UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

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

For the quarterly period ended June 30, 2007

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

For the transition period from                      to

JEFFERIES GROUP, INC.

(Exact name of registrant as specified in its charter)

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

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

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

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

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

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

Indicate the number of shares outstanding of the registrant’s class of common stock, as of the latest practicable date. 125,840,905 shares as of the close of business August 6, 2007.

 

 

JEFFERIES GROUP, INC. AND SUBSIDIARIES
INDEX TO QUARTERLY REPORT ON FORM 10-Q
JUNE 30, 2007

						Page
PART I.				FINANCIAL INFORMATION
		Item 1.		Financial Statements
				Consolidated Statements of Financial Condition (unaudited) — June 30, 2007 and December 31, 2006		3
				Consolidated Statements of Earnings (unaudited) — Three Months and Six Months Ended June 30, 2007 and 2006		4
				Consolidated Statement of Changes in Stockholders’ Equity (unaudited) — Six Months Ended June 30, 2007 and Year Ended December 31, 2006		5
				Consolidated Statements of Cash Flows (unaudited) — Six Months Ended June 30, 2007 and 2006		6
				Notes to Consolidated Financial Statements (unaudited)		8
		Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		43
		Item 3.		Quantitative and Qualitative Disclosures About Market Risk		58
		Item 4.		Controls and Procedures		62
PART II.				OTHER INFORMATION
		Item 1.		Legal Proceedings		62
		Item 1A.		Risk Factors		62
		Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		62
		Item 4.		Submission of Matters to a Vote of Security Holders		63
		Item 6.		Exhibits		64
		Signature				65
EXHIBIT 10.3
EXHIBIT 10.4
EXHIBIT 10.5
EXHIBIT 10.6
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32

PART I. FINANCIAL INFORMATION

		June 30,				December 31,
		2007				2006
ASSETS
Cash and cash equivalents		$	709,661			$	513,041
Cash and securities segregated and on deposit for regulatory purposes or deposited with clearing and depository organizations			757,415				508,303
Investments			137,613				125,533
Investments in managed funds			327,392				372,869
Securities borrowed			19,679,270				9,711,894
Securities purchased under agreements to resell			1,705,693				226,176
Receivable from brokers, dealers and clearing organizations			845,279				254,580
Receivable from customers			777,322				663,552
Financial instruments owned, including securities pledged to creditors of $2,010,710 and $1,481,098 in 2007 and 2006, respectively			6,629,269				4,606,223
Premises and equipment			109,536				91,375
Goodwill			305,324				257,321
Other assets			529,301				494,590
Total Assets		$	32,513,075			$	17,825,457
LIABILITIES AND STOCKHOLDERS’ EQUITY
Bank loans and current portion of long-term debt		$	163,796			$	99,981
Securities loaned			9,871,507				6,794,554
Securities sold under agreements to repurchase			10,557,975				2,092,838
Payable to brokers, dealers and clearing organizations			1,216,533				669,196
Payable to customers			1,015,156				1,010,486
Financial instruments sold, not yet purchased			4,807,479				3,600,869
Accrued expenses and other liabilities			600,535				650,974
			28,232,981				14,918,898
Long-term debt			1,759,284				1,168,562
Mandatorily redeemable convertible preferred stock			125,000				125,000
Minority interest			607,166				31,910
Total Liabilities			30,724,431				16,244,370
STOCKHOLDERS’ EQUITY
Common stock, $.0001 par value. Authorized 500,000,000 shares; issued 153,078,810 shares in 2007 and 145,628,024 shares in 2006			15				14
Additional paid-in capital			1,020,542				876,393
Retained earnings			1,049,323				952,263
Less:
Treasury stock, at cost, 27,338,668 shares in 2007 and 26,081,110 shares in 2006			(289,479	)			(254,437	)
Accumulated other comprehensive gain:
Currency translation adjustments			11,153				9,764
Additional minimum pension liability			(2,910	)			(2,910	)
Total accumulated other comprehensive gain			8,243				6,854
Total stockholders’ equity			1,788,644				1,581,087
Total Liabilities and Stockholders’ Equity		$	32,513,075			$	17,825,457

See accompanying unaudited notes to consolidated financial statements.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

		Three Months Ended								Six Months Ended
		June 30,				June 30,				June 30,				June 30,
		2007				2006				2007				2006
Revenues:
Commissions		$	83,094			$	71,634			$	160,126			$	140,636
Principal transactions			129,030				94,124				273,479				254,104
Investment banking			223,093				122,932				393,208				250,666
Asset management fees and investment income from managed funds			13,384				22,527				35,869				63,349
Interest			310,739				138,851				511,901				252,611
Other			7,005				7,051				15,046				19,830
Total revenues			766,345				457,119				1,389,629				981,196
Interest expense			300,885				129,776				505,360				238,439
Revenues, net of interest expense			465,460				327,343				884,269				742,757
Non-interest expenses:
Compensation and benefits			251,602				176,675				479,268				409,409
Floor brokerage and clearing fees			16,527				16,934				31,109				30,867
Technology and communications			23,703				19,128				45,860				38,373
Occupancy and equipment rental			17,864				13,399				36,035				28,571
Business development			12,080				10,801				25,189				23,404
Other			15,293				9,691				34,924				34,011
Total non-interest expenses			337,069				246,628				652,385				564,635
Earnings before income taxes, minority interest and cumulative effect of change in accounting principle			128,391				80,715				231,884				178,122
Income taxes			45,046				31,357				85,704				69,789
Earnings before minority interest and cumulative effect of change in accounting principle			83,345				49,358				146,180				108,333
Minority interest in earnings of consolidated subsidiaries			15,510				3,778				16,086				5,912
Earnings before cumulative effect of change in accounting principle, net			67,835				45,580				130,094				102,421
Cumulative effect of change in accounting principle, net			—				—				—				1,606
Net earnings		$	67,835			$	45,580			$	130,094			$	104,027
Earnings per share:
Basic-
Earnings before cumulative effect of change in accounting principle, net		$	0.48			$	0.34			$	0.92			$	0.78
Cumulative effect of change in accounting principle, net			—				—				—				0.01
Net earnings		$	0.48			$	0.34			$	0.92			$	0.79
Diluted-
Earnings before cumulative effect of change in accounting principle, net		$	0.45			$	0.32			$	0.86			$	0.72
Cumulative effect of change in accounting principle, net			—				—				—				0.01
Net earnings		$	0.45			$	0.32			$	0.86			$	0.73
Weighted average shares:
Basic			142,092				133,621				141,498				131,993
Diluted			154,301				147,605				153,183				145,287
Fixed charge coverage ratio			5.5X				4.2X				5.3X				4.7X

See accompanying unaudited notes to consolidated financial statements.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

		Six Months				Year
		Ended				Ended
		June 30,				December 31,
		2007				2006
Common stock, par value $.0001 per share
Balance, beginning of year		$	14			$	7
Issued stock			1				7
Balance, end of period		$	15			$	14
Additional paid in capital
Balance, beginning of year		$	876,393			$	709,447
Benefit plan share activity (1)			24,648				33,360
Amortization expense			73,047				83,137
Proceeds from exercise of stock options			2,391				17,543
Acquisitions			7,896				—
Tax benefits			36,167				32,906
Balance, end of period		$	1,020,542			$	876,393
Retained earnings
Balance, beginning of year, as previously reported		$	952,263			$	803,262
Cumulative effect of adjustment from adoption of FIN 48			(410	)			—
Net earnings			130,094				205,750
Dividends			(32,624	)			(56,749	)
Balance, end of period		$	1,049,323			$	952,263
Treasury stock, at cost
Balance, beginning of year		$	(254,437	)		$	(220,703	)
Purchases			(32,720	)			(23,972	)
Returns / forfeitures			(2,322	)			(9,762	)
Balance, end of period		$	(289,479	)		$	(254,437	)
Accumulated other comprehensive income (loss)
Balance, beginning of year		$	6,854			$	(5,163	)
Currency adjustment			1,389				8,802
Pension adjustment			—				3,215
Balance, end of period		$	8,243			$	6,854
Total stockholders’ equity		$	1,788,644			$	1,581,087
Comprehensive income
Net earnings		$	130,094			$	205,750
Other comprehensive income			1,389				12,017
Total comprehensive income		$	131,483			$	217,767

See accompanying unaudited notes to consolidated financial statements.

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

		Six Months Ended
		June 30,				June 30,
		2007				2006
Cash flows from operating activities:
Net earnings		$	130,094			$	104,027
Adjustments to reconcile net earnings to net cash used in operating activities:
Cumulative effect of accounting change, net			—				1,606
Depreciation and amortization			13,173				9,593
Accruals related to various benefit plans, stock issuances, net of forfeitures			95,374				46,794
(Increase) in cash and securities segregated and on deposit for regulatory purposes or deposited with clearing and depository organizations			(248,279	)			(292,527	)
(Increase) decrease in receivables:
Securities borrowed			(9,967,303	)			168,137
Brokers, dealers and clearing organizations			(632,768	)			(181,543	)
Customers			(113,390	)			(58,612	)
Increase in financial instruments owned			(1,721,667	)			(1,936,566	)
Increase in securities purchased under agreements to resell			(1,479,517	)			—
Increase in other assets			(38,559	)			(31,885	)
Increase (decrease) in operating payables:
Securities loaned			3,110,333				(140,623	)
Securities sold under agreements to repurchase			8,465,137				—
Brokers, dealers and clearing organizations			624,170				261,915
Customers			4,678				155,412
Increase in financial instruments sold, not yet purchased			1,136,303				1,451,725
(Decrease) increase in accrued expenses and other liabilities			(59,865	)			38,789
Increase (decrease) in minority interest			16,086				(2,699	)
Net cash used in operating activities			(666,000	)			(406,457	)
Cash flows from investing activities:
Decrease in short term bond funds			—				7,037
Increase in investments			(9,953	)			(17,256	)
Increase in investments in managed funds			(13,216	)			(2,747	)
Business acquisitions, net of cash received			(17,185	)			—
Cash paid for contingent consideration			(25,720	)			(19,944	)
Purchase of premises and equipment			(30,409	)			(15,107	)
Net cash used in investing activities			(96,483	)			(48,017	)

Continued on next page.

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

		Six Months Ended
		June 30,				June 30,
		2007				2006
Cash flows from financing activities
Tax benefit from the issuance of stock based awards			36,167				16,802
Proceeds from reorganization of high yield secondary market trading			354,256				—
Redemption of capital units related to our reorganization of high yield secondary market trading			(25,780	)			—
Net proceeds from (payments on):
Bank loans			63,801				—
Issuance of senior notes			593,176				492,155
Issuance of mandatorily redeemable convertible preferred stock			—				125,000
Minority interest holders of consolidated subsidiaries related to asset management activities			525				—
Repurchase of treasury stock			(32,720	)			(15,218	)
Dividends			(32,624	)			(25,203	)
Exercise of stock options, not including tax benefits			2,391				11,695
Net cash provided by financing activities			959,192				605,231
Effect of foreign currency translation on cash and cash equivalents			(89	)			(587	)
Net increase in cash and cash equivalents			196,620				150,170
Cash and cash equivalents — beginning of period			513,041				255,933
Cash and cash equivalents — end of period		$	709,661			$	406,103
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest		$	485,991			$	217,162
Income taxes		$	27,112			$	94,921
Non-cash proceeds from reorganization of high yield secondary market trading		$	230,169			$	—
LongAcre Acquisition:
Fair value of assets acquired, including goodwill			31,231				—
Liabilities assumed			(6,150	)			—
Stock issued (311,831 shares)			(7,896	)			—
Cash paid for acquisition			17,185				—

See accompanying unaudited notes to consolidated financial statements.

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

Index

				Page
Note 1.		Organization and Summary of Significant Accounting Policies		9
Note 2.		Asset Management Fees and Investment Income From Managed Funds		19
Note 3.		Cash, Cash Equivalents, and Short-Term Investments		22
Note 4.		Financial Instruments		22
Note 5.		Short-Term Borrowings		25
Note 6.		Long-Term Debt		25
Note 7.		Mandatorily Redeemable Convertible Preferred Stock		25
Note 8.		Income Taxes		26
Note 9.		Benefit Plans		26
Note 10.		Minority Interest		27
Note 11.		Earnings Per Share		28
Note 12.		Derivative Financial Instruments		29
Note 13.		Other Comprehensive Gain (Loss)		32
Note 14.		Net Capital Requirements		33
Note 15.		Commitments, Contingencies and Guarantees		33
Note 16.		Segment Reporting		35
Note 17.		Goodwill		36
Note 18.		Quarterly Dividends		37
Note 19.		Variable Interest Entities (“VIEs”)		37
Note 20.		High Yield Secondary Market Trading (“HYSMT”)		38
Note 21.		Stock Based Compensation		39

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

Note 1. Organization and Summary of Significant Accounting Policies

Organization

The accompanying unaudited consolidated financial statements include the accounts of Jefferies Group, Inc. and all its subsidiaries (together, “we” or “us”), including Jefferies & Company, Inc. (“Jefferies”), Jefferies Execution Services, Inc., (“Jefferies Execution”), Jefferies International Limited, Jefferies Asset Management, LLC, Jefferies Financial Products, LLC and all other entities in which we have a controlling financial interest or are the “primary beneficiary”, including Jefferies High Yield Holdings, LLC (“JHYH”), Jefferies Special Opportunities Partners, LLC (“JSOP”) and Jefferies Employees Special Opportunities Partners, LLC (“JESOP”). The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the U.S. for complete financial statements. All adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the six-month period ended June 30, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007. These unaudited consolidated financial statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2006.

Reclassifications

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

Starting in the third quarter of 2006, we included contingent consideration paid in subsequent periods relating to prior business combinations as investing activities in the Consolidated Statements of Cash Flows included in this report and accordingly have corrected the June 30, 2006 period to be consistent with the current presentation. The cash payments related to the contingent consideration are primarily paid during the first quarter. For the six months ended June 30, 2006, this correction had the effect of reducing net cash used in operating activities and increasing net cash used in investing activities by $19.9 million from that previously reported. The amounts involved are immaterial to the Consolidated Financial Statements. In addition, the change only affects the presentation within the Consolidated Statements of Cash Flows and does not impact the Consolidated Statements of Financial Condition or the Consolidated Statements of Earnings, debt balances or compliance with debt covenants.

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

Summary of Significant Accounting Policies

Principles of Consolidation

Our policy is to consolidate all entities in which we own more than 50% of the outstanding voting stock and have control. In addition, in accordance with Financial Accounting Standards Board (“FASB”) Interpretation No. 46(R), Consolidation of Variable Interest Entities (“FIN 46(R)”), as revised, we consolidate entities which lack characteristics of an operating entity or business for which we are the primary beneficiary. Under FIN 46(R), the primary beneficiary is the party that absorbs a majority of the entity’s expected losses, receives a majority of its expected residual returns, or both, as a result of holding variable interests, direct or implied. In situations where we have significant influence but not control of an entity that does not qualify as a variable interest entity, we apply the equity method of accounting. If we do not consolidate an entity or apply the equity method of accounting, we account for our investment at fair value. We also have formed nonconsolidated investment vehicles with third-party investors that are typically organized as limited partnerships. We act as general partner for these investment vehicles and have generally provided the third-party investors with termination or “kick-out” rights as defined by EITF 04-5, Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights.

All material intercompany accounts and transactions are eliminated in consolidation.

Revenue Recognition Policies

Commissions. All customer securities transactions are reported on the Consolidated Statement of Financial Condition on a settlement date basis with related income reported on a trade-date basis. Under clearing agreements, we clear trades for unaffiliated correspondent brokers and retain a portion of commissions as a fee for our services. Correspondent clearing revenues are included in other revenue. We permit institutional customers to allocate a portion of their gross commissions to pay for research products and other services provided by third parties. The amounts allocated for those purposes are commonly referred to as soft dollar arrangements. Soft dollar expenses amounted to $8.9 million and $9.0 million for the three month periods ended June 30, 2007 and 2006, respectively. Soft dollar expenses amounted to $16.6 million and $17.0 million for the six month periods ended June 30, 2007 and 2006, respectively. We are accounting for the cost of these arrangements on an accrual basis. Our accounting for commission revenues includes the guidance contained in Emerging Issues Task Force (“EITF”) Issue No. 99-19, Reporting Revenues Gross versus Net, because we are not the primary obligor of such arrangements, and accordingly, expenses relating to soft dollars are netted against the commission revenues.

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

Investment Banking. Underwriting revenues and fees from mergers and acquisitions, restructuring and other investment banking advisory assignments are recorded when the services related to the underlying transaction are completed under the terms of the assignment or engagement. Expenses associated with such transactions are deferred until reimbursed by the client, the related revenue is recognized or the engagement is otherwise concluded. Expenses are recorded net of client reimbursements. Revenues are presented net of related unreimbursed expenses. Unreimbursed expenses with no related revenues are included in business development in the Consolidated Statement of Earnings. Reimbursed expenses totaled approximately $3.6 million and $3.1 million for the three month periods ended June 30, 2007 and 2006, respectively, and totaled approximately $5.8 million and $6.7 million for the six month periods ended June 30, 2007 and 2006, 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

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

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. 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. 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. In addition, we recognize interest revenue related to our securities borrowed activities and interest expense related to our securities loaned activities. See accounting policies related to securities borrowed and securities loaned for further explanation.

Cash Equivalents

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

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

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

Foreign Currency Translation

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

Investments

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

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

Receivable from, and Payable to, Customers

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

Fair Value of Financial Instruments

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

In addition to the interest rate swaps mentioned above, we have derivative financial instrument positions in exchange traded and over-the-counter option contracts, foreign exchange forward contracts, index futures contracts, commodities swap and option contracts and commodities futures contracts, which are measured at fair value with

JEFFERIES GROUP, INC. AND SUBSIDIARIES
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gains and losses recognized in principal transactions. The gross contracted or notional amount of these contracts is not reflected in the Consolidated Statements of Financial Condition. We follow FIN No. 39, Offsetting Amounts Related to Certain Contracts (“FIN 39”), and offset assets and liabilities in the Consolidated Statements of Financial Condition provided that the legal right of offset exists under a master netting agreement. This includes the offsetting of payables or receivables relating to the fair value of cash collateral received or paid associated with its derivative inventory, on a counterparty basis.

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

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 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 this 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

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

Income Taxes

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

Legal Reserves

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

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

Stock Based Compensation

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

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inception date, which is the grant date, through the date the employee is no longer required to provide service to earn the award.

In addition, with the adoption of FASB 123R on January 1, 2006, the awards granted to retirement eligible employees where the award does not contain future service requirements must be either expensed on the date of grant or, in certain circumstances, may be accrued in the periods prior to the grant date. Subsequent to the adoption of FASB 123R, we made certain changes to the terms of certain new grants which effectively eliminated accelerated expense recognition upon retirement and/or increased the retirement eligibility age and years of service from those generally provided for in prior grants. During the three month and six month periods ended June 30, 2007, we granted stock-based awards with a fair value of $0.3 million and $9.2 million, respectively, which require accelerated expense recognition upon retirement under FASB 123R.

Earnings per Common Share

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

Accounting and Regulatory Developments

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FASB Interpretation No. 48. In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The transition adjustment to beginning retained earnings was a reduction of approximately $0.4 million.

FASB No. 157. In September 2006, the FASB issued FASB No. 157, Fair Value Measurements (“FASB 157”). FASB 157 clarifies that fair value is the amount that would be exchanged to sell an asset or transfer a liability, in an orderly transaction between market participants. FASB 157 reverses the consensus reached in EITF Issue No. 02-3 prohibiting the recognition of day one gain or loss on derivative contracts where we cannot verify all of the significant model inputs to observable market data and verify the model to market transactions. However, FASB 157 requires that a fair value measurement technique include an adjustment for risks inherent in a particular valuation technique (such as a pricing model) and/or the risks inherent in the inputs to the model, if market participants would also include such an adjustment. In addition, FASB 157 prohibits the recognition of “block discounts” for large holdings of unrestricted financial instruments where quoted prices are readily and regularly available in an active market. The provisions of FASB 157 are to be applied prospectively, except for changes in fair value measurements that result from the initial application of FASB 157 to existing derivative financial instruments measured under EITF Issue No. 02-3 and block discounts, which are to be recorded as an adjustment to opening retained earnings in the year of adoption. FASB 157 is effective for fiscal years beginning after November 15, 2007. We adopted FASB No. 157 as of the beginning of 2007. To determine the transition adjustment to opening retained earnings, we performed an analysis of existing derivative instruments measured under EITF Issue 02-3 and block discounts, and determined that there was no transition adjustment to opening retained earnings as of January 1, 2007.

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

FASB No. 159. In February 2007, the FASB issued FASB No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115 (“FASB 159”). This standard permits an entity to measure financial instruments and certain other items at estimated fair value. Most of the provisions of FASB

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

FSP FIN 39-1. In April 2007, the FASB issued a Staff Position (“FSP”) FIN No. 39-1, Amendment of FASB Interpretation No. 39. FSP FIN No. 39-1 defines “right of setoff” and specifies what conditions must be met for a derivative contract to qualify for this right of setoff. It also addresses the applicability of a right of setoff to derivative instruments and clarifies the circumstances in which it is appropriate to offset amounts recognized for those instruments in the statement of financial position. In addition, this FSP permits offsetting of fair value amounts recognized for multiple derivative instruments executed with the same counterparty under a master netting arrangement and fair value amounts recognized for the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) arising from the same master netting arrangement as the derivative instruments. The provisions of this FSP are consistent with our current accounting practice. This interpretation is effective for fiscal years beginning after November 15, 2007, with early application permitted. The adoption of FSP FIN No. 39-1 will not have a material impact on our Consolidated Financial Statements.

EITF Issue No. 06-11. In June 2007, the FASB ratified the consensus reached by the Emerging Issues Task Force on Issue 06-11, Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards (“EITF 06-11”). EITF 06-11 requires that the tax benefit related to dividends or dividend equivalents that are charged to retained earnings and are paid to employees for equity classified nonvested equity shares, nonvested equity share units, and outstanding equity share options be recorded as an increase in additional paid-in capital. We currently account for this tax benefit as a reduction to income tax expense. EITF 06-11 is to be applied prospectively for tax benefits on dividends declared in fiscal years beginning after December 15, 2007. We intend to adopt EITF 06-11 in the first quarter of 2008. We are currently evaluating the impact of EITF 06-11 on our results of operations for the first quarter of 2008.

SOP No. 07-1. In June 2007, the American Institute of Certified Public Accountants issued Statement of Position No. 07-1, Clarification of the Scope of the Audit and Accounting Guide ‘Audits of Investment Companies’ and Accounting by Parent Companies and Equity Method Investors for Investments in Investment Companies (“SOP 07-1”). SOP 07-1 clarifies the scope of when an entity may apply the provisions of the AICPA Audit and Accounting

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Guide Investment Companies (“the Guide”). SOP 07-1 also provides guidance for determining whether the specialized industry accounting principles of the Guide should be retained in the financial statements of a parent company of an investment company or an equity method investor in an investment company, and includes certain disclosure requirements. SOP 07-1 is effective for fiscal years beginning after December 15, 2007 with early adoption encouraged. We are currently evaluating the impact of SOP 07-1 on our results of operations.

Use of Estimates

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

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

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

		June 30,				June 30,
		2007				2006
Assets under management:
Fixed Income (1)		$	1,481			$	1,077
Equities			235				465
Convertibles			2,872				1,987
			4,588				3,529
Assets under management by third parties (2):
Equities, Convertibles and Fixed Income			303				254
Private Equity			600				600
			903				854
Total		$	5,491			$	4,383

The following summarizes revenues from asset management fees and investment income from managed funds relating to funds managed by us and funds managed by third parties for the three and six-month periods ended June 30, 2007 and 2006 (in thousands of dollars):

		Three Months Ended								Six Months Ended
		June 30,				June 30,				June 30,				June 30,
		2007				2006				2007				2006
Asset management fees:
Fixed Income (1)		$	3,162			$	11,068			$	7,602			$	16,110
Equities			965				(5,247	)			3,145				11,883
Convertibles			3,166				3,054				5,997				4,697
Real Assets			—				43				—				2,237
			7,293				8,918				16,744				34,927
Investment income from managed funds			6,091				13,609				19,125				28,422
Total		$	13,384			$	22,527			$	35,869			$	63,349

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The following tables detail our average investment in managed funds, investment income from managed funds, investment income from managed funds — minority interest portion and net investment income from managed funds relating to funds managed by us and funds managed by third parties for the three months ended June 30, 2007 and 2006 (in millions of dollars):

Three Months Ended June 30, 2007

										Investment Income
										from Managed Funds —				Net Investment
		Average				Investment Income				Minority				Income from Managed
		Investment				from Managed Funds				Interest Portion				Funds
Fixed Income (1)		$	222.0			$	5.0			$	—			$	5.0
Equities			169.0				0.4				0.3				0.1
Convertibles			34.1				0.7				—				0.7
Total		$	425.1			$	6.1			$	0.3			$	5.8

Three Months Ended June 30, 2006

										Investment Income
										from Managed Funds —				Net Investment
		Average				Investment Income				Minority				Income from Managed
		Investment				from Managed Funds				Interest Portion				Funds
Fixed Income		$	185.7			$	13.3			$	4.1			$	9.2
Equities			74.0				—				—				—
Convertibles			12.8				0.3				—				0.3
Real Assets			3.0				—				—				—
Total		$	275.5			$	13.6			$	4.1			$	9.5

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The following tables detail our average investment in managed funds, investment income from managed funds, investment income from managed funds — minority interest portion and net investment income from managed funds relating to funds managed by us and funds managed by third parties for the six months ended June 30, 2007 and 2006 (in millions of dollars):

Six Months Ended June 30, 2007

										Investment Income
										from Managed Funds -				Net Investment
		Average				Investment Income				Minority				Income from Managed
		Investment				from Managed Funds				Interest Portion				Funds
Fixed Income (1)		$	248.4			$	12.4			$	0.4			$	12.0
Equities			165.3				5.5				0.4				5.1
Convertibles			33.8				1.2				—				1.2
Total		$	447.5			$	19.1			$	0.8			$	18.3

Six Months Ended June 30, 2006

										Investment Income
										from Managed Funds -				Net Investment
		Average				Investment Income				Minority				Income from Managed
		Investment				from Managed Funds				Interest Portion				Funds
Fixed Income		$	171.9			$	20.8			$	5.8			$	15.0
Equities			74.1				5.9				—				5.9
Convertibles			12.5				1.0				—				1.0
Real Assets			7.1				0.7				—				0.7
Total		$	265.6			$	28.4			$	5.8			$	22.6

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

We generally invest our excess cash in money market funds and other short-term investments. Cash equivalents include highly liquid investments not held for resale with original maturities of three months or less. The following are financial instruments that are cash and cash equivalents or are deemed by our management to be generally readily convertible into cash as of June 30, 2007 and December 31, 2006 (in thousands of dollars):

		June 30, 2007				December 31, 2006
Cash and cash equivalents:
Cash in banks		$	216,815			$	107,488
Money market investments			492,846				405,553
Total cash and cash equivalents			709,661				513,041
Cash and securities segregated (1)			757,415				508,303
Mortgage-backed securities (2)			1,001				43,151
Asset-backed securities (2)			2,570				28,009
		$	1,470,647			$	1,092,504

Note 4. Financial Instruments

The following is a summary of the fair value of major categories of financial instruments owned and financial instruments sold, not yet purchased, as of June 30, 2007 and December 31, 2006 (in thousands of dollars):

		June 30, 2007								December 31, 2006
						Financial								Financial
						Instruments								Instruments
		Financial				Sold,				Financial				Sold,
		Instruments				Not Yet				Instruments				Not Yet
		Owned				Purchased				Owned				Purchased
Corporate equity securities		$	2,985,217			$	2,540,460			$	1,737,174			$	1,835,046
Corporate debt securities			2,351,668				1,300,265				1,918,829				1,185,400
U.S. Government and agency obligations			963,538				596,667				634,263				339,891
Mortgage-backed securities			1,001				—				43,151				—
Asset-backed securities			2,570				—				28,009				—
Derivatives			320,948				369,781				234,646				240,231
Other			4,327				306				10,151				301
		$	6,629,269			$	4,807,479			$	4,606,223			$	3,600,869

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Financial instruments owned includes securities pledged to creditors. The following is a summary of the fair value of major categories of securities pledged to creditors as of June 30, 2007 and December 31, 2006 (in thousands of dollars):

		June 30, 2007				December 31, 2006
Corporate equity securities		$	1,711,914			$	1,068,498
Corporate debt securities			298,796				412,600
		$	2,010,710			$	1,481,098

At June 30, 2007 and December 31, 2006, the approximate fair value of collateral received by us that may be sold or repledged by us was $20.7 billion and $9.8 billion, respectively. This collateral was received in connection with resale agreements and securities borrowings. At June 30, 2007 and December 31, 2006, a substantial portion of this collateral received by us had been sold or repledged.

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

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

The following is a summary of our financial assets and liabilities that are accounted for at fair value as of June 30, 2007 by level within the fair value hierarchy (in thousands of dollars):

														Counterparty
														and Cash
														Collateral
		Level 1				Level 2				Level 3				Netting				Total
Assets:
Financial instruments owned:
Non-derivative instruments		$	2,992,206			$	3,063,420			$	252,695			$	—			$	6,308,321
Derivative instruments			542,495				153,272				—				(374,819	)			320,948
Total financial instruments owned			3,534,701				3,216,692				252,695				(374,819	)			6,629,269
Investments (1)			—				—				92,923				—				92,923
Other assets (2)			—				3,939				—				—				3,939
Liabilities:
Financial instruments sold, not yet purchased:
Non-derivative instruments			3,140,115				1,294,748				2,835				—				4,437,698
Derivative instruments			517,694				277,426				—				(425,339	)			369,781
Total financial instruments sold, not yet purchased			3,657,809				1,572,174				2,835				(425,339	)			4,807,479

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The following is a summary of changes in fair value of our financial assets and liabilities that have been classified as Level 3 for the three and six months ended June 30, 2007 (in thousands of dollars):

		Three Months Ended
		Non-derivative				Non-derivative
		instruments —				instruments —
		Assets				Liabilities				Investments
Balance, March 31, 2007		$	160,377			$	—			$	97,653
Total gains/ (losses) (realized and unrealized) (1)			260				—				3,307
Purchases, sales, settlements, and Issuances			77,055				(1,318	)			(8,037	)
Net transfers in and/or out of Level 3			15,003				(1,517	)			—
Balance, June 30, 2007		$	252,695			$	(2,835	)		$	92,923
Change in unrealized gains/ (losses) relating to instruments still held at June 30, 2007 (1)		$	(17,744	)		$	—				3,307

		Six Months Ended
		Non-derivative				Non-derivative
		instruments —				instruments —
		Assets				Liabilities				Investments
Balance, December 31, 2006		$	205,278			$	—			$	97,289
Total gains/ (losses) (realized and unrealized) (1)			(2,783	)			—				8,661
Purchases, sales, settlements, and Issuances			49,633				(1,318	)			(13,027	)
Net transfers in and/or out of Level 3			567				(1,517	)			—
Balance, June 30, 2007		$	252,695			$	(2,835	)		$	92,923
Change in unrealized gains/ (losses) relating to instruments still held at June 30, 2007 (1)		$	(21,364	)		$	—			$	8,661

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Note 5. Short-Term Borrowings

Bank loans represent short-term borrowings that are payable on demand and generally bear interest at a spread over the Fed Funds rate. We had no outstanding secured bank loans as of June 30, 2007 and December 31, 2006. Unsecured bank loans are typically overnight loans used to finance securities owned or clearing related balances. We had $63.8 million and $0 of outstanding unsecured bank loans as of June 30, 2007 and December 31, 2006, respectively. Average daily bank loans for the six month period ended June 30, 2007 and year ended December 31, 2006 were $247.7 million and $12.4 million, respectively.

In addition, the current portion of our long-term debt maturing within one year of the financial statement date is classified with bank loans on the Consolidated Statement of Financial Condition. As of June 30, 2007 and December 31, 2006, the outstanding balance of our 7¹/2% Senior Notes, due in the third quarter of 2007, was $100.0 million and $100.0 million, respectively.

Note 6. Long-Term Debt

The following summarizes long-term debt outstanding at June 30, 2007 and December 31, 2006 (in thousands of dollars):

		June 30, 2007				December 31, 2006
7.75% Senior Notes, due 2012, net of unamortized discount of $4,318 (2007)			324,621				328,003
5.875% Senior Notes, due 2014, net of unamortized discount of $1,857 (2007)			248,143				—
5.5% Senior Notes, due 2016, net of unamortized discount of $1,590 (2007)			348,410				348,320
6.45% Senior Debentures, due 2027, net of unamortized discount of $4,176 (2007)			345,824				—
6.25% Senior Debentures, due 2036, net of unamortized discount of $7,714 (2007)			492,286				492,239
		$	1,759,284			$	1,168,562

We previously entered into a fair value hedge with no ineffectiveness using interest rate swaps in order to convert $200 million aggregate principal amount of unsecured 7 ³/4 % senior notes due March 15, 2012 into floating rates based upon LIBOR. The effective interest rate on the $200 million aggregate principal amount of unsecured 7 ³/4 % senior notes, after giving effect to the swaps, is 7.5%. The fair value of the swaps was $3.9 million as of June 30, 2007, which was recorded as an increase in the book value of the debt and an increase in other assets.

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

In June 2007, we sold in a registered public offering $600 million aggregate principal amount of our senior debt, consisting of $250 million of 5.875% senior notes due June 8, 2014 and $350 million of 6.45% senior debentures due June 8, 2027.

Note 7. Mandatorily Redeemable Convertible Preferred Stock

In February 2006, Massachusetts Mutual Life Insurance Company (“MassMutual”) purchased in a private placement $125 million of our Series A convertible preferred stock. Our Series A convertible preferred stock has a 3.25% annual, cumulative cash dividend and is currently convertible into 4,066,875 shares of our common stock at an effective conversion price of approximately $30.74 per share. The preferred stock is callable beginning in 2016 and will mature in 2036. The dividend is recorded as a component of interest expense as the Series A convertible preferred stock is treated as debt in accordance with FASB 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. The dividend is not deductible for tax purposes because the Series A convertible preferred stock is considered “equity” for tax purposes. As of June 30, 2007, 10,000,000 shares of preferred stock were authorized and 125,000 shares of preferred stock were issued and outstanding.

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

Note 8. Income Taxes

We adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), as of January 1, 2007. As a result of adoption, we recognized a $0.4 million increase to reserves for uncertain tax positions. This increase was accounted for as an adjustment to the beginning balance of retained earnings on the Consolidated Statement of Financial Condition. As of June 30, 2007 and January 1, 2007, we had approximately $4.2 million and $3.3 million, respectively, of total gross unrecognized tax benefits. These totals also represent the amount of unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in any future periods.

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

We recognize interest accrued related to unrecognized tax benefits in interest expense. Penalties, if any, are recognized in other expenses. As of June 30, 2007 and January 1, 2007, we had accrued interest and penalties related to unrecognized tax benefits of approximately $1.0 million and $1.0 million, respectively.

Note 9. Benefit Plans

The following summarizes the net periodic pension cost for the three-month and six-month periods ended June 30, 2007 and 2006 (in thousands of dollars):

		Three Months Ended								Six Months Ended
		June 30,				June 30,				June 30,				June 30,
		2007				2006				2007				2006
Net pension cost included the following components:
Service cost (1)		$	69			$	—			$	138			$	—
Interest cost on projected benefit obligation			590				638				1,180				1,276
Expected return on plan assets			(628	)			(560	)			(1,256	)			(1,120	)
Amortization of prior service cost			—				—				—				—
Amortization of net loss			141				255				282				510
Net periodic pension cost		$	172			$	333			$	344			$	666

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

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

Note 10. Minority Interest

Under FASB No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (“FASB 150”), certain minority interests in consolidated entities may meet the standard’s definition of a mandatorily redeemable financial instrument and thus require reclassification as liabilities and remeasurement at the estimated amount of cash that would be due and payable to settle such minority interests under the applicable entity’s organization agreement, assuming an orderly liquidation of the entity, net of estimated liquidation costs. Our consolidated financial statements include certain minority interests that meet the standard’s definition of mandatorily redeemable financial instruments. These mandatorily redeemable minority interests represent interests held by third parties in Jefferies High Yield Holdings, LLC (“JHYH”). The mandatorily redeemable minority interests are entitled to a pro rata share of the profits of JHYH, as set forth in JHYH’s organization agreements, and are scheduled to terminate in 2013, with an option to extend up to three additional one-year periods. The carrying amount of these mandatorily redeemable minority interests are approximately $613.5 million at June 30, 2007, which represents the initial capital and the pro rata share of the profits of JHYH assigned to the holder of the mandatorily redeemable minority interests. A certain portion of these mandatorily redeemable minority interests represent investments from Jefferies Special Opportunities Partners (“JSOP”) and Jefferies Employees Special Opportunities Partners (“JESOP”), and are eliminated in consolidation. The carrying amount of these mandatorily redeemable minority interests eliminated in consolidation is approximately $254.6 million at June 30, 2007, resulting in minority interest related to JHYH on a consolidated basis of approximately $358.9 million at June 30, 2007.

Minority interest also includes the minority equity holders’ proportionate share of the equity of JSOP and JESOP. At June 30, 2007, minority interest related to JSOP and JESOP was approximately $213.2 million and $27.7 million, respectively.

At June 30, 2007, we had other minority interests of approximately $7.4 million primarily related to our start-up asset management funds.

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

Note 11. Earnings Per Share

The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations for the three-month and six-month period ended June 30, 2007 and 2006 (in thousands, except per share amounts):

		Three Months Ended								Six Months Ended
		June 30,				June 30,				June 30,				June 30,
		2007				2006				2007				2006
Earnings before cumulative effect of change in accounting principle, net		$	67,835			$	45,580			$	130,094			$	102,421
Cumulative effect of change in accounting principle, net			—				—				—				1,606
Net earnings		$	67,835			$	45,580			$	130,094			$	104,027
Add: Convertible preferred stock dividends			1,016				1,016				2,032				1,512
Net earnings for diluted earnings per share		$	68,851			$	46,596			$	132,126			$	105,539
Shares:
Average shares used in basic computation			142,092				133,621				141,498				131,993
Unvested restricted stock / restricted stock units			7,577				8,660				7,017				8,885
Stock options			568				1,290				608				1,422
Convertible preferred stock			4,064				4,034				4,060				2,987
Average shares used in diluted computation			154,301				147,605				153,183				145,287
Earnings per share:
Basic-
Earnings before cumulative effect of change in accounting principle, net		$	0.48			$	0.34			$	0.92			$	0.78
Cumulative effect of change in accounting principle, net			—				—				—				0.01
Net earnings		$	0.48			$	0.34			$	0.92			$	0.79
Diluted-
Earnings before cumulative effect of change in accounting principle, net		$	0.45			$	0.32			$	0.86			$	0.72
Cumulative effect of change in accounting principle, net			—				—				—				0.01
Net earnings		$	0.45			$	0.32			$	0.86			$	0.73