liquidity and volatility of the securities we accept as collateral for margin loans. Trading liquidity and volatility may be dependent, in part, upon the market in which the security is traded, the number of outstanding shares of the issuer, events affecting the issuer and/or securities markets in general, and whether or not there are any legal restrictions on the sale of the securities. Certain types of securities have historical trading patterns, which may assist us in making this evaluation. Historical trading patterns, however, may not be good indicators over relatively short time periods or in markets which are affected by unusual or unexpected developments. We consider all of these factors at the time we agree to extend credit to customers and continue to review extensions of credit on an ongoing basis.

The majority of our margin loans are made to United States citizens or to corporations which are domiciled in the United States. We may extend credit to investors or corporations who are citizens of foreign countries or who may reside outside the United States. We believe that should such foreign investors default upon their loans and should the collateral for those loans be insufficient to satisfy the investors’ obligations, it may be more difficult to collect such investors’ outstanding indebtedness than would be the case if investors were citizens or residents of the United States.

Although we attempt to minimize the risk associated with the extension of credit in margin accounts, there is no assurance that the assumptions on which we base our decisions will be correct or that we are in a position to predict factors or events which will have an adverse impact on any individual customer or issuer, or the securities markets in general.

Underwriting Risk

Investment banking activity involves both economic and regulatory risks. An underwriter may incur losses if it is unable to sell the securities it is committed to purchase or if it is forced to liquidate its commitments at less than the agreed upon purchase price. In addition, under the federal securities laws and other laws and court decisions with respect to underwriters’ liability and limitations on indemnification of underwriters by issuers, an underwriter is subject to substantial potential liability for material misstatements or omissions in prospectuses and other communications with respect to underwritten offerings. Further, underwriting commitments constitute a charge against net capital and our underwriting commitments may be limited by the requirement that our broker-dealers must, at all times, be in compliance with the Uniform Net Capital Rule 15c3-1 of the Securities Exchange Act of 1934. We intend to continue to pursue opportunities for our corporate customers, which may require us to finance and/or underwrite the issuance of securities. Under circumstances where we are required to act as an underwriter or to take a position in the securities of our customers, we may assume greater risk than would normally be assumed in our normal trading activity.

Item 1A. Risk Factors

Factors Affecting Our Business

The following factors describe some of the assumptions, risks, uncertainties and other factors that could adversely affect our business or that could otherwise result in changes that differ materially from our expectations. In addition to the factors mentioned in this report, we are also affected by changes in general economic and business conditions, acts of war, terrorism and natural disasters.

Changing conditions in financial markets and the economy could result in decreased revenues.

As an investment banking and securities firm, changes in the financial markets or economic conditions in the United States and elsewhere in the world could adversely affect our business in many ways, including the following:

•		A market downturn could lead to a decline in the volume of transactions executed for customers and, therefore, to a decline in the revenues we receive from commissions and spreads.

•		Unfavorable financial or economic conditions could likely reduce the number and size of transactions in which we provide underwriting, financial advisory and other services. Our investment banking revenues, in the form of financial advisory and underwriting or placement fees, are directly related to the number and size of the transactions in which we participate and could therefore be adversely affected by unfavorable financial or economic conditions.

•		Adverse changes in the market could lead to a reduction in revenues from principal transactions and commissions.

•		Adverse changes in the market could also lead to a reduction in revenues from asset management fees and investment income from managed funds and losses from managed funds. Continued increases in our asset management business, especially increases in the amount of our investments in managed funds, would make us more susceptible to adverse changes in the market.

Our principal trading and investments expose us to risk of loss.

A significant portion of our revenues is derived from trading in which we act as principal. Although a significant portion of our principal trading is “riskless principal” in nature, we may incur trading losses relating to the purchase, sale or short sale of high yield, international, convertible, and equity securities and futures and commodities for our own account and from other program or principal trading. Additionally, we have made substantial investments of our capital in debt securities, equity securities and commodities, including investments managed by us and investments managed by third parties. In any period, we may experience losses as a result of price declines, lack of trading volume, and illiquidity. From time to time, we may engage in a large block trade in a single security or maintain large position concentrations in a single security, securities of a single issuer, or securities of issuers engaged in a specific industry. In general, because our inventory is marked to market on a daily basis, any downward price movement in these securities could result in a reduction of our revenues and profits. In addition, we may engage in hedging transactions that if not successful, could result in losses.

Increased competition may adversely affect our revenues and profitability.

All aspects of our business are intensely competitive. We compete directly with numerous other brokers and dealers, investment banking firms and banks. In addition to competition from firms currently in the securities business, there has been increasing competition from others offering financial services, including automated trading and other services based on technological innovations. We believe that the principal factors affecting competition involve market focus, reputation, the abilities of professional personnel, the ability to execute the transaction, relative price of the service and products being offered and the quality of service. Increased competition or an adverse change in our competitive position could lead to a reduction of business and therefore a reduction of revenues and profits. Competition also extends to the hiring and retention of highly skilled employees. A competitor may be successful in hiring away an employee or group of employees, which may result in our losing business formerly serviced by such employee or employees. Competition can also raise our costs of hiring and retaining the key employees we need to effectively execute our business plan.

Operational risks may disrupt our business, result in regulatory action against us or limit our growth.

Our businesses are highly dependent on our ability to process, on a daily basis, a large number of transactions across numerous and diverse markets in many currencies, and the transactions we process have become increasingly complex. If any of our financial, accounting or other data processing systems do not operate properly or are disabled or if there are other shortcomings or failures in our internal processes, people or systems, we could suffer an impairment to our liquidity, financial loss, a disruption of our businesses, liability to clients, regulatory intervention or reputational damage. These systems may fail to operate properly or become disabled as a result of events that are wholly or partially beyond our control, including a disruption of electrical or communications services or our inability to occupy one or more of our buildings. The inability of our systems to accommodate an increasing volume of transactions could also constrain our ability to expand our businesses.

We also face the risk of operational failure or termination of any of the clearing agents, exchanges, clearing houses or other financial intermediaries we use to facilitate our securities transactions. Any such failure or termination could adversely affect our ability to effect transactions and manage our exposure to risk.

In addition, despite the contingency plans we have in place, our ability to conduct business may be adversely impacted by a disruption in the infrastructure that supports our businesses and the communities in which they are located. This may include a disruption involving electrical, communications, transportation or other services used by us or third parties with which we conduct business.

Our operations rely on the secure processing, storage and transmission of confidential and other information in our computer systems and networks. Although we take protective measures and endeavor to modify them as circumstances warrant, our computer systems, software and networks may be vulnerable to unauthorized access, computer viruses or other malicious code, and other events that could have a security impact. If one or more of such events occur, this potentially could jeopardize our or our clients’ or counterparties’ confidential and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our, our clients’, our counterparties’ or third parties’ operations. We may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to litigation and financial losses that are either not insured against or not fully covered through any insurance maintained by us.

Asset management revenue is subject to variability based on market and economic factors and the amount of assets under management.

Asset management revenue includes revenues we receive from management, administrative and performance fees from funds managed by us, revenues from asset management and performance fees we receive from third-party managed funds, and investment income from our investments in these funds. These revenues are dependent upon the amount of assets under management and the performance of the funds. If these funds do not perform as well as our asset management clients expect, our clients may withdraw their assets from these funds, which would reduce our revenues. Some of our revenues from management, administrative and performance fees are derived from our own investments in these funds. We experience significant fluctuations in our quarterly operating results due to the nature of our asset management business and therefore may fail to meet revenue expectations.

We face numerous risks and uncertainties as we expand our business.

We expect the growth of our business to come primarily from internal expansion and through acquisitions and strategic partnering. As we expand our business, there can be no assurance that our financial controls, the level and knowledge of our personnel, our operational abilities, our legal and compliance controls and our other corporate support systems will be adequate to manage our business and our growth. The ineffectiveness of any of these controls or systems could adversely affect our business and prospects. In addition, as we acquire new businesses, we face numerous risks and uncertainties integrating their controls and systems into ours, including financial controls, accounting and data processing systems, management controls and other operations. A failure to integrate these systems and controls, and even an inefficient integration of these systems and controls, could adversely affect our business and prospects.

Our business depends on our ability to maintain adequate levels of personnel.

We have made substantial increases in personnel. If a significant number of our key personnel leave, or if our business volume increases significantly over current volume, we could be compelled to hire additional personnel. At that time, there could be a shortage of qualified and, in some cases, licensed personnel whom we could hire. This could hinder our ability to expand or cause a backlog in our ability to conduct our business, including the handling of investment banking transactions and the processing of brokerage orders, all of which could harm our business, financial condition and operating results.

Extensive regulation of our business limits our activities, and, if we violate these regulations, we may be subject to significant penalties.

The securities industry in the United States is subject to extensive regulation under both federal and state laws. The SEC is the federal agency responsible for the administration of federal securities laws. In addition, self-regulatory organizations, principally NASD and the securities exchanges, are actively involved in the regulation of broker-dealers. Securities firms are also subject to regulation by regulatory bodies, state securities commissions and state attorneys general in those foreign jurisdictions and states in which they do business. Broker-dealers are subject to regulations which cover all aspects of the securities business, including sales methods, trade practices among broker-dealers, use and safekeeping of customers’ funds and securities, capital structure of securities firms, anti-money laundering, record-keeping and the conduct of directors, officers and employees. Broker-dealers that engage in commodities and futures transactions are also subject to regulation by the CFTC and the NFA. The SEC, self-regulatory organizations, state securities commissions, state attorneys general, the CFTC and the NFA may conduct administrative proceedings which can result in censure, fine, suspension, expulsion of a broker-dealer or its officers or employees, or revocation of broker-dealer licenses. Additional legislation, changes in rules or changes in the interpretation or enforcement of existing laws and rules, may directly affect our mode of operation and our profitability. Continued efforts by market regulators to increase transparency and reduce the transaction costs for investors, such as decimalization and NASD’s Trade Reporting and Compliance Engine, or TRACE, has affected and could continue to affect our trading revenue.

Our business is substantially dependent on our Chief Executive Officer.

Our future success depends to a significant degree on the skills, experience and efforts of Richard Handler, our Chief Executive Officer. We do not have an employment agreement with Mr. Handler which provides for his continued employment. The loss of his services could compromise our ability to effectively operate our business. In addition, in the event that Mr. Handler ceases to actively manage the three funds that invest on a pari passu basis with our High Yield Division, investors in those funds would have the right to withdraw from the funds. Although we have substantial key man life insurance covering Mr. Handler, the proceeds from the policy may not be sufficient to offset any loss in business.

Legal liability may harm our business.

Many aspects of our business involve substantial risks of liability, and in the normal course of business, we have been named as a defendant or co-defendant in lawsuits involving primarily claims for damages. The risks associated with potential legal liabilities often may be difficult to assess or quantify and their existence and magnitude often remain unknown for substantial periods of time. Private Client Services involves an aspect of the business that has historically had more risk of litigation than our institutional business. Additionally, the expansion of our business, including increases in the number and size of investment banking transactions and our expansion into new areas, imposes greater risks of liability. In addition, unauthorized or illegal acts of our employees could result in substantial liability to us. Substantial legal liability could have a material adverse financial effect or cause us significant reputational harm, which in turn could seriously harm our business and our prospects.

Our business is subject to significant credit risk.

In the normal course of our businesses, we are involved in the execution, settlement and financing of various customer and principal securities and commodities transactions. These activities are transacted on a cash, margin or delivery-versus-payment basis and are subject to the risk of counterparty or customer nonperformance. Although transactions are generally collateralized by the underlying security or other securities, we still face the risks associated with changes in the market value of the collateral through settlement date or during the time when margin is extended. We may also incur credit risk in our derivative transactions to the extent such transactions result in uncollateralized credit exposure to our counterparties. We seek to control the risk associated with these transactions by establishing and monitoring credit limits and by monitoring collateral and transaction levels daily. We may require counterparties to deposit additional collateral or return collateral pledged. In the case of aged securities failed to receive, we may, under industry regulations, purchase the underlying securities in the market and seek reimbursement for any losses from the counterparty.

Item 1B. Unresolved Staff Comments.

None.

Item 2. Properties.

We maintain offices throughout the world including New York, Atlanta, Boston, Calgary, Chicago, Dallas, Dubai, Houston, Jersey City, London, Los Angeles, Nashville, Richmond, Silicon Valley, Paris, San Francisco, Short Hills, Singapore, Shanghai, Stamford, Tokyo, Washington, D.C. and Zurich. In addition, we maintain back-up facilities with redundant technologies in Dallas. We lease all of our office space which management believes is adequate for our business. For information concerning leasehold improvements and rental expense, see notes 1, 6 and 13 of the Notes to Consolidated Financial Statements.

Item 3. Legal Proceedings.

Many aspects of our business involve substantial risks of legal liability. In the normal course of business, we have been named as defendants or co-defendants in lawsuits involving primarily claims for damages. We are also involved in a number of judicial and regulatory matters arising out of the conduct of our business. Our management, based on currently available information, does not believe that any matter will have a material adverse effect on our financial condition, although, depending on our results for a particular period, an adverse determination could be material for a particular period.

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

None.

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Our common stock trades on the NYSE under the symbol JEF. 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 has been restated to retroactively reflect the effect of the two-for-one stock split.

The following table sets forth for the periods indicated the range of high and low sales prices per share of our common stock as reported by the NYSE.


	High		Low
2006
Fourth Quarter	$	31.76	$	26.41
Third Quarter		30.50		21.45
Second Quarter		34.80		24.73
First Quarter		29.58		22.38

2005
Fourth Quarter	$	23.94	$	19.30
Third Quarter		21.78		18.57
Second Quarter		19.50		16.78
First Quarter		20.38		18.13

There were approximately 750 holders of record of our common stock at February 12, 2007.

In 1988, we instituted a policy of paying regular quarterly cash dividends. There are no restrictions on our present ability to pay dividends on our common stock, other than the applicable provisions of the Delaware General Corporation Law.

During the first quarter of 2005, we announced a 20% increase in our quarterly dividend to $0.06 per share and then in the fourth quarter of 2005, we announced an additional 25% increase in our quarterly dividend to $0.075 per share. In the second quarter of 2006, we announced a 67% increase in our quarterly dividend to $0.125 per share.

Dividends per share of common stock (declared and paid):


	First		Second		Third		Fourth
	Quarter		Quarter		Quarter		Quarter
2006	$	.075	$	.125	$	.125	$	.125
2005	$	.060	$	.060	$	.060	$	.075

Issuer Purchases of Equity Securities


					(c) Total Number of		(d) Maximum Number
	(a) Total		(b)		Shares Purchased as		of Shares that May
	Number of		Average		Part of Publicly		Yet Be Purchased
	Shares		Price Paid		Announced Plans or		Under the Plans or
Period	Purchased (1)		per Share		Programs (2)		Programs
October 1 — October 31, 2006		11,127		29.97		10,000		5,939,000
November 1 — November 30, 2006		68,421		29.57		—		5,939,000
December 1 — December 31, 2006		168,075		29.61		—		5,939,000

Total		247,623		29.62		10,000		5,939,000

(1) We repurchased an aggregate of 237,623 shares during the fourth quarter other than as part of a publicly announced plan or program. We repurchased these securities in connection with our equity compensation plans which allow participants to use shares to pay the exercise price of options exercised and to use shares to satisfy tax liabilities arising from the exercise of options or the vesting of restricted stock. This number does not include unvested shares forfeited back to us pursuant to the terms of our equity compensation plans.

(2) On July 26, 2005, we issued a press release announcing the authorization by our Board of Directors to repurchase, from time to time, up to an aggregate of 3,000,000 shares of our common stock. After giving effect to the 2-for-1 stock split effected as a stock dividend on May 15, 2006, this authorization increased to 6,000,000 shares.

Shareholder Return Performance Presentation

Set forth below is a line graph comparing the yearly change in the cumulative total shareholder return on our common stock against the cumulative total return of the Standard & Poor’s 500, and the Financial Service Analytics Brokerage (“FSA Composite”) Indices for the period of five fiscal years, commencing January 1, 2002 (based on prices at December 31, 2001), and ending December 31, 2006.


	2001		2002		2003		2004		2005		2006
Jefferies Group Inc.		100		136		136		215		264		298
FSA Composite		100		78		115		128		155		203
S&P500		100		78		100		111		117		135

Normalized so that the value of our common stock and each index was $100 on December 31, 2001.

Item 6. Selected Financial Data.

The selected data presented below as of and for each of the years in the five-year period ended December 31, 2006, are derived from the consolidated financial statements of Jefferies Group, Inc. and its subsidiaries, which financial statements have been audited by KPMG LLP, our independent registered public accounting firm. The data should be read in connection with the consolidated financial statements including the related notes contained on pages 48 through 83. On July 14, 2003, we declared a 2-for-1 split of all outstanding shares of common stock, payable August 15, 2003 to stockholders of record as of July 31, 2003. On April 18, 2006, we declared a 2-for-1 split of all outstanding shares of common stock, payable May 15, 2006 to stockholders of record as of April 28, 2006. The stock splits were 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 has been restated to retroactively reflect the effect of the two-for-one stock splits. Certain reclassifications have been made to the prior period amounts to conform to the current period’s presentation.


	Year Ended December 31,
	2006		2005		2004		2003		2002
			(In Thousands, Except Per Share Amounts)
Earnings Statement Data
Revenues:
Commissions	$	280,681	$	246,943	$	258,838	$	250,191	$	268,984
Principal transactions		468,002		349,489		358,213		301,299		227,664
Investment banking		540,596		495,014		352,804		229,608		139,828
Asset management fees and investment income from managed funds		109,550		82,052		81,184		32,769		19,643
Interest		528,882		304,053		134,450		102,403		92,027
Other		35,497		20,322		13,150		10,446		6,630

Total revenues		1,963,208		1,497,873		1,198,639		926,716		754,776
Interest expense		505,606		293,173		140,394		97,102		80,087

Revenues, net of interest expense		1,457,602		1,204,700		1,058,245		829,614		674,689

Non-interest expenses:
Compensation and benefits		791,255		669,957		595,887		474,709		385,585
Floor brokerage and clearing fees		62,564		46,644		52,922		48,217		54,681
Technology and communications		80,840		67,666		64,555		58,581		52,216
Occupancy and equipment rental		59,792		47,040		39,553		32,534		26,156
Business development		48,634		42,512		35,006		26,481		22,973
Other		65,863		62,474		43,333		44,559		29,386

Total non-interest expenses		1,108,948		936,293		831,256		685,081		570,997

Earnings before income taxes, minority interest, and cumulative effect of change in accounting principle		348,654		268,407		226,989		144,533		103,692
Income taxes		137,541		104,089		83,955		52,851		41,121

Earnings before minority interest and cumulative effect of change in accounting principle		211,113		164,318		143,034		91,682		62,571
Minority interest in earnings of consolidated subsidiaries, net		6,969		6,875		11,668		7,631		—

Earnings before cumulative effect of change in accounting principle, net		204,144		157,443		131,366		84,051		62,571
Cumulative effect of change in accounting principle, net		1,606		—		—		—		—

Net earnings	$	205,750	$	157,443	$	131,366	$	84,051	$	62,571

Earnings per share of Common Stock:
Basic-
Earnings before cumulative effect of change in accounting principle, net	$	1.53	$	1.27	$	1.14	$	0.79	$	0.64
Cumulative effect of change in accounting principle, net		0.01		—		—		—		—

Net earnings	$	1.54	$	1.27	$	1.14	$	0.79	$	0.64

Diluted-
Earnings before cumulative effect of change in accounting principle, net	$	1.41	$	1.16	$	1.03	$	0.71	$	0.57
Cumulative effect of change in accounting principle, net		0.01		—		—		—		—

Net earnings	$	1.42	$	1.16	$	1.03	$	0.71	$	0.57

Weighted average shares of Common Stock:
Basic		133,898		123,646		114,906		106,179		98,463
Diluted		147,531		135,569		127,815		118,531		110,040
Cash dividends per common share	$	0.42	$	0.26	$	0.18	$	0.11	$	0.05
Selected Balance Sheet Data
Total assets	$	17,899,882	$	12,780,931	$	13,824,628	$	10,992,283	$	6,898,691
Long-term debt	$	1,268,543	$	779,873	$	789,067	$	443,148	$	452,606
Mandatorily redeemable convertible preferred stock	$	125,000		—		—		—		—
Total stockholders’ equity	$	1,581,087	$	1,286,850	$	1,039,133	$	838,371	$	628,517
Shares outstanding		119,547		116,220		114,578		113,404		107,808
Other Data (Unaudited)
Book value per share of Common Stock	$	13.23	$	11.07	$	9.07	$	7.40	$	5.83
Fixed charge coverage ratio (1)		4.5X		5.5X		5.6X		5.6X		4.5X

(1)

The ratio of earnings to fixed charges is computed by dividing (a) income from continuing operations before income taxes plus fixed charges by (b) fixed charges. Fixed charges consist of interest expense on all long-term indebtedness and the portion of operating lease rental expense that is representative of the interest factor (deemed to be one-third of operating lease rentals).

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

This report contains or incorporates by reference “forward-looking statements” within the meaning of the safe harbor provisions of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements include statements about our future and statements that are not historical facts. These forward-looking statements are usually preceded by the words “believe,” “intend,” “may,” “will,” or similar expressions. Forward-looking statements may contain expectations regarding revenues, earnings, operations and other financial projections, and may include statements of future performance, plans and objectives. Forward-looking statements also include statements pertaining to our strategies for future development of our business and products. Forward-looking statements represent only our belief regarding future events, many of which by their nature are inherently uncertain and outside of our control. It is possible that the actual results may differ, possibly materially, from the anticipated results indicated in these forward-looking statements. Information regarding important factors that could cause actual results to differ, perhaps materially, from those in our forward-looking statements is contained in this report and other documents we file. You should read and interpret any forward-looking statement together with these documents, including the following:

	•		the description of our business contained in this report under the caption “Business”;

	•		the risk factors contained in this report under the caption “Risk Factors”;

	•		the discussion of our analysis of financial condition and results of operations contained in this report under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations”;

	•		the notes to the consolidated financial statements contained in this report; and

	•		cautionary statements we make in our public documents, reports and announcements.

Any forward-looking statement speaks only as of the date on which that statement is made. We will not update any forward-looking statement to reflect events or circumstances that occur after the date on which the statement is made.

Critical Accounting Policies

The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America, which require management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and related notes. Actual results can and will differ from estimates. These differences could be material to the financial statements.

We believe our application of accounting policies and the estimates required therein are reasonable. These accounting policies and estimates are constantly re-evaluated, and adjustments are made when facts and circumstances dictate a change. Historically, we have found our application of accounting policies to be appropriate, and actual results have not differed materially from those determined using necessary estimates.

Our management believes our critical accounting policies (policies that are both material to the financial condition and results of operations and require management’s most difficult, subjective or complex judgments) are our valuation methodologies applied to investments, certain securities positions and OTC derivatives and our use of estimates related to compensation and benefits during the year.

Fair Value of Financial Instruments

Investments are stated at fair value as determined in good faith by management. Factors considered in valuing individual investments 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, and other pertinent information.

Furthermore, judgment is used to value certain securities (e.g., private securities, 144A securities, less liquid securities) if quoted current market prices are not available. These valuations are made with consideration for various assumptions, including time value, yield curve, volatility factors, liquidity, market prices on comparable securities and other factors. The subjectivity involved in this process makes these valuations inherently less reliable than quoted market prices. We believe that our comprehensive risk management policies and procedures serve to monitor the appropriateness of the assumptions used. The use of different assumptions, however, could produce materially different estimates of fair value.

Fair Value of Derivatives

Fair values of exchange-traded derivatives are generally determined from quoted market prices. OTC derivatives are valued using valuation models. The valuation models that we use to derive the fair values of our OTC derivatives require inputs including contractual terms, market prices, yield curves, measures of volatility and correlations of such inputs. The selection of a model to value an OTC derivative depends upon the contractual terms of, and specific risks inherent in, the instrument as well as the availability of pricing information in the market. We generally use similar models to value similar instruments. Where possible, we compare and verify the values produced by our pricing models to market transactions. For OTC derivatives that trade in liquid markets, such as generic forwards, swaps and options, model selection does not involve significant judgment because market prices are readily available. For OTC derivatives that trade in less liquid markets, model selection and inputs require more judgment because such instruments tend to be more complex and pricing information is less available in the market. As markets continue to develop and more pricing information becomes available, we continue to review and refine the models that we use. At the inception of an OTC derivative contract (day one), we value the contract at the model value if we can verify all of the significant model inputs to observable market data and verify the model to market transactions. If we cannot verify all of the significant model inputs to observable market data and verify the model to market transactions, we value the contract at the transaction price at inception and, consequently, record no day one gain or loss in accordance with Emerging Issues Task Force (EITF) Issue No. 02-3, Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities. Subsequent to the transaction date, we recognize trading profits deferred at inception of the derivative transaction in the period in which the valuation of such instrument becomes observable.

Compensation and Benefits

The use of estimates is important in determining compensation and benefits expenses for interim and year end periods. A substantial portion of our compensation and benefits represents discretionary bonuses, which are fixed at year end. In addition to the level of net revenues, our overall compensation expense in any given year is influenced by prevailing labor markets, revenue mix and our use of equity-based compensation programs. We believe the most appropriate way to allocate estimated annual discretionary bonuses among interim periods is in proportion to projected net revenues earned. Consequently, we have generally accrued interim compensation and benefits based on annual targeted compensation ratios, taking into account the guidance contained in FASB 123R regarding the timing of expense recognition for non retirement-eligible and retirement-eligible employees. Our fourth quarter reflects the difference between the compensation and benefits we determine at year end and the accruals recorded through the end of the third quarter.

Revenues by Source

For presentation purposes, the remainder of “Results of Operations” is presented on a detailed product and expense basis rather than on a business segment basis.

Our earnings are subject to wide fluctuations since many factors over which we have little or no control, particularly the overall volume of trading, the volatility and general level of market prices, and the number and size of investment banking transactions may significantly affect our operations. The following provides a summary of revenues by source for the past three years.


	Year Ended December 31,
	2006					2005					2004
			% of					% of					% of
			Total					Total					Total
	Amount		Revenues			Amount		Revenues			Amount		Revenues
	(Dollars in Thousands)
Equity	$	538,891		27	%	$	438,080		29	%	$	503,848		42	%
Fixed income & commodities		245,289		12			178,674		12			126,353		11

Total		784,180		39			616,754		41			630,201		53
Investment banking		540,596		28			495,014		33			352,804		29
Asset management fees and investment income from managed funds:
Asset management fees		55,462		3			50,943		4			38,208		3
Investment income from managed funds		54,088		3			31,109		2			42,976		4

Total		109,550		6			82,052		6			81,184		7
Interest		528,882		27			304,053		20			134,450		11

Total revenues	$	1,963,208		100	%	$	1,497,873		100	%	$	1,198,639		100	%

2006 Compared to 2005

Overview

Revenues, net of interest expense, increased $252.9 million, or 21%, to $1.5 billion, compared to $1.2 billion for 2005. The increase was primarily due to a $167.4 million, or 27%, increase in equity and fixed income and commodities revenues, a $27.5 million, or 34%, increase in asset management fees and investment income from managed funds, a $45.6 million, or 9%, increase in investment banking revenue, and a $224.8 million, or 74%, increase in interest revenues (net interest income which is interest revenue less interest expense only increased $12.4 million). The 2006 results included an after-tax gain of $1.6 million, or $0.01 per diluted common share, as a cumulative effect of change in accounting principle associated with our adoption of FASB 123R on January 1, 2006.

Equity Product Revenue

Equity product revenue is comprised of equity (including principal transaction and commission revenue), correspondent clearing and prime brokerage, and execution product revenues. Equity product revenue was $538.9 million, up 23% from 2005 reflecting higher revenues across most of our core equity businesses. The increase in equity product revenue was due to moderate volatility in the market, several large block and proprietary trading opportunities generated from our investment banking relationships and the continued expansion of our secondary trading activity generated off of our capital markets platform.

Fixed Income & Commodities Revenue

Investment Banking Product Revenue


	Year Ended
	December 31,		December 31,		Percentage
	2006		2005		Change
	(Dollars in Thousands)
Capital markets	$	231,261	$	221,479		4	%
Advisory		309,335		273,535		13	%

Total	$	540,596	$	495,014		9	%

Capital markets revenues, which consist primarily of debt, equity and convertible financing services were $231.3 million, an increase of 4% from 2005. The increase in capital markets revenues is primarily attributable to increases in revenue from equity and convertible underwritings, offset by the decrease in revenue generated from high yield underwritings.

Revenues from advisory activities were $309.3 million, an increase of 13% from 2005. The increase is primarily attributable to services rendered on assignments in the technology, aerospace and defense, industrial and energy sectors.

Asset Management Fee Revenue

Asset management revenue includes revenues from management, administrative and performance fees from funds managed by us, revenues from asset management and performance fees from third-party managed funds, and investment revenue from our investments in these funds. Asset management revenues were $109.6 million, up 34% over 2005. The increase in asset management revenue was a result of solid performance and expansion of the JAM platform along with strong 2006 results from our High Yield Funds. During 2006, we formed a total of four new funds, one focused on distressed debt and risk arbitrage, two technology-oriented long-short equity funds, and one financial services long-short equity fund. In addition, we launched the Summit Lake CLO and Diamond Lake CLO.

Changes in Assets under Management (1)


	Year Ended		Year Ended
	December 31,		December 31,		Percent
In millions	2006		2005		Change
Balance, beginning of period	$	4,031	$	3,287		23	%
Net cash flow in		792		556		42	%
Net market appreciation		459		188		144	%

		1,251		744		68	%

Balance, end of period	$	5,282	$	4,031		31	%

(1)

Excludes certain third party managed funds that are no longer considered assets under management.

Net Interest Revenue

Interest income increased $224.8 million primarily as a result of increased stock borrowing activity and increases in interest rates, and interest expense increased by $212.4 million primarily as a result of increased stock lending activity, increases in interest rates, the issuance of our $500 million of senior unsecured debentures and our $125 million in Series A Mandatorily Convertible Preferred Stock.

Compensation and Benefits

Compensation and benefits, including the amortization of previously awarded equity awards, increased $121.3 million, or 18%, versus the 21% increase in net revenues. The increase was consistent with our increase in headcount and change to our revenue mix offset by changes to FASB 123R guidance regarding the timing of expense recognition for non retirement-eligible employees. Under FASB 123 we defined the service period (over which compensation costs should be recognized) to generally include the year prior to the grant and the subsequent vesting periods. With the adoption of FASB 123R, 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.

Average employee headcount increased 10% from 1,937 during 2005 to 2,140 during 2006. The ratio of compensation to net revenues was approximately 54.3% for 2006 as compared to 55.6% for 2005.

Non-Personnel Expenses

Non-personnel expense was $317.7 million or 21.8% of net revenues for 2006 versus $266.3 or 22.1% of net revenues for 2005. The increase in non-personnel expenses is consistent with our revenue growth and primarily attributable to increased technology and communications, occupancy, legal and compliance and other costs associated with higher levels of business activity.

Earnings before Income Taxes, Minority Interest, and Cumulative Effect of Change in Accounting Principle, Net

Earnings before income taxes, minority interest and cumulative effect of change in accounting principle, net, were up $80.2 million, or 30%, to $348.7 million, compared to $268.4 million for 2005. The effective tax rates were approximately 39.4% for 2006 and 38.8% for 2005. The 2006 basic and diluted calculations included an additional $0.01 per share related to the cumulative effect of the change in accounting principle, net.

Earnings per Share

Basic net earnings per share were $1.54 for 2006 on 133,898,000 shares compared to $1.27 in 2005 on 123,646,000 shares. Diluted net earnings per share were $1.42 for 2006 on 147,531,000 shares compared to $1.16 in 2005 on 135,569,000 shares. Both the 2006 basic and diluted calculations included an additional $0.01 per share related to the cumulative effect of the change in accounting principle, net.

2005 Compared to 2004

Overview

Revenues, net of interest expense, increased $146.5 million, or 14%, to $1,204.7 million, compared to $1,058.2 million for 2004. The increase was primarily due to a $142.2 million, or 40%, increase in investment banking revenue, a $16.8 million increase in net interest revenues (interest income less interest expense), a $41.7 million increase in commodities revenues, and a $868,000, or 1%, increase in asset management fees and investment income from managed funds, partially offset by a $20.6 million, or 3%, decrease in trading revenues (commissions and principal transactions).

Equity Product Revenue

Equity product revenue is comprised of equity (including principal transaction and commission revenue), correspondent clearing and prime brokerage, and execution product revenues. Equity product revenue was $438.1 million, down 13% from 2004. The decrease in equity product revenue was due to a decline in block trading volumes, which we consider a benchmark for institutional equity trading, fewer large block trade opportunities, and reduced principal trading results.

Fixed Income & Commodities Revenue

Fixed income and commodities revenue is comprised of high yield, investment grade fixed income, convertible and commodities product revenue. Fixed income and commodities revenue was $178.7 million, up 41% over last year driven by increased activity in the high yield, investment grade corporate bond and commodity markets. High yield product revenue, not including origination revenues, was $61.9 million, up 38% over 2004. This increase was generally due to increased trading activity as a result of increased origination activity and an increase in proprietary trading profits offset by the impact of the roll out of NASD’s Trade Reporting and Compliance Engine (“TRACE”) resulting in tighter trading spreads. Investment Grade Fixed Income product revenue was $28.7 million, down 30% from 2004. The decrease was driven by the decreased demand for “odd lot” corporate bonds, reduced client activity in treasuries and the impact of the roll out of TRACE, resulting in tighter spreads. Commodities revenue includes revenues from the commodity index swap, option and futures transactions of JFP. Commodities revenue was $41.7 million, versus $6.9 million in 2004. The increase in commodities revenue was due to the expansion of JFP as well as increased activity and volatility in most commodities markets, including energy related commodities markets.

Investment Banking Product Revenue


	Year Ended
	December 31,		December 31,		Percentage
	2005		2004		Change
	(Dollars in Thousands)
Capital markets	$	221,479	$	171,654		29	%
Advisory		273,535		181,150		51	%

Total	$	495,014	$	352,804		40	%

Capital markets revenues, which consist primarily of debt, equity and convertible financing services were $221.5 million, an increase of 29% from 2004. The increase in capital markets revenues was attributed primarily to the increase in lead or co-manager assignments for high yield and equity offerings in the consumer, energy and financial service sectors.

Revenues from advisory activities were $273.5 million, an increase of 51% from 2004. The increase was primarily attributable to services rendered on assignments in the technology and energy sectors.

Asset Management Revenue

Asset management revenue includes revenues from management, administrative and performance fees from funds managed by us, revenues from asset management and performance fees from third-party managed funds, and investment revenue from our investments in these funds. Asset management revenues were $82.1 million, up 1% over 2004. The increase in asset management revenue was a result of management and performance fees on a higher base of assets under management (up 13% versus the 2004 assets under management) and a shift in the mix of assets under management toward funds on which we earn higher fees as a percentage of assets, offset by lower returns on investments in managed funds.

Changes in Assets Under Management (1)


					Percent
In millions	2005		2004		Change
Opening balance	$	3,287	$	1,680		96	%
Net cash flow		556		1,279		(57	%)
Net market appreciation		188		328		(43	%)

		744		1,607		(54	%)

Ending balance	$	4,031	$	3,287		23	%

(1)

Excludes certain third party managed funds that are no longer considered assets under management.

Net Interest Revenue

Interest income increased $169.6 million primarily as a result of increased stock borrowing activity and increases in interest rates, and interest expense increased by $152.8 million primarily as a result of increased stock lending activity and increases in interest rates.

Compensation and Benefits

Compensation and benefits increased $74.1 million, or 12%, versus the 14% increase in net revenues. Average employee headcount increased 13.9% from 1,701 to 1,937 at December 31, 2005. The majority of the increase was a result of our acquisitions of Randall & Dewey and Helix Associates early in 2005. The ratio of compensation to net revenues was approximately 56% for both 2005 and 2004.

Non-Personnel Expenses

Non-Personnel expense was $266.3 million, up about 13% over 2004. The increase in non-personnel expenses is primarily the result of the cost associated with the growth of our business, and higher legal and compliance costs.

Earnings before Income Taxes and Minority Interest

Earnings before income taxes and minority interest were up $41.4 million, or 18%, to $268.4 million, compared to $227.0 million for 2004. The effective tax rates were approximately 38.8% for 2005 and 37.0% in 2004. This increase in rates was due primarily to the 2004 tax rate being positively impacted by the favorable determination of several state tax issues.

Earnings per Share

Basic net earnings per share were $1.27 for 2005 on 123,646,000 shares compared to $1.14 in 2004 on 114,906,000 shares. Diluted net earnings per share were $1.16 for 2005 on 135,569,000 shares compared to $1.03 in 2004 on 127,815,000 shares.

Liquidity, Financial Condition and Capital Resources

Our Chief Financial Officer and Treasurer are responsible for developing and implementing our liquidity, funding and capital management strategies. These policies are determined by the nature of our day to day business operations, business growth possibilities, regulatory obligations, and liquidity requirements.

Our actual level of capital, total assets, and financial leverage are a function of a number of factors, including, asset composition, business initiatives, regulatory requirements and cost availability of both long term and short term funding. We have historically maintained a highly liquid balance sheet, with a substantial portion of our total assets consisting of cash, highly liquid marketable securities and short-term receivables, arising principally from traditional securities brokerage activity. The highly liquid nature of these assets provides us with flexibility in financing and managing our business.

Liquidity

The following are financial instruments that are cash and cash equivalents or are deemed by management to be generally readily convertible into cash, marginable or accessible for liquidity purposes within a relatively short period of time (in thousands of dollars):


	December 31, 2006		December 31, 2005
Cash and cash equivalents:
Cash in banks	$	107,488	$	85,191
Money market investments		405,553		170,742

Total cash and cash equivalents		513,041		255,933
Cash and securities segregated (1).		525,911		629,360
Short-term bond funds		—		7,037
Auction rate preferreds (2)		—		28,756
Mortgage-backed securities (2)		43,151		13,458
Asset-backed securities (2)		28,009		33,159

	$	1,110,112	$	967,703

(1)		In accordance with Rule 15c3-3 of the Securities Exchange Act of 1934, Jefferies, 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 on a net basis, in accordance with FASB Interpretation No. 39, Offsetting of Amounts Related to Certain Contracts, in this caption.

(2)		Items are included in Financial Instruments Owned (see note 5 of the Notes to Consolidated Financial Statements). Items are financial instruments utilized in our overall cash management activities and are readily convertible to cash in normal market conditions.

Unsecured bank loans are typically overnight loans used to finance financial instruments owned or clearing related balances. There were no unsecured bank loans at December 31, 2006 and December 31, 2005. Average daily bank loans for the years ended December 31, 2006 and December 31, 2005 were $12.4 million and $11.2 million, respectively.

A substantial portion of our assets are liquid, consisting of cash or assets readily convertible into cash. The majority of securities positions (both long and short) in our trading accounts are readily marketable and actively traded. In addition, receivables from brokers and dealers are primarily current open transactions or securities borrowed transactions, which are typically settled or closed out within a few days. Receivable from customers includes margin balances and amounts due on transactions in the process of settlement. Most of our receivables are secured by marketable securities.

Our assets are funded by equity capital, senior debt, mandatorily redeemable convertible preferred stock, securities loaned, customer free credit balances, bank loans and other payables. Bank loans represent temporary (usually overnight) secured and unsecured short-term borrowings, which are generally payable on demand. We have arrangements with banks for unsecured financing of up to $274 million. Secured bank loans are collateralized by a combination of customer, non-customer and firm securities. We have always been able to obtain necessary short-term borrowings in the past and believe that we will continue to be able to do so in the future. Additionally, we have $264.3 million in letters of credit outstanding as of December 31, 2006, which are used in the normal course of business mostly to satisfy various collateral requirements in lieu of depositing cash or securities.

Excess Liquidity

Our policy is to maintain excess liquidity to cover all expected cash outflows for one year in a stressed liquidity environment. Liquid resources consist of unrestricted cash and unencumbered assets that are readily convertible into cash on a secured basis on short notice. Certain investments, short term bond funds and auction rated convertibles are also readily convertible to cash. In addition, we have $274 million of unsecured, uncommitted lines of credit with various banks.

Management believes these resources provide sufficient excess liquidity to cover all expected cash outflows, inclusive of potential equity repurchases, for one year during a stressed liquidity environment. Expected cash outflows include:

•		The repayment of our unsecured debt maturing within twelve months ($100 million outstanding at December 31, 2006);

•		The payment of interest expense (including dividends on our mandatorily redeemable convertible preferred stock) on our long term debt;

•		The anticipated funding of outstanding investment commitments;

•		The anticipated fixed costs over the next 12 months;

•		Potential stock repurchases; and

•		Certain accrued expenses and other liabilities

Analysis of Financial Condition and Capital Resources

Financial Condition

As previously discussed, we have historically maintained a highly liquid balance sheet, with a substantial portion of our total assets consisting of cash, highly liquid marketable securities and short-term receivables, arising principally from traditional securities brokerage activity. Total assets increased $5,119.0 million, or 40%, from $12,780.9 million at December 31, 2005 to $17,899.9 million at December 31, 2006. Our financial instruments owned, including securities pledged to creditors, and securities purchased under agreements to resell increased $3,096.0 million, while our financial instruments sold, not yet purchased and securities sold under agreements to repurchase, increased $4,411.5 million.

The following table sets forth book value, pro forma book value, tangible book value and pro forma tangible book value per share (dollars in thousands, except per share data):


	December 31, 2006			December 31, 2005
Stockholders’ equity	$	1,581,087		$	1,286,850
Less: Goodwill		(257,321	)		(220,607	)

Tangible stockholders’ equity	$	1,323,766		$	1,066,243

Stockholders’ equity	$	1,581,087		$	1,286,850
Add: Projected tax benefit on vested portion of restricted stock		130,700			137,193

Pro forma stockholders’ equity	$	1,711,787		$	1,424,043

Tangible stockholders’ equity	$	1,323,766		$	1,066,243
Add: Projected tax benefit on vested portion of restricted stock		130,700			137,193

Pro forma tangible stockholders’ equity	$	1,454,466		$	1,203,436

Shares outstanding		119,546,914			116,220,784
Add: Shares not issued, to the extent of related expense amortization		24,139,907			21,093,398

Less: Shares issued, to the extent related expense has not been amortized		(1,813,423	)		(2,618,570	)

Adjusted shares outstanding		141,873,398			134,695,612

Book value per share (1)	$	13.23		$	11.07

Pro forma book value per share (2)	$	12.07		$	10.57

Tangible book value per share (3)	$	11.07		$	9.17

Pro forma tangible book value per share (4)	$	10.25		$	8.93

(1)		Book value per share equals stockholders’ equity divided by common shares outstanding.

(2)		Pro forma book value per share equals stockholders’ equity plus the projected deferred tax benefit on the amortized portion of restricted stock and RSUs divided by common shares outstanding adjusted for shares not yet issued to the extent of the related expense amortization and shares issued to the extent the related expense has not been amortized.

(3)		Tangible book value per share equals tangible stockholders’ equity divided by common shares outstanding.

(4)		Pro forma tangible book value per share equals tangible stockholders’ equity plus the projected deferred tax benefit on the amortized portion of restricted stock and RSUs divided by common shares outstanding adjusted for shares not yet issued to the extent of the related expense amortization and shares issued to the extent the related expense has not been amortized.

Tangible stockholders’ equity, pro forma book value per share, tangible book value per share and pro forma tangible book value per share are “non-GAAP financial measures.” A “non-GAAP financial measure” is a numerical measure of financial performance that includes adjustments to the most directly comparable measure calculated and presented in accordance with GAAP, or for which there is no specific GAAP guidance. We calculate tangible stockholders’ equity as stockholders’ equity less intangible assets. We calculate pro forma book value per share as stockholders’ equity plus the projected deferred tax benefit on the vested portion of restricted stock and RSUs divided by common shares outstanding adjusted for shares not yet issued to the extent of the related expense amortization and shares issued to the extent the related expense has not been amortized. We calculate tangible book value per share by dividing tangible stockholders’ equity by common stock outstanding. We calculate pro forma tangible book value per share by dividing tangible stockholders’ equity plus the projected deferred tax benefit on the vested portion of restricted stock and RSUs by common shares outstanding adjusted for shares not yet issued to the extent of the related expense amortization and shares issued to the extent the related expense has not been amortized. We consider these ratios as meaningful measurements of our financial condition and believe they provide investors with additional metrics to comparatively assess the fair market value of our stock.

Capital Resources

We have total long term capital of $3.0 billion and $2.1 billion resulting in a long-term debt to total capital ratio of 47% and 38%, at year end 2006 and 2005, respectively. Our total capital base as of December 31 was as follows (in thousands):


	December 31,		December 31,
	2006		2005
Long-Term Debt	$	1,268,543	$	779,873
Mandatorily Redeemable Convertible Preferred Stock		125,000		—
Total Stockholders’ Equity		1,581,087		1,286,850


Total Capital	$	2,974,630	$	2,066,723

Our ability to support increases in total assets is largely a function of our ability to obtain short term secured and unsecured funding, primarily through securities lending, and through our $274 million of uncommitted unsecured bank lines. Our ability is further enhanced by the cash proceeds from the $500 million senior unsecured bonds and $125 million in series A preferred stock, both issued in the first quarter of 2006.

At December 31, 2006, our senior debt, net of unamortized discount, consisted of contractual principal payments (adjusted for amortization) of $492.2 million, $348.3 million, $328.0 million and $100.0 million due in 2036, 2016, 2012 and 2007, respectively.

We rely upon our cash holdings and external sources to finance a significant portion of our day-to-day operations. Access to these external sources, as well as the cost of that financing, is dependent upon various factors, including our debt ratings. Our current debt ratings are dependent upon many factors, including operating results, operating margins, earnings trend and volatility, balance sheet composition, liquidity and liquidity management, our capital structure, our overall risk management, business diversification and our market share and competitive position in the markets in which we operate.

Our long term debt ratings are as follows:


		Rating
Moody’s Investors Services		Baa1
Standard and Poor’s		BBB+
Fitch Ratings		BBB+

Jefferies and Jefferies Execution are subject to the net capital requirements of the SEC and other regulators, which are designed to measure the general financial soundness and liquidity of broker-dealers. Jefferies and Jefferies Execution use the alternative method of calculation.

Net Capital

As of December 31, 2006, Jefferies’ and Jefferies Execution’s net capital and excess net capital were as follows (in thousands of dollars):


	Net Capital		Excess Net Capital
Jefferies	$	191,830	$	174,597
Jefferies Execution	$	21,477	$	21,227

Guarantees

As of December 31, 2006, we had outstanding guarantees of $20.0 million relating to an undrawn bank credit obligation of an associated investment fund in which we have an interest. In addition, we guarantee up to an aggregate of approximately $36 million in bank loans committed to an employee parallel fund of Jefferies Capital Partners IV L.P. (“Fund IV”).

We have guaranteed the performance of JIL and JFP to their trading counterparties and various banks and other entities, which provide clearing and credit services to JIL and JFP. Also, we have provided a guarantee to a third-party bank in connection with the bank’s extension of 500 million Japanese yen (approximately $4.1 million) to Jefferies (Japan) Limited. In addition, as of December 31, 2006, we had commitments to invest up to $279.9 million in various investments, including $225.0 million in Jefferies Finance LLC, $41.0 million in Fund IV and $13.9 million in other investments.

Leverage Ratios

The following table presents total assets, adjusted assets, and net adjusted assets with the resulting leverage ratios as of December 31, 2006 and December 31, 2005. With respect to leverage ratio, we believe that net adjusted leverage is the most relevant measure, given the low-risk, collateralized nature of our securities borrowed and segregated cash assets.


	December 31, 2006		December 31, 2005
Total assets	$	17,899,882	$	12,780,931
Adjusted assets (1)		17,373,971		12,151,571
Net adjusted assets (2)		7,662,077		4,008,093
Leverage ratio (3)		11.3		9.9
Adjusted leverage ratio (4)		11.0		9.4
Net adjusted leverage ratio (5)		4.8		3.1

(1)		Adjusted assets are total assets less cash and securities segregated.

(2)		Net adjusted assets are adjusted assets, less securities borrowed.

(3)		Leverage ratio equals total assets divided by stockholders’ equity.

(4)		Adjusted leverage ratio equals adjusted assets divided by stockholders’ equity.

(5)		Net adjusted leverage ratio equals net adjusted assets divided by stockholders’ equity.

Stock Repurchases

During 2006, we purchased 900,475 shares of our common stock for $24.0 million mostly in connection with our stock compensation plans which allow participants to use shares to pay the exercise price of options exercised and to use shares to satisfy tax liabilities arising from the exercise of options or the vesting of restricted stock. The number above does not include unvested shares forfeited back to us pursuant to the terms of our stock compensation plans. We believe that we have sufficient liquidity and capital resources to make these repurchases without any material adverse effect on us.

Commitments

The tables below provide information about our commitments related to debt obligations, interest rate swaps, leases, guarantees, letters of credit and investments as of December 31, 2006. For debt obligations, leases and investments, the table presents principal cash flows with expected maturity dates. For interest rate swaps, guarantees and letters of credit, the table presents notional amounts with expected maturity dates.


	Expected Maturity Date
	2007		2008		2009		2010		2011		After 2011		Total
	(Dollars in Millions)
Debt obligations
Senior notes	$	100.0		—		—		—		—	$	1,175.0	$	1,275.0
Mandatorily redeemable convertible preferred stock		—		—		—		—		—	$	125.0	$	125.0

Interest rate swaps		—		—		—		—		—	$	200.0	$	200.0

Leases
Gross lease commitments	$	47.8	$	46.7	$	41.1	$	39.6	$	37.3	$	180.3	$	392.8
Sub-leases		8.3		9.1		7.5		7.2		6.9		19.2		58.2

Net lease commitments	$	39.5	$	37.6	$	33.6	$	32.4	$	30.4	$	161.1	$	334.6

Guarantees	$	60.1		—		—		—		—		—	$	60.10

Letters of credit	$	264.3		—		—		—		—		—	$	264.3

Commitments to invest	$	0.3		—		—		—	$	1.4	$	278.2	$	279.9

Subsequent Events

As more fully disclosed in note 25 of the Notes to Consolidated Financial Statements, on February 28, 2007, we announced that we have entered into an agreement with Leucadia National Corporation (“Leucadia”) to expand and restructure the operation of our High Yield secondary market business into an entity to be called Jefferies High Yield Trading, LLC (“the Company”). Pursuant to the agreement, Leucadia will increase its investment to $600 million and we and our affiliates will increase our investment to the same level as Leucadia. The investments will be in a new holding company that will own the Company, to be called Jefferies High Yield Holdings, LLC. Commencement of the investments is subject to the receipt of regulatory approvals and certain other conditions. We do not believe that our investment or the operations of the Company will have a material adverse impact on us.

Off Balance Sheet Arrangements

Information concerning our off balance sheet arrangements are included in note 14 of the Notes to Consolidated Financial Statements. Such information is hereby incorporated by reference.

Effects of Changes in Foreign Currency Rates

We maintain a foreign securities business in our foreign offices (London, Paris, Tokyo and Zurich) as well as in some of our domestic offices. Most of these activities are hedged by related foreign currency liabilities or by forward exchange contracts. However, we are still subject to some foreign currency risk. A change in the foreign currency rates could create either a foreign currency transaction gain/loss (recorded in our Consolidated Statements of Earnings) or a foreign currency translation adjustment to the stockholders’ equity section of our Consolidated Statements of Financial Condition.

Effects of Inflation

Based on today’s modest inflationary rates and because our assets are primarily monetary in nature, consisting of cash and cash equivalents, securities and receivables, we believe that our assets are not significantly affected by inflation. The rate of inflation, however, can affect various expenses, including employee compensation, communications and technology and occupancy, which may not be readily recoverable in charges for services provided by us.

Risk Management

Risk is an inherent part of our business and activities. The extent to which we properly and effectively identify, assess, monitor and manage each of the various types of risk involved in our activities is critical to our financial soundness and profitability. We seek to identify, assess, monitor and manage the following principal risks involved in our business activities: market, credit, operational, legal and compliance and new business. Risk management is a multi-faceted process that requires communication, judgment and knowledge of financial products and markets. Senior management takes an active role in the risk management process and requires specific administrative and business functions to assist in the identification, assessment and control of various risks. Our risk management policies, procedures and methodologies are fluid in nature and are subject to ongoing review and modification.

Market Risk. The potential for changes in the value of the financial instruments is referred to as market risk. Our market risk generally represents the risk of loss that may result from a change in the value of a financial instrument as a result of fluctuations in interest rates, credit spreads, equity prices and the correlation among them, along with the level of volatility. Interest rate risks result primarily from exposure to changes in the yield curve, the volatility of interest rates, and credit spreads. Equity price risks result from exposure to changes in prices and volatilities of individual equities, equity baskets and equity indices. Commodity price risks result from exposure to the changes in prices and volatilities of individual commodities, commodity baskets and commodity indices. We make dealer markets in equity securities, debt securities and commodities. To facilitate customer order flow, we may be required to own equity and debt securities in our trading and inventory accounts. We attempt to hedge our exposure to market risk by managing our net long or short position. Due to imperfections in correlations, gains and losses can occur even for positions that are hedged. Position limits in trading and inventory accounts are established and monitored on an ongoing basis. Each day, consolidated position and exposure reports are prepared and distributed to various levels of management, which enable management to monitor inventory levels and results of the trading groups.

Credit Risk. Credit risk represents the loss that we would incur if a client, counterparty or issuer of securities or other instruments held by us fails to perform its contractual obligations. We follow industry practices to reduce credit risk related to various trading, investing and financing activities by obtaining and maintaining collateral. We adjust margin requirements if we believe the risk exposure is not appropriate based on market conditions. Liabilities to other brokers and dealers related to unsettled transactions (i.e., securities failed-to-receive) are recorded at the amount for which the securities were purchased, and are paid upon receipt of the securities from other brokers or dealers. In the case of aged securities failed-to-receive, we may purchase the underlying security in the market and seek reimbursement for losses from the counterparty in accordance with standard industry practices.

Operational Risk. Operational risk generally refers to the risk of loss resulting from our operations, including, but not limited to, improper or unauthorized execution and processing of transactions, deficiencies in our operating systems, business disruptions and inadequacies or breaches in our internal control processes. Our businesses are highly dependent on our ability to process, on a daily basis, a large number of transactions across numerous and diverse markets in many currencies. In addition, the transactions we process have become increasingly complex. If any of our financial, accounting or other data processing systems do not operate properly or are disabled or if there are other shortcomings or failures in our internal processes, people or systems, we could suffer an impairment to our liquidity, financial loss, a disruption of our businesses, liability to clients, regulatory intervention or reputational damage. These systems may fail to operate properly or become disabled as a result of events that are wholly or partially beyond our control, including a disruption of electrical or communications services or our inability to occupy one or more of our buildings. The inability of our systems to accommodate an increasing volume of transactions could also constrain our ability to expand our businesses.

Legal and Compliance Risk. Legal and compliance risk includes the risk of non-compliance with applicable legal and regulatory requirements. We are subject to extensive regulation in the different jurisdictions in which we conduct our business. We have various procedures addressing issues such as regulatory capital requirements, sales and trading practices, use of and safekeeping of customer funds, credit granting, collection activities, anti-money laundering and record keeping. We also maintain an anonymous hotline for employees or others to report suspected inappropriate actions by us or by our employees or agents.

New Business Risk. New business risk refers to the risks of entering into a new line of business or offering a new product. By entering a new line of business or offering a new product, we may face risks that we are unaccustomed to dealing with and may increase the magnitude of the risks we currently face. We review proposals for new businesses and new products to determine if we are prepared to handle the additional or increased risks associated with entering into such activities.

Reputational Risk. We recognize that maintaining our reputation among clients, investors, regulators and the general public is an important aspect of minimizing legal and operational risks. Maintaining our reputation depends on a large number of factors, including the selection of our clients and the conduct of our business activities. We seek to maintain our reputation by screening potential clients and by conducting our business activities in accordance with high ethical standards.

Other Risk. Other risks encountered by us include political, regulatory and tax risks. These risks reflect the potential impact that changes in local and international laws and tax statutes have on the economics and viability of current or future transactions. In an effort to mitigate these risks, we continuously review new and pending regulations and legislation and participate in various industry interest groups.

Accounting and Regulatory Developments

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 January 1, 2006 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 04-5 was not material.

In April 2006, the FASB issued FASB Staff Position FIN 46(R)-6, Determining the Variability to Be Considered in Applying FASB Interpretation No. 46(R), (“FSP FIN 46(R)-6”). FSP FIN 46(R)-6 addresses how variability should be considered when applying FIN 46(R). Variability affects the determination of whether an entity is a variable interest entity (“VIE”), which interests are variable interests, and which party, if any, is the primary beneficiary of the VIE required to consolidate. FSP FIN 46(R)-6 clarifies that the design of the entity also should be considered when identifying which interests are variable interests. FSP FIN 46(R)-6 must be applied

prospectively to all entities in which we first become involved, beginning July 1, 2006. The adoption of FSP FIN 46(R)-6 did not have a material effect on our consolidated financial statements.

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. We do not believe that the adoption of FIN 48 will have a significant effect on our consolidated financial statements.

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, existing hybrid instruments measured at fair value, 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 intend to adopt FASB 157 in the first quarter of 2007. To determine the transition adjustment to opening retained earnings, we have performed an analysis of existing derivative instruments measured under EITF Issue 02-3 and block discounts. The transition adjustment to opening retained earnings will not have a material effect on our financial condition. We are currently evaluating the impact of FASB 157 on our results of operations for the first quarter of 2007.

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 requires 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 requires 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 in the 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.

On February 15, 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 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 intend to adopt FASB 159 in the first quarter of 2007. We are currently evaluating the impact of FASB 159 on our results of operations for the first quarter of 2007.

In September 2006, the SEC issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in the Current Year Financial Statements (“SAB 108”). SAB 108 addresses how the effects of prior year uncorrected misstatements should be considered when quantifying misstatements in current year financial statements. SAB 108 requires an entity to quantify misstatements using a balance sheet and income statement approach and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors. SAB No. 108 is effective for fiscal years ending after November 15, 2006. The adoption of SAB No. 108 did not have material impact on the consolidated financial statements.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

We use a number of quantitative tools to manage our exposure to market risk. These tools include:

	•		inventory position and exposure limits, on a gross and net basis;

	•		scenario analyses, stress tests and other analytical tools that measure the potential effects on our trading net revenues of various market events, including, but not limited to, a large widening of credit spreads, a substantial decline in equities markets and significant moves in selected emerging markets; and

	•		risk limits based on a summary measure of risk exposure referred to as Value-at-Risk (“VaR”).

Value-at Risk

In general, VaR measures potential loss of trading revenues at a given confidence level over a specified time horizon. We calculate VaR over a one day holding period measured at a 95% confidence level which implies the potential loss of daily trading revenue is expected to be at least as large as the VaR amount on one out of every twenty trading days.

VaR is one measurement of potential loss in trading revenues that may result from adverse market movements over a specified period of time with a selected likelihood of occurrence. As with all measures of VaR, our estimate has substantial limitations due to our reliance on historical performance, which is not necessarily a predictor of the future. Consequently, this VaR estimate is only one of a number of tools we use in our daily risk management activities.

The VaR numbers below are shown separately for interest rate, equity, currency and commodity products, as well as for our overall trading positions, excluding corporate investments in asset management positions, using a historical simulation approach. The aggregated VaR presented here is less than the sum of the individual components (i.e., interest rate risk, foreign exchange rate risk, equity risk and commodity price risk) due to the benefit of diversification among the risk categories. Diversification benefit equals the difference between aggregated VaR and the sum of VaRs for the four risk categories. The following table illustrates the VaR for each component of market risk.


	Daily VaR (1)
	(In Millions)
	Value at Risk in trading portfolios
	At 12-31				Year ending 12-31-2006						Year ending 12-31-2005
Risk Categories	2006		2005		Average		High		Low		Average		High		Low
Interest Rates	$	1.39	$	0.56	$	0.81	$	1.50	$	0.41	$	0.59	$	1.49	$	0.27
Equity Prices	$	6.37	$	2.11	$	4.35	$	13.30	$	1.10	$	2.30	$	3.38	$	1.19
Currency Rates	$	0.34	$	0.36	$	0.37	$	0.53	$	0.24	$	0.17	$	0.45	$	0.02
Commodity Prices	$	0.80	$	0.20	$	1.98	$	4.87	$	0.61	$	1.03	$	2.60	$	0.03
Diversification Effect	$	-3.36	$	-1.10	$	-2.76					$	-1.38


Firmwide	$	5.54	$	2.13	$	4.75	$	13.90	$	1.95	$	2.71	$	3.89	$	1.17

(1)

VaR is the potential loss in value of our trading positions due to adverse market movements over a defined time horizon with a specific confidence level. For the VaR numbers reported above, a one-day time horizon and 95% confidence level were used.

Average firmwide VaR of $4.75 million during 2006 increased from the $2.71 million average during 2005 due to an increase in exposure to equity prices, interest rates, and commodity prices.

The following table presents our daily VaR over the last four quarters:

The increase in VaR in the first quarter of 2006 is related to a large block trading opportunity from an investment banking relationship that was closed during the quarter ended March 31, 2006.

VaR Back-Testing

The comparison of daily actual revenue fluctuations with the daily VaR estimate is the primary method used to test the efficacy of the VaR model. A back-testing exception occurs when the daily loss exceeds the daily VaR estimate. Results of the process at the aggregate level demonstrated eight outliers when comparing the 95% one-day VaR with the back-testing profit and loss in 2006. A 95% confidence one-day VaR model should not have more than twelve (1 out of 20 days) back-testing exceptions on an annual basis under normal market conditions. Back-testing profit and loss is a subset of actual trading revenue and includes the profit and loss effects relevant to the VaR model, excluding fees, commissions and certain provisions. We compare the trading revenue with VaR for back-testing purposes because VaR assesses only the potential change in position value due to overnight movements in financial market variables such as prices, interest rates and volatilities under normal market conditions. The graph below illustrates the relationship between daily back-testing profit and loss and daily VaR for us in 2006.

(RELATIONSHIP BETWEEN BACK-TESTING P&L ABD VaR ESTIMATES DURING 2006)

Maturity Data

At December 31, 2006, we had $1,275.0 million aggregate principal amount of senior notes outstanding, with fixed interest rates. We 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 mark-to-market of the swaps was positive $7.7 million as of December 31, 2006, which was recorded as an increase in the book value of the debt and an increase in other assets.

The table below provides information about our derivative financial instruments and other financial instruments that are sensitive to changes in interest rates, exchange rates and price movements. For debt obligations and manditorily redeemable convertible preferred stock, the table presents principal cash flows with expected maturity dates. For interest rate swaps, foreign exchange forward contracts, futures contracts, commodities related swaps and option contracts, the table presents notional amounts with expected maturity dates.


	Expected Maturity Date
	2007			2008			2009			2010			2011			After 2011			Total			Fair Value
	(Dollars in Millions)
Interest rate sensitivity
7.75% Senior notes		—			—			—			—			—		$	325.0		$	325.0		$	356.3
7.5% Senior notes	$	100.0			—			—			—			—			—		$	100.0		$	101.0
6.25% Senior notes		—			—			—			—			—		$	500.0		$	500.0		$	483.7
5.5% Senior notes		—			—			—			—			—		$	350.0		$	350.0		$	341.2
Mandatorily redeemable convertible preferred stock		—			—			—			—			—		$	125.0		$	125.0		$	132.8
Interest rate swaps		—			—			—			—			—		$	200.0		$	200.0		$	7.7

Exchange rate sensitivity
Foreign exchange forwards, net	$	(7.0	)	$	0.8			—			—		$	11.1			—		$	4.9		$	0.8

Price sensitivity
Exchange-traded futures, net	$	5,222.0		$	166.1		$	49.7		$	26.8			—			—		$	5,464.6		$	17.6
Commodities related swaps, net	$	(6,287.0	)	$	(5.2	)		—		$	(5.0	)		—			—		$	(6,297.2	)	$	156.1
Option contracts, net	$	(605.3	)	$	(148.8	)	$	(275.2	)	$	(89.3	)	$	(213.9	)	$	(5.6	)	$	(1,338.1	)	$	(85.8	)

Management’s Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management evaluated our internal control over financial reporting as of December 31, 2006. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control — Integrated Framework. As a result of this assessment and based on the criteria in this framework, management has concluded that, as of December 31, 2006, our internal control over financial reporting was effective.

Our independent registered public accounting firm, KPMG LLP, audited management’s assessment of our internal control over financial reporting. Their opinion on management’s assessment and their opinions on the effectiveness of our internal control over financial reporting and on our consolidated financial statements appear in this annual report.

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders
Jefferies Group, Inc.:

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that Jefferies Group, Inc. and subsidiaries maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Jefferies Group, Inc. management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

In our opinion, management’s assessment that Jefferies Group, Inc. and subsidiaries maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Jefferies Group, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statements of financial condition of Jefferies Group, Inc. and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of earnings, changes in stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2006, and our report dated February 28, 2007 expressed an unqualified opinion on those consolidated financial statements.

/s/ KPMG LLP

New York, New York
February 28, 2007

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders
Jefferies Group, Inc.:

We have audited the accompanying consolidated statements of financial condition of Jefferies Group, Inc. and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of earnings, changes in stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2006. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Jefferies Group, Inc. and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.

As more fully described in note 1 to the consolidated financial statements, in 2006 the Company changed its method of accounting for share-based payments.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Jefferies Group, Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 28, 2007 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.

/s/ KPMG LLP

New York, New York
February 28, 2007

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Consolidated Statements of Financial Condition
December 31, 2006 and 2005
(Dollars in thousands, except per share amounts)


	2006			2005
Assets
Cash and cash equivalents	$	513,041		$	255,933
Cash and securities segregated and on deposit for regulatory purposes or deposited with clearing and depository organizations		525,911			629,360
Short term bond funds		—			7,037
Investments		134,278			107,684
Investments in managed funds		364,124			278,116
Securities borrowed		9,711,894			8,143,478
Securities purchased under agreements to resell		226,176			—
Receivable from brokers, dealers and clearing organizations		254,580			389,994
Receivable from customers		663,552			457,839
Financial instruments owned, including securities pledged to creditors of $1,481,098 and $178,686 in 2006 and 2005, respectively		4,698,578			1,828,766
Premises and equipment		91,375			69,821
Goodwill		257,321			220,607
Other assets		459,052			392,296

Total Assets	$	17,899,882		$	12,780,931


Liabilities and Stockholders’ Equity

Securities loaned		6,794,554			7,729,544
Payable to brokers, dealers and clearing organizations		669,196			303,480
Securities sold under agreements to repurchase		2,092,838			—
Payable to customers		1,010,486			813,896
Financial instruments sold, not yet purchased		3,619,004			1,300,317
Accrued expenses and other liabilities		707,264			530,477

		14,893,342			10,677,714
Long-term debt		1,268,543			779,873
Mandatorily redeemable convertible preferred stock		125,000			—
Minority interest		31,910			36,494

Total Liabilities		16,318,795			11,494,081
Stockholders’ equity:
Preferred stock, $.0001 par value. Authorized 10,000,000 shares; none issued		—			—
Common stock, $.0001 par value. Authorized 500,000,000 shares; issued 145,628,024 shares in 2006 and 140,857,994 shares in 2005		14			7
Additional paid-in capital		876,393			709,447
Retained earnings		952,263			803,262
Less:
Treasury stock, at cost; 26,081,110 shares in 2006 and 24,637,210 shares in 2005		(254,437	)		(220,703	)
Accumulated other comprehensive income (loss):
Currency translation adjustments		9,764			962
Additional minimum pension liability adjustment		(2,910	)		(6,125	)

Total accumulated other comprehensive income (loss)		6,854			(5,163	)

Total stockholders’ equity		1,581,087			1,286,850

Total liabilities and stockholders’ equity	$	17,899,882		$	12,780,931

See accompanying notes to consolidated financial statements.

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Consolidated Statements of Earnings
For each of the years in the three-year period ended December 31, 2006
(In thousands, except per share amounts)


	2006		2005		2004
Revenues:
Commissions	$	280,681	$	246,943	$	258,838
Principal transactions		468,002		349,489		358,213
Investment banking		540,596		495,014		352,804
Asset management fees and investment income from managed funds		109,550		82,052		81,184
Interest		528,882		304,053		134,450
Other		35,497		20,322		13,150

Total revenues		1,963,208		1,497,873		1,198,639
Interest expense		505,606		293,173		140,394

Revenues, net of interest expense		1,457,602		1,204,700		1,058,245

Non-interest expenses:
Compensation and benefits		791,255		669,957		595,887
Floor brokerage and clearing fees		62,564		46,644		52,922
Technology and communications		80,840		67,666		64,555
Occupancy and equipment rental		59,792		47,040		39,553
Business development		48,634		42,512		35,006
Other		65,863		62,474		43,333

Total non-interest expenses		1,108,948		936,293		831,256

Earnings before income taxes, minority interest, and cumulative effect of change in accounting principle		348,654		268,407		226,989
Income taxes		137,541		104,089		83,955

Earnings before minority interest and cumulative effect of change in accounting principle		211,113		164,318		143,034
Minority interest in earnings of consolidated subsidiaries, net		6,969		6,875		11,668

Earnings before cumulative effect of change in accounting principle, net		204,144		157,443		131,366
Cumulative effect of change in accounting principle, net		1,606		—		—

Net earnings	$	205,750	$	157,443	$	131,366

Earnings per share:
Basic-
Earnings before cumulative effect of change in accounting principle, net	$	1.53	$	1.27	$	1.14
Cumulative effect of change in accounting principle, net		0.01		—		—

Net earnings	$	1.54	$	1.27	$	1.14

Diluted-
Earnings before cumulative effect of change in accounting principle, net	$	1.41	$	1.16	$	1.03
Cumulative effect of change in accounting principle, net		0.01		—		—

Net earnings	$	1.42	$	1.16	$	1.03

Weighted average shares of common stock:
Basic		133,898		123,646		114,906
Diluted		147,531		135,569		127,815

See accompanying notes to consolidated financial statements.

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income
For each of the years in the three-year period ended December 31, 2006
(Dollars in thousands, except per share amounts)


	Year Ended December 31,
	2006			2005			2004
Common stock, par value $0.0001 per share
Balance, beginning of year		7			7			6
Issued / stock dividend		7			—			1

Balance, end of year		14			7			7


Additional paid in capital
Balance, beginning of year		709,447			508,221			364,774
Benefit plan share activity (1)		33,360			13,432			37,724
Amortization expense		83,137			100,217			68,839
Proceeds from exercise of stock options		17,543			33,661			10,184
Acquisitions		—			26,998			10,886
Tax benefits		32,906			26,918			15,814

Balance, end of year		876,393			709,447			508,221


Retained earnings
Balance, beginning of year		803,262			677,464			567,632
Net earnings		205,750			157,443			131,366
Dividends		(56,749	)		(31,645	)		(21,534	)

Balance, end of year		952,263			803,262			677,464


Treasury stock, at cost
Balance, beginning of year		(220,703	)		(149,039	)		(91,908	)
Purchases		(23,972	)		(76,291	)		(59,492	)
Returns / forfeitures		(9,762	)		(6,717	)		(8,525	)
Issued		—			11,344			10,886

Balance, end of year		(254,437	)		(220,703	)		(149,039	)


Accumulated other comprehensive income (loss)
Balance, beginning of year		(5,163	)		2,480			(2,133	)
Currency adjustment, net of tax		8,802			(8,386	)		4,017
Pension adjustment, net of tax		3,215			743			596

Balance, end of year		6,854			(5,163	)		2,480


Total stockholders’ equity		1,581,087			1,286,850			1,039,133


Comprehensive income
Net earnings		205,750			157,443			131,366
Other comprehensive income (loss), net of tax		12,017			(7,643	)		4,613

Total comprehensive income		217,767			149,800			135,979

(1)

Includes grants related to the Incentive Plan, Deferred Compensation Plan, ESOP, ESPP and Director Plan.

See accompanying notes to consolidated financial statements.

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Consolidated Statements of Cash Flows
Three years ended December 31, 2006
(Dollars in thousands)


	2006			2005			2004
Cash flows from operating activities:
Net earnings	$	205,750		$	157,443		$	131,366

Adjustments to reconcile net earnings to net cash provided by (used in) operating activities:
Cumulative effect of accounting change, net		(1,606	)		—			—
Depreciation and amortization		19,891			15,556			14,544
Accruals related to various benefit plans, stock issuances, net of forfeitures		109,505			118,276			117,720
Deferred income taxes		(37,982	)		(23,475	)		(31,532	)
(Increase) decrease in cash and securities segregated		103,254			(75,640	)		(371,079	)
(Increase) decrease in receivables:
Securities borrowed		(1,568,414	)		2,089,418			(1,864,593	)
Brokers, dealers and clearing organizations		149,026			(92,263	)		(20,370	)
Customers		(186,651	)		(105,113	)		(88,251	)
Increase in financial instruments owned		(2,868,747	)		(545,364	)		(337,857	)
Increase in securities purchased under agreements to resell		(226,176	)		—			—
Increase in other assets		(29,493	)		(71,318	)		(68,114	)
Increase (decrease) in payables:
Securities loaned		(934,990	)		(1,601,436	)		1,244,397
Brokers, dealers and clearing organizations		347,797			(58,856	)		263,386
Customers		183,265			127,959			211,503
Increase in financial instruments sold, not yet purchased		2,318,687			140,392			446,951
Increase in securities sold under agreements to repurchase		2,092,838			—			—
Increase in accrued expenses and other liabilities		159,926			222,027			90,810
Increase (decrease) in minority interest		(4,584	)		1,408			(14,834	)

Net cash used in (provided by) operating activities		(168,704	)		299,014			(275,953	)

Cash flows from investing activities:
(Increase) decrease in short term bond funds		7,037			(176	)		208,929
(Increase) decrease in investments		(26,407	)		(9,277	)		(11,623	)
Increase in investments in managed funds		(86,008	)		(82,134	)		(68,796	)
Purchase of premises and equipment		(39,342	)		(27,186	)		(17,012	)
Business acquisitions, net of cash received		(19,944	)		(61,955	)		(9,994	)

Net cash flows (used in) provided by investing activities		(164,664	)		(180,728	)		101,504

Cash flows from financing activities:
Tax benefits from the issuance of stock based awards		32,906			—			—
Net proceeds from (payments on):
Bank loans		—			(70,000	)		70,000
Issuance of long term debt		492,155			—			347,809
Issuance of mandatorily redeemable convertible preferred stock		125,000			—			—
Retirement of long term debt		—			—			(300	)
Payments on:
Repurchase of treasury stock		(23,972	)		(76,291	)		(59,492	)
Dividends paid		(56,749	)		(31,645	)		(21,534	)
Proceeds from exercise of stock options		17,543			33,661			10,184
Common shares		—			—			—

Net cash (used in) provided by financing activities		586,883			(144,275	)		346,667

Effect of currency translation on cash		3,593			(2,189	)		4,017

Net (decrease) increase in cash and cash equivalents		257,108			(28,178	)		176,235
Cash and cash equivalents at beginning of year		255,933			284,111			107,876

Cash and cash equivalents at end of year	$	513,041		$	255,933		$	284,111

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Consolidated Statements of Cash Flows — (Continued)
Three years ended December 31, 2006
(Dollars in thousands)


	2006		2005			2004
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest	$	492,179	$	283,318		$	121,444
Income taxes		198,294		87,013			91,954

Randall & Dewey acquisition:
Fair value of assets acquired, including goodwill			$	53,503
Liabilities assumed				(8,769	)
Stock issued (456,442 shares)				(17,500	)

Cash paid for acquisition				27,234
Cash acquired in acquisition				1,435

Net cash paid for acquisition			$	25,799


Helix acquisition:
Fair value of assets acquired, including goodwill			$	41,615
Liabilities assumed				(5,085	)
Stock issued (315,597 shares)				(9,498	)

Cash paid for acquisition				27,032
Cash acquired in acquisition				—

Net cash paid for acquisition			$	27,032


Bonds Direct acquisition:
Fair value of assets acquired, including goodwill						$	20,643
Liabilities assumed							(863	)
Stock issued (311,842 shares)							(10,886	)

Cash paid for acquisition							8,894
Cash acquired in acquisition							11

Net cash paid for acquisition						$	8,883

Supplemental disclosure of non-cash financing activities:

In 2004, the additional minimum pension liability included in stockholders’ equity of $6,868 resulted from a decrease of $596 to accrued expenses and other liabilities and an offsetting increase in stockholders’ equity. In 2005, the additional minimum pension liability included in stockholders’ equity of $6,125 resulted from a decrease of $743 to accrued expenses and other liabilities and an offsetting increase in stockholders’ equity. In 2006, the additional minimum pension liability included in stockholders’ equity of $2,910 resulted from a decrease of $3,215 to accrued expenses and other liabilities and an offsetting increase in stockholders’ equity.

See accompanying notes to consolidated financial statements.

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements
December 31, 2006 and 2005

Index


Note		Page
(1)	Organization and Summary of Significant Accounting Policies		49
(2)	Asset Management Fees and Investment Income From Managed Funds		57
(3)	Cash, Cash Equivalents, and Short-Term Investments		59
(4)	Receivable from, and Payable to, Customers		60
(5)	Financial Instruments Owned and Financial Instruments Sold, Not Yet Purchased		60
(6)	Premises and Equipment		61
(7)	Long-Term Debt		61
(8)	Mandatorily Redeemable Convertible Preferred Stock		62
(9)	Income Taxes		62
(10)	Defined Benefit Plan		64
(11)	Minority Interest		65
(12)	Earnings Per Share		66
(13)	Leases		67
(14)	Derivative Financial Instruments		67
(15)	Other Comprehensive Income (Loss)		70
(16)	Net Capital Requirements		71
(17)	Commitments and Guarantees		71
(18)	Segment Reporting		73
(19)	Goodwill		74
(20)	Quarterly Dividends		75
(21)	Variable Interest Entities (“VIEs”)		75
(22)	Related Party Disclosures		76
(23)	Stock Based Compensation		76
(24)	Selected Quarterly Financial Data (Unaudited)		83
(25)	Subsequent Events (Unaudited)		83

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2006 and 2005

(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 audited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S.”) for financial information and with the instructions to Form 10-K and Article 10 of Regulation S-X.

Reclassifications

Certain reclassifications have been made to previously reported balances to conform to the current presentation. These reclassifications had no effect on net earnings.

Commencing this year, 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 December 31, 2005 and December 31, 2004 periods to be consistent with the current presentation. The cash payments related to the contingent consideration are primarily paid during the first quarter. For the year ended December 31, 2005, this correction had the effect of reducing net cash used in operating activities and increasing net cash used in investing activities by $8.9 million from that previously reported. For the year ended December 31, 2004, this correction had the effect of increasing net cash provided by operating activities and increasing net cash used in investing activities by $1.1 million from that previously reported. The amounts involved are immaterial to the Consolidated Financial Statements. In addition, the change only affects 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 annual 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)
December 31, 2006 and 2005

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. In those cases where our investment is less than 20% and significant influence does not exist, the investments are carried at fair value. Significant influence generally is deemed to exist when we own 20% to 50% of the voting equity of a corporation, or when we hold at least 3% of a limited partnership interest. 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 and accounted for under the equity method of accounting. 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 $32.1 million and $37.7 million for 2006 and 2005, 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) are valued at market or fair value, as appropriate, with unrealized gains and losses reflected in Principal transactions in the Consolidated Statement of Earnings on a trade date basis. Market value generally is determined based on listed prices or broker quotes. In certain instances, such price quotations may be deemed unreliable when the instruments are thinly traded and the listed price is not deemed to be readily realizable. In these instances we determine fair value based on our management’s best estimate, giving appropriate consideration to reported prices, the extent of public trading in similar securities and the discount from the listed price associated with the cost at the date of acquisition, among other factors. When listed prices or broker quotes are not available, we determine fair value based on pricing models or other valuation techniques, including the use of implied pricing from similar instruments. We typically use pricing models to derive fair value based on the net present value of estimated future cash flows including adjustments, when appropriate, for liquidity, credit and/or other factors.

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2006 and 2005

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 $17.9 million and $16.3 million for the year ended December 31, 2006 and 2005, respectively.

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, 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 on a net basis, in accordance with FASB Interpretation No. 39, Offsetting of Amounts Related to Certain Contracts, 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.

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2006 and 2005

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. In situations where we have significant influence but not control, we apply the equity method of accounting. In those cases where our investment is less than 20% and significant influence does not exist, the investments are carried at fair value. Significant influence generally is deemed to exist when we own 20% to 50% of the voting equity of a corporation or when we hold at least 3% of a limited partnership interest. Factors considered in valuing investments where significant influence does not exist 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. Investment gains and losses are included in Principal transactions in the Consolidated Statements of Earnings.

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 carried at fair value.

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. Long-term 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. 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, market 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.

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2006 and 2005

We follow Emerging issues Task Force (“EITF”) 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. This guidance generally prohibits recognizing profit at the inception of a derivative contract unless the fair value of the derivative is obtained from a quoted market price in an active market or is 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 recognize trading profits deferred at inception of the derivative transaction in the period in which the valuation of an instrument becomes observable.

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 2006 that required a re-evaluation of goodwill for impairment purposes. Goodwill was tested for impairment as of September 30, 2006 and based on this impairment test/analysis no reporting units were considered impaired.

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2006 and 2005

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

We adopted FASB No. 123R, Share-Based Payment (“FASB 123R”), as required, on January 1, 2006, using the modified prospective method. FASB 123R applies to all awards granted after January 1, 2006 and to awards modified, repurchased, or cancelled after that date. Upon adoption of FASB 123R on January 1, 2006, we recognized an after-tax gain of approximately $1.6 million as the cumulative effect of a change in accounting principle, attributable to the requirement to estimate forfeitures at the date of grant instead of recognizing them as incurred. The accounting treatment of share-based awards granted to employees prior to the adoption of FASB 123R has not changed and financial statements for periods prior to adoption are not restated for the effects of adopting FASB 123R.

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


		Page
Management’s Report on Internal Control over Financial Reporting.		40
Report of Independent Registered Public Accounting Firm.		41
Report of Independent Registered Public Accounting Firm.		42
Consolidated Statements of Financial Condition as of December 31, 2006 and 2005.		43
Consolidated Statements of Earnings for Each of the Years in the Three-Year Period Ended December 31, 2006.		44
Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income for Each of the Years in the Three-Year Period Ended December 31, 2006.		45
Consolidated Statements of Cash Flows for Each of the Years in the Three-Year Period Ended December 31, 2006.		46
Notes to Consolidated Financial Statements.		48