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 August 31, 2010

OR

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

For the transition period from                      to

Commission file number 1-14947

JEFFERIES GROUP, INC.

(Exact name of registrant as specified in its charter)

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

520 Madison Avenue, 10th 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o

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

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

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. 171,831,346 shares as of the close of business on September 22, 2010.

 

 

					Page
PART I.		FINANCIAL INFORMATION
Item 1.		Financial Statements
		Consolidated Statements of Financial Condition (unaudited) - August 31, 2010 and December 31, 2009			3
		Consolidated Statements of Earnings (unaudited) - Three and Eight Months Ended August 31, 2010 and Three and Nine Months Ended September 30, 2009			5
		Consolidated Statements of Changes in Stockholders’ Equity (unaudited) - Eight Months Ended August 31, 2010 and Year Ended December 31, 2009			6
		Consolidated Statements of Comprehensive Income (unaudited) - Three and Eight Months Ended August 31, 2010 and Three and Nine Months Ended September 30, 2009			7
		Consolidated Statements of Cash Flows (unaudited) - Eight Months Ended August 31, 2010 and Nine Months Ended September 30, 2009			8
		Notes to Consolidated Financial Statements (unaudited)			10
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			59
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			85
Item 4.		Controls and Procedures			88
PART II.		OTHER INFORMATION
Item 1.		Legal Proceedings			88
Item 1A.		Risk Factors			88
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			89
Item 6.		Exhibits			90
Signature					91
EX-18
EX-31.1
EX-31.2
EX-32
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT
EX-101 DEFINITION LINKBASE DOCUMENT

PART I. FINANCIAL INFORMATION

		August 31,				December 31,
		2010 (1)				2009
ASSETS
Cash and cash equivalents (including $249,772 from VIEs)		$	2,089,940			$	1,853,167
Cash and securities segregated and on deposit for regulatory purposes or deposited with clearing and depository organizations			1,337,949				1,089,803
Financial instruments owned, at fair value, including securities pledged of $10,650,264 and $5,623,345 in 2010 and 2009, respectively:
Corporate equity securities (including $118,042 from VIEs)			1,670,545				1,500,042
Corporate debt securities (including $477,357 from VIEs)			3,495,590				2,412,134
Government, federal agency and other sovereign obligations			3,892,319				1,762,643
Mortgage- and asset-backed securities (including $44,777 from VIEs)			4,676,293				3,089,435
Loans and other receivables (including $203,687 from VIEs)			292,839				591,208
Derivatives (including $3,389 from VIEs)			64,330				62,117
Investments, at fair value (including $15,725 from VIEs)			79,356				70,156
Total financial instruments owned, at fair value (including $862,977 from VIEs)			14,171,272				9,487,735
Investments in managed funds			125,446				115,774
Other investments			170,861				193,628
Securities borrowed			6,767,967				8,237,998
Securities purchased under agreements to resell			3,185,288				3,515,247
Securities received as collateral			108,344				68,494
Receivables:
Brokers, dealers and clearing organizations (including $249,858 from VIEs)			1,252,668				1,504,480
Customers (including $23 from VIEs)			1,223,784				1,020,480
Fees, interest and other			100,301				108,749
Premises and equipment			141,236				140,132
Goodwill			364,390				364,795
Other assets (including $1,714 from VIEs)			596,384				488,789
Total assets (including $1,364,344 from VIEs)		$	31,635,830			$	28,189,271

Continued on next page.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

		August 31,				December 31,
		2010 (1)				2009
LIABILITIES AND STOCKHOLDERS’ EQUITY
Financial instruments sold, not yet purchased, at fair value:
Corporate equity securities (including $56,078 from VIEs)		$	1,513,716			$	1,360,528
Corporate debt securities (including $447,169 from VIEs)			2,383,054				1,909,781
Government, federal agency and other sovereign obligations			3,590,232				1,735,861
Mortgage- and asset-backed securities			29,292				21,474
Loans (including $231,718 from VIEs)			244,199				363,080
Derivatives			57,414				18,427
Total financial instruments sold, not yet purchased, at fair value (including $734,965 from VIEs)			7,817,907				5,409,151
Securities loaned (including $75,000 from VIEs)			2,004,014				3,592,836
Securities sold under agreements to repurchase			9,596,298				8,239,117
Obligation to return securities received as collateral			108,344				68,494
Payables:
Brokers, dealers and clearing organizations (including $120,057 from VIEs)			1,675,371				889,687
Customers			3,172,435				3,246,485
Accrued expenses and other liabilities (including $1,596 from VIEs)			903,253				941,210
Long-term debt			3,278,102				2,729,117
Mandatorily redeemable convertible preferred stock			125,000				125,000
Mandatorily redeemable preferred interest of consolidated subsidiaries (including $300,944 from VIEs)			300,944				318,047
Total liabilities (including $1,232,562 from VIEs)			28,981,668				25,559,144
STOCKHOLDERS’ EQUITY
Common stock, $.0001 par value. Authorized 500,000,000 shares; issued 198,413,425 shares in 2010 and 187,855,347 shares in 2009			20				19
Additional paid-in capital			2,084,740				2,036,087
Retained earnings			817,178				698,488
Less:
Treasury stock, at cost, 27,172,616 shares in 2010 and 22,217,793 shares in 2009			(506,432	)			(384,379	)
Accumulated other comprehensive loss:
Currency translation adjustments			(47,971	)			(34,369	)
Additional minimum pension liability			(7,257	)			(7,257	)
Total accumulated other comprehensive loss			(55,228	)			(41,626	)
Total common stockholders’ equity			2,340,278				2,308,589
Noncontrolling interests			313,884				321,538
Total stockholders’ equity			2,654,162				2,630,127
Total liabilities and stockholders’ equity		$	31,635,830			$	28,189,271

See accompanying unaudited notes to consolidated financial statements.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

										Eight Months				Nine Months
		Three Months Ended								Ended				Ended
		August 31,				September 30,				August 31,				September 30,
		2010				2009				2010				2009
Revenues:
Commissions		$	118,571			$	127,800			$	347,527			$	395,085
Principal transactions			74,282				338,552				324,037				711,165
Investment banking			246,193				122,529				598,450				280,446
Asset management fees and investment income from managed funds			786				20,966				11,804				21,485
Interest			152,546				161,091				430,902				413,777
Other			16,879				6,239				44,241				28,699
Total revenues			609,257				777,177				1,756,961				1,850,657
Interest expense			89,159				76,756				237,493				218,086
Net revenues			520,098				700,421				1,519,468				1,632,571
Interest on mandatorily redeemable preferred interest of consolidated subsidiaries			(2,537	)			23,596				(26	)			30,620
Net revenues, less mandatorily redeemable preferred interest			522,635				676,825				1,519,494				1,601,951
Non-interest expenses:
Compensation and benefits			308,797				395,031				877,204				956,619
Floor brokerage and clearing fees			30,244				20,677				84,702				54,007
Technology and communications			46,135				36,141				114,189				104,508
Occupancy and equipment rental			18,433				18,121				49,448				52,168
Business development			17,420				10,293				42,405				29,273
Professional services			13,008				8,874				34,702				29,883
Other			9,404				12,658				37,224				28,953
Total non-interest expenses			443,441				501,795				1,239,874				1,255,411
Earnings before income taxes			79,194				175,030				279,620				346,540
Income tax expense			35,067				65,210				112,960				130,299
Net earnings			44,127				109,820				166,660				216,241
Net (loss) earnings to noncontrolling interests			(2,129	)			23,534				1,865				29,718
Net earnings to common shareholders		$	46,256			$	86,286			$	164,795			$	186,523
Earnings per common share:
Basic		$	0.23			$	0.42			$	0.81			$	0.92
Diluted		$	0.23			$	0.42			$	0.81			$	0.92
Weighted average common shares:
Basic			195,601				200,609				196,943				201,860
Diluted			195,612				204,736				201,062				205,986

See accompanying unaudited notes to consolidated financial statements.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

		Eight Months Ended				Year Ended
		August 31, 2010				December 31, 2009
Common stock, par value $0.0001 per share
Balance, beginning of period		$	19			$	17
Issued			1				2
Balance, end of period			20				19
Additional paid-in capital
Balance, beginning of period			2,036,087				1,870,120
Benefit plan share activity (1)			10,425				16,499
Share-based expense, net of forfeitures and clawbacks			27,555				125,127
Proceeds from exercise of stock options			108				69
Contingent consideration			419				(2,710	)
Tax benefit (deficiency) for issuance of share-based awards			2,750				(14,606	)
Equity component of convertible debt issuance, net of tax			—				41,588
Dividend equivalents on share-based plans			7,396				—
Balance, end of period			2,084,740				2,036,087
Retained earnings
Balance, beginning of period			698,488				418,445
Net earnings to common shareholders			164,795				280,043
Dividends			(46,105	)			—
Balance, end of period			817,178				698,488
Treasury stock, at cost
Balance, beginning of period			(384,379	)			(115,190	)
Purchases			(114,893	)			(263,794	)
Returns / forfeitures			(7,160	)			(8,105	)
Issued			—				2,710
Balance, end of period			(506,432	)			(384,379	)
Accumulated other comprehensive (loss) income
Balance, beginning of period			(41,626	)			(52,121	)
Currency adjustment			(13,602	)			9,306
Pension adjustment, net of tax			—				1,189
Balance, end of period			(55,228	)			(41,626	)
Total common stockholders’ equity			2,340,278				2,308,589
Noncontrolling interests
Balance, beginning of period			321,538				287,805
Net earnings to noncontrolling interests			1,865				36,537
Contributions			2,087				2,860
Distributions			(14,664	)			(5,664	)
Adoption of accounting changes to ASC 810			3,058				—
Balance, end of period			313,884				321,538
Total stockholders’ equity		$	2,654,162			$	2,630,127

See accompanying unaudited notes to consolidated financial statements.

										Eight Months				Nine Months
		Three Months Ended								Ended				Ended
		August 31,				September 30,				August 31,				September 30,
		2010				2009				2010				2009
Net earnings to common shareholders		$	46,256			$	86,286			$	164,795			$	186,523
Other comprehensive income (loss):
Currency translation adjustments			17,381				(5,751	)			(13,602	)			7,733
Total other comprehensive income (loss) (1)			17,381				(5,751	)			(13,602	)			7,733
Comprehensive income		$	63,637			$	80,535			$	151,193			$	194,256

See accompanying unaudited notes to consolidated financial statements.

		Eight Months Ended				Nine Months Ended
		August 31, 2010				September 30, 2009
Cash flows from operating activities:
Net earnings		$	166,660			$	216,241
Adjustments to reconcile net earnings to net cash used in operating activities:
Depreciation and amortization			27,490				23,390
Gain on repurchase of long-term debt			—				(7,673	)
Fees related to assigned management agreements			(2,589	)			—
Interest on mandatorily redeemable preferred interests of consolidated subsidiaries			(26	)			30,620
Accruals related to various benefit plans, stock issuances, net of forfeitures			30,821				4,331
Increase in cash and securities segregated and on deposit for regulatory purposes or deposited with clearing and depository organizations			(248,032	)			(101,213	)
Decrease (increase) in receivables:
Brokers, dealers and clearing organizations			226,379				(948,060	)
Customers			(216,894	)			(861,053	)
Fees, interest and other			7,625				(15,648	)
Decrease in securities borrowed			1,427,952				914,875
Increase in financial instruments owned			(4,687,754	)			(5,108,735	)
Decrease (increase) in other investments			22,359				(44,576	)
Increase in investments in managed funds			(9,672	)			(14,062	)
Decrease (increase) in securities purchased under agreements to resell			324,488				(1,658,835	)
(Increase) decrease in other assets			(118,548	)			143,602
Increase (decrease) in payables:
Brokers, dealers and clearing organizations			810,761				708,141
Customers			(75,927	)			1,687,146
Decrease in securities loaned			(1,552,550	)			(802,546	)
Increase in financial instruments sold, not yet purchased			2,429,942				2,727,098
Increase in securities sold under agreements to repurchase			1,361,466				2,589,696
(Decrease) increase in accrued expenses and other liabilities			(16,634	)			159,941
Net cash used in operating activities			(92,683	)			(357,320	)
Cash flows from investing activities:
Purchase of premises and equipment			(24,678	)			(18,324	)
Business acquisition			—				(38,760	)
Cash received from contingent consideration			1,927				—
Cash paid for contingent consideration			(8,101	)			(28,653	)
Net cash used in investing activities			(30,852	)			(85,737	)

Continued on next page.

		Eight Months Ended				Nine Months Ended
		August 31, 2010				September 30, 2009
Cash flows from financing activities:
Excess tax benefits from the issuance of share-based awards		$	2,148			$	8,155
Net proceeds from (payments on):
Issuance of senior notes, net of issuance costs			543,510				713,526
Repurchase of long-term debt			—				(12,796	)
Mandatorily redeemable preferred interest of consolidated subsidiaries			(17,077	)			(125	)
Noncontrolling interest			(12,577	)			(2,947	)
Repurchase of common stock			(114,893	)			(158,418	)
Dividends			(38,709	)			—
Exercise of stock options, not including tax benefits			108				69
Net cash provided by financing activities			362,510				547,464
Effect of foreign currency translation on cash and cash equivalents			(2,202	)			6,665
Net increase in cash and cash equivalents			236,773				111,072
Cash and cash equivalents at beginning of period			1,853,167				1,294,329
Cash and cash equivalents at end of period		$	2,089,940			$	1,405,401
Supplemental disclosures of cash flow information:
Cash paid (received) during the period for:
Interest		$	234,065			$	219,085
Income taxes			180,420				(42,361	)
Acquisitions:
Fair value of assets acquired, including goodwill							53,104
Liabilities assumed							14,344
Cash paid for acquisition							38,760

See accompanying unaudited notes to consolidated financial statements.

Index

						Page
Note 1.		Organization and Summary of Significant Accounting Policies					11
Note 2.		Cash, Cash Equivalents and Short-Term Investments					19
Note 3.		Financial Instruments					20
Note 4.		Derivative Financial Instruments					31
Note 5.		Collateralized Transactions					34
Note 6.		Securitization Activities and Variable Interest Entities					35
Note 7.		Acquisitions					42
Note 8.		Short-Term Borrowings					44
Note 9.		Long-Term Debt					44
Note 10.		Mandatorily Redeemable Convertible Preferred Stock					45
Note 11.		Noncontrolling Interest and Mandatorily Redeemable Preferred Interests of Consolidated Subsidiaries					45
Note 12.		Benefit Plans					46
Note 13.		Compensation Plans					47
Note 14.		Earnings Per Share					52
Note 15.		Income Taxes					53
Note 16.		Commitments, Contingencies and Guarantees					54
Note 17.		Net Capital Requirements					56
Note 18.		Segment Reporting					56
Note 19.		Related Party Transactions					57

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

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 U.S generally accepted accounting principles for complete financial statements. All adjustments (consisting of normal recurring accruals) considered necessary for fair presentation have been included. These unaudited consolidated financial statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2009.

On April 19, 2010, our Board of Directors approved a change to our fiscal year end from a calendar year basis to a fiscal year ending on November 30. Our 2010 third quarter consists of the three months ended August 31, 2010 and our results included within this report on Form 10-Q reflects the eight months ended August 31, 2010. Our 2010 fiscal year will consist of the eleven month transition period beginning January 1, 2010 through November 30, 2010. Financial statements for 2009 continue to be presented on the basis of our previous calendar year end.

Prior to October 1, 2009, commissions and commission equivalents earned on certain over-the-counter equity securities trades were reported within Principal transactions revenue. As of October 1, 2009, these revenues are included within Commission revenue on the Consolidated Statements of Earnings. Previously presented financial statements have been adjusted to change these revenues from Principal transactions revenue to Commissions revenue. The impact of these changes is to increase Commissions revenue for the three and nine months ended September 30, 2009 by $33.6 million and $96.5 million, respectively, from $94.2 million and $298.6 million, respectively, to $127.8 million and $395.1 million, respectively, and conversely to decrease Principal transactions by $33.6 million and $96.5 million, respectively, from $372.1 million and $807.6 million, respectively, to $338.6 million and $711.2 million, respectively, for transactions during the three and nine months ended September 30, 2009 previously presented in our Quarterly Report on Form 10-Q, as filed on November 5, 2009. There was no impact on Total revenues, Net revenues, Net earnings or Earnings per share for the three and nine months ended September 30, 2009 due to these changes.

Interest income and interest expense for the five months ended May 31, 2010 previously reported in our quarterly report on Form 10-Q were understated by equal and offsetting amounts. There was no impact on Interest income or Interest expense for the three months ended August 31, 2010. Interest income for the eight months ended August 31, 2010 has been adjusted to increase interest income for the three months ended March 31, 2010 by $5.6 million from $150.0 million to $155.6 million, to increase interest income for the three months ended May 31, 2010 by $24.9 million from $150.2 million to $175.1 million and to increase interest income for the five months ended May 31, 2010 by $28.3 million from $250.1 million to $278.4 million. Interest expense for the eight months ended August 31, 2010 has been adjusted to increase interest expense for the three months ended March 31, 2010 by $5.6 million from $75.4 million to $81.0 million, to increase interest expense for the three months ended May 31, 2010 by $24.9 million from $71.1 million to $96.0 million and to increase interest expense for the five months ended May 31, 2010 by $28.3 million from $120.0 million to $148.3 million. There was no impact on Net revenues, Net earnings or Earnings per share for the three months ended March 31, 2010, for the five months ended May 31, 2010 or for the eight months ended August 31, 2010 due to these changes. These adjustments had similar impacts on the supplemental disclosure of cash paid (received) for interest contained within the Consolidated Statement of Cash Flows.

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

Our policy is to consolidate all entities in which we own more than 50% of the outstanding voting stock and have control. In addition, we consolidate entities which lack characteristics of an operating entity or business for which we are the primary beneficiary. The primary beneficiary is the party who has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and who has an obligation to absorb losses of the entity or a right to receive benefits from the entity that could potentially be significant to the entity. 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 or fair value accounting. We also have formed nonconsolidated investment vehicles with third-party investors that are typically organized as partnerships or limited liability companies. We act as general partner or managing member for these investment vehicles and have generally provided the third-party investors with termination or “kick-out” rights.

All material intercompany accounts and transactions are eliminated in consolidation.

Commissions. All customer securities transactions are reported on the Consolidated Statements 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 $8.7 million and $9.2 million for the three months ended August 31, 2010 and September 30, 2009, respectively, and $25.8 million and $24.3 million for the eight months ended August 31, 2010 and nine months ended September 30, 2009, respectively. We account for the cost of these arrangements on an accrual basis. As we are not the primary obligor for these arrangements, expenses relating to soft dollars are netted against 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 carried at fair value with unrealized gains and losses reflected in Principal transactions in the Consolidated Statements of Earnings on a trade date basis.

Investment Banking. Underwriting revenues and fees from mergers and acquisitions, restructuring and other investment banking advisory assignments or engagements are recorded when the services related to the underlying transactions are completed under the terms of the assignment or engagement. Expenses associated with such assignments are deferred until reimbursed by the client, the related revenue is recognized or the engagement is otherwise concluded. Out-of-pocket expenses are recorded net of client reimbursements. Revenues are presented net of related out-of-pocket unreimbursed expenses. Unreimbursed out-of-pocket expenses with no related revenues are included in Business development and Professional services expenses in the Consolidated Statements of Earnings.

Asset Management Fees and Investment Income From Managed Funds. Asset management fees and investment income from managed funds include revenues we earn from management, administrative and performance fees from funds managed by us, revenues from management and performance fees we earn from third-party managed funds and investment income from our investments in these funds. We earn fees in connection with management and investment advisory services performed for various funds and managed accounts. These fees are based on 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.

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

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 expense. Interest flows on derivative trading transactions and dividends are included as part of the fair 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, long-term borrowings and our mandatorily redeemable convertible preferred stock on an accrual basis with related interest recorded as interest expense. In addition, we recognize interest revenue related to our securities borrowed and securities purchased under agreements to resell activities and interest expense related to our securities loaned and securities sold under agreements to repurchase activities on an accrual basis.

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

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 in this caption.

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 Other comprehensive income. Gains or losses resulting from foreign currency transactions are included in Principal transactions in the Consolidated Statements of Earnings.

Financial instruments owned and Financial instruments sold, not yet purchased are recorded at fair value, either as required by accounting pronouncements or through the fair value option election. These instruments primarily represent our trading activities and include both cash and derivative products. Gains and losses are recognized in Principal transactions in our Consolidated Statements of Earnings. 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).

In determining fair value, we maximize the use of observable inputs and minimize the use of unobservable inputs by requiring that observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability based on market data obtained from independent sources. Unobservable inputs reflect our assumptions that market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. We apply a hierarchy to categorize our fair value measurements broken down into three levels based on the transparency of inputs as follows:

Level 1:		Quoted prices are available in active markets for identical assets or liabilities as of the reported date.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
(Unaudited)

Level 2:		Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these financial instruments include cash instruments for which quoted prices are available but traded less frequently, derivative instruments whose fair value have been derived using a model where inputs to the model are directly observable in the market, or can be derived principally from or corroborated by observable market data, and instruments that are fair valued using other financial instruments, the parameters of which can be directly observed.

Level 3:		Instruments that have little to no pricing observability as of the reported date. These financial instruments are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

The availability of observable inputs can vary and is affected by a wide variety of factors, including, for example, the type of financial instrument and market conditions. To the extent that valuation is based on models or input that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised in determining fair value is greatest for instruments categorized in Level 3.

We use prices and inputs that are current as of the measurement date. As the observability of prices and inputs may change for a financial instrument from period to period, this condition may cause a transfer of an instrument among the fair value hierarchy levels. Transfers among the levels are recognized at the beginning of each period.

Financial instruments are valued at quoted market prices, if available. Certain financial instruments have bid and ask prices that can be observed in the marketplace. For financial instruments whose inputs are based on bid-ask prices, we allow for mid-market pricing and adjust to the point within the bid-ask range that meets our best estimate of fair value. For offsetting positions in the same financial instrument, the same price within the bid-ask spread is used to measure both the long and short positions.

For financial instruments that do not have readily determinable fair values using 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. The valuation process for financial instruments may include the use of valuation models and other techniques. Adjustments to valuations (such as counterparty, credit, concentration or liquidity) derived from valuation models may be made when, in management’s judgment, either the size of the position in the financial instrument in a nonactive market or other features of the financial instrument such as its complexity, or the market in which the financial instrument is traded require that an adjustment be made to the value derived from the models. An adjustment may be made if a financial instrument is subject to sales restrictions that would result in a price less than the quoted market price. Adjustments from the price derived from a valuation model reflect management’s judgment that other participants in the market for the financial instrument being measured at fair value would also consider in valuing that same financial instrument and are adjusted for assumptions about risk uncertainties and market conditions. Results from valuation models and valuation techniques in one period may not be indicative of future period fair value measurements.

See Note 3, Financial Instruments, for a description of valuation techniques applied to the classes of financial instruments at fair value.

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

Investments in managed funds include 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 nonconsolidated managed funds are accounted for on the equity method or fair value. Gains or losses on our investments in managed funds are included in Asset management fees and investment income from managed funds in the Consolidated Statements of Earnings.

Other investments includes investments entered into where we exercise significant influence over operating and capital decisions in private equity and other operating entities in connection with our capital market activities and loans issued in connection with such activities. Other investments are accounted for on the equity method or at cost, as appropriate. Revenues on Other investments are included in Other income in the Consolidated Statement of Earnings.

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 included within this financial statement line item 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.

Securities borrowed and securities loaned are carried at the amounts of cash collateral advanced and received in connection with the transactions and accounted for as collateralized financing transactions. 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. 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 (collectively “repos”) are accounted for as collateralized financing transactions and are recorded at their contracted repurchase amount. We earn net interest revenues from this activity which is reflected in our Consolidated Statements of Earnings. We monitor the fair value of the underlying securities daily versus the related receivable or payable balances. Should the fair value of the underlying securities decline or increase, additional collateral is requested or excess collateral is returned, as appropriate. We carry repos on a net basis by counterparty when appropriate.

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 the related leases or the estimated useful lives of the assets, whichever is shorter.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
(Unaudited)

At least annually, and more frequently if warranted, we assess whether goodwill has been impaired by comparing the estimated fair value of each reporting unit with its estimated net book value. Periodically estimating the fair value of a reporting unit requires significant judgment and often involves the use of significant estimates and assumptions. These estimates and assumptions could have a significant effect on whether or not an impairment charge is recorded and the magnitude of such a charge. We completed our annual assessment of goodwill as of June 1, 2010 and no impairment was identified. (Refer to Note 7, Acquisitions, for further details on our annual assessment of goodwill.)

We file a consolidated U.S. federal income tax return, which includes all of our qualifying subsidiaries. We also are subject to income tax in various states and municipalities and those foreign jurisdictions in which we operate. 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 and for tax loss carry-forwards. 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, share-based compensation, deferred compensation, unrealized gains and losses on investments and tax amortization on intangible assets. The realization of deferred tax assets is assessed and a valuation allowance is recorded to the extent that it is more likely than not that any portion of the deferred tax asset will not be realized.

The tax benefit related to dividends and dividend equivalents paid on nonvested share based payment awards and outstanding equity options is recognized as an increase to additional paid in capital. These amounts are included in tax benefits for issuance of share-based awards on the Consolidated Statement of Changes in Stockholders’ Equity.

In the normal course of business, we have been named, from time to time, as a defendant in various legal actions, including arbitrations, class actions and other litigation, arising in connection with our activities as a global securities and investment banking firm. We are also involved, from time to time, in other reviews, investigations and proceedings (both formal and informal) by governmental and self-regulatory agencies regarding our businesses, certain of which may result in judgments, settlements, fines, penalties or other injunctions.

We recognize a liability for a contingency in Accrued expenses and other liabilities 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. The determination of the outcome and loss estimates requires significant judgment on the part of management.

In many instances, it is not possible to determine whether any loss is probable or even possible or to estimate the amount of any loss or the size of any range of loss. We believe that, in the aggregate, the pending legal actions or proceedings should not have a material adverse affect on our consolidated results of operations, cash flows or financial condition, although they might be material to the results of a quarter.

Share-based awards are measured based on the grant-date fair value of the award and recognized over the period from the service inception date through the date the employee is no longer required to provide service to earn the award. Expected forfeitures are included in determining share-based compensation expense.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
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Basic earnings per share (“EPS”) is computed by dividing net earnings (loss) available to common shareholders by the weighted average number of common shares outstanding and certain other shares committed to be, but not yet issued. Net earnings (loss) available to common shareholders represent net earnings (loss) to common shareholders reduced by the allocation of earnings to participating securities. Losses are not allocated to participating securities. Common shares outstanding and certain other shares committed to be, but not yet issued, include restricted stock and restricted stock units for which no future service is required. Diluted EPS is computed by dividing net earnings available to common shareholders plus dividends on dilutive mandatorily redeemable convertible preferred stock by the weighted average number of common shares outstanding and certain other shares committed to be, but not yet issued, plus all dilutive common stock equivalents outstanding during the period.

Unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and, therefore, are included in the earnings allocation in computing earnings per share under the two-class method of earning per share. We grant restricted stock and restricted stock units as part of our share-based compensation that contain nonforfeitable rights to dividends and dividend equivalents, respectively, and therefore, prior to the requisite service being rendered for the right to retain the award, restricted stock and restricted stock units meet the definition of a participating security. As such, we calculate Basic and Diluted earnings per share under the two-class method. All prior-period earnings per share data presented have been adjusted to include participating securities in the earnings per share computation using the two-class method.

We engage in securitization activities related to mortgage-backed and other asset-backed securities. Such transfers of financial assets are generally accounted for as sales when we have relinquished control over the transferred assets. The gain or loss on sale of such financial assets depends, in part, on the previous carrying amount of the assets involved in the transfer allocated between the assets sold and the retained interests, if any, based upon their respective fair values at the date of sale. We may retain interests in the securitized financial assets as one or more tranches of the securitization. These retained interests are included within Financial instruments owned in the Consolidated Statement of Financial Condition at fair value. Any changes in the fair value of such retained interests are recognized within Principal transactions revenues in the Consolidated Statement of Earnings.

When a transfer of assets does not meet the criteria of a sale, that transfer is treated as a secured borrowing. We continue to recognize the assets of a secured borrowing in Financial instruments owned and recognize the associated financing in Other liabilities in the Consolidated Statements of Financial Condition.

The following is a summary of Accounting Standards Codification™ (“ASC”) Topics that have impacted or will impact our disclosures and/or accounting policies for financial statements issued for interim and annual periods:

We have adopted accounting changes described in ASC Topic 810, Consolidation, as of January 1, 2010, which require that the party who has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and who has an obligation to absorb losses of the entity or a right to receive benefits from the entity that could potentially be significant to the entity consolidate the variable interest entity. The changes to ASC 810, effective as of January 1, 2010, eliminate the quantitative approach previously applied to assessing whether to consolidate a variable interest entity and require ongoing reassessments for consolidation. Upon adoption of these accounting changes on January 1, 2010, we consolidated certain CLOs and other investment vehicles. We applied the fair value option as our transition method to consolidate these entities. The following table presents the effect of the consolidation of these entities on our assets, liabilities and stockholders’ equity on January 1, 2010 (in thousands):

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
(Unaudited)

Cash and cash equivalents		$	66,254
Financial instruments owned, at fair value:
Corporate debt securities			30,393
Loans and other receivables			1,523,566
Investments, at fair value			2,990
Total financial instruments owned, at fair value			1,556,949
Investments in managed funds			(7,273	)
Receivable from customers			(13,317	)
Receivable from fees, interest and other			4,265
Total assets		$	1,606,878
Accrued expenses and other liabilities		$	2,886
Long-term debt			1,600,934
Total liabilities			1,603,820
Noncontrolling interests			3,058
Total stockholders’ equity			3,058
Total liabilities and stockholders’ equity		$	1,606,878

On January 29, 2010, we sold and assigned our management agreements for the CLOs to a third party; thus, we no longer have the power to direct the most significant activities of the CLOs. Upon the assignment of the management agreements in the first quarter of 2010, we deconsolidated the CLOs and account for our remaining interests in the CLOs at fair value.

We adopted further accounting changes described in ASC Topic 860, Transfers and Servicing, as of January 1, 2010, which eliminate the concept of a qualifying special purpose entity, require that a transferor consider all arrangements made contemporaneously with, or in contemplation of, a transfer of assets when determining whether derecognition of a financial asset is appropriate, clarify the requirement that a transferred financial asset be legally isolated from the transferor and any of its consolidated affiliates, stipulate that constraints on a transferee’s ability to freely pledge or exchange transferred assets causes the transfer to fail sale accounting, and define participating interests and provides guidance on derecognizing participating interests. The adoption did not have an effect on our financial condition, results of operations or cash flows.

We have 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. The most important of these estimates and assumptions relate to fair value measurements and compensation and benefits. Although these and other estimates and assumptions are based on the best available information, actual results could be materially different from these estimates. Current economic conditions increased the risks and complexity of the judgments in these estimates.

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Note 2. 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 that are deemed by us to be generally readily convertible into cash as of August 31, 2010 and December 31, 2009 (in thousands):

		August 31, 2010				December 31, 2009
Cash and cash equivalents:
Cash in banks		$	260,359			$	196,189
Money market investments			1,829,581				1,656,978
Total cash and cash equivalents			2,089,940				1,853,167
Cash and securities segregated (1)			1,337,949				1,089,803
		$	3,427,889			$	2,942,970

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The following is a summary of our financial assets and liabilities that are accounted for at fair value on a recurring basis as of August 31, 2010 and December 31, 2009 by level within the fair value hierarchy (in thousands):

		As of August 31, 2010
														Counterparty
														and Cash
														Collateral
		Level 1				Level 2				Level 3				Netting (2)				Total
Assets:
Financial instruments owned:
Corporate equity securities		$	1,506,064			$	138,902			$	25,579			$	—			$	1,670,545
Corporate debt securities			23				3,394,283				101,284				—				3,495,590
Collateralized debt obligations			—				—				26,306				—				26,306
U.S. government and federal agency securities			1,358,506				421,624				—				—				1,780,130
U.S. issued municipal securities			—				220,233				429				—				220,662
Sovereign obligations			1,215,675				675,852				—				—				1,891,527
Residential mortgage-backed securities			—				3,983,504				167,839				—				4,151,343
Commercial mortgage-backed securities			—				411,060				50				—				411,110
Other asset-backed securities			—				87,534				—				—				87,534
Loans and other receivables			—				207,498				85,341				—				292,839
Derivatives			228,511				147,363				—				(311,544	)			64,330
Investments at fair value			—				—				79,356				—				79,356
Total financial instruments owned		$	4,308,779			$	9,687,853				486,184			$	(311,544	)		$	14,171,272
Level 3 assets for which the firm does not bear economic exposure (1)											(116,528	)
Level 3 assets for which the firm bears economic exposure										$	369,656
Liabilities:
Financial instruments sold, not yet purchased:
Corporate equity securities		$	1,440,660			$	72,960			$	96			$	—			$	1,513,716
Corporate debt securities			1,208				2,381,846				—				—				2,383,054
U.S. government and federal agency securities			1,156,496				49,232				—				—				1,205,728
U.S. issued municipal securities			—				65,765				—				—				65,765
Sovereign obligations			1,400,566				918,173				—				—				2,318,739
Residential mortgage-backed securities			—				29,292				—				—				29,292
Loans			—				218,087				26,112				—				244,199
Derivatives			218,798				204,844				1,294				(367,522	)			57,414
Total financial instruments sold, not yet purchased		$	4,217,728			$	3,940,199			$	27,502			$	(367,522	)		$	7,817,907

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

		As of December 31, 2009
														Counterparty
														and Cash
														Collateral
		Level 1				Level 2				Level 3				Netting (2)				Total
Assets:
Financial instruments owned:
Corporate equity securities		$	1,419,019			$	37,981			$	43,042			$	—			$	1,500,042
Corporate debt securities			—				2,295,486				116,648				—				2,412,134
Collateralized debt obligations			—				—				9,570				—				9,570
U.S. government and federal agency securities			821,323				367,642				—				—				1,188,965
U.S. issued municipal securities			—				127,346				420				—				127,766
Sovereign obligations			71,199				374,517				196				—				445,912
Residential mortgage-backed securities			—				2,578,796				136,496				—				2,715,292
Commercial mortgage-backed securities			—				307,068				3,215				—				310,283
Other asset-backed securities			—				54,180				110				—				54,290
Loans and other receivables			—				84,666				506,542				—				591,208
Derivatives			219,067				102,357				1,909				(261,216	)			62,117
Investments at fair value			—				4,592				65,564				—				70,156
Total financial instruments owned		$	2,530,608			$	6,334,631				883,712			$	(261,216	)		$	9,487,735
Level 3 assets for which the firm does not bear economic exposure (1)											(379,153	)
Level 3 assets for which the firm bears economic exposure										$	504,559
Liabilities:
Financial instruments sold, not yet purchased:
Corporate equity securities		$	1,350,125			$	10,403			$	—			$	—			$	1,360,528
Corporate debt securities			—				1,909,781				—				—				1,909,781
U.S. government and federal agency securities			1,350,155				1,911				—				—				1,352,066
U.S. issued municipal securities			—				10				—				—				10
Sovereign obligations			150,684				233,101				—				—				383,785
Residential mortgage-backed securities			—				21,474				—				—				21,474
Loans			—				10,660				352,420				—				363,080
Derivatives			225,203				100,731				4,926				(312,433	)			18,427
Total financial instruments sold, not yet purchased		$	3,076,167			$	2,288,071			$	357,346			$	(312,433	)		$	5,409,151

We elected to apply the fair value option to loans and loan commitments made in connection with our investment banking and sales and trading activities and certain investments held by subsidiaries that are not registered broker-dealers. Loans and investments at fair value are included in Financial instruments owned and loan commitments are included in Financial instruments sold, not yet purchased – derivatives on the Consolidated Statements of Financial Condition. 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. We have elected to apply the fair value option to certain secured financings that arise in connection with our securitization activities. At August 31, 2010, $41.4 million in secured financings, included within Other liabilities on the Consolidated Statement

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of Financial Position, are accounted for at fair value and are classified as Level 2 liabilities. Cash and cash equivalents, the cash component of cash and securities segregated and on deposit for regulatory purposes or deposited with clearing and depository organizations, receivables – brokers, dealers and clearing organizations, receivables – customers, receivables – fees, interest and other, payables – brokers, dealers and clearing organizations and payables – customers, are not accounted for at fair value; however, the recorded amounts approximate fair value due to their liquid or short-term nature.

The following is a description of the valuation basis, including valuation techniques and inputs, used in measuring our financial assets and liabilities that are accounted for at fair value on a recurring basis:

Corporate Equity Securities

•

Exchange Traded Equity Securities: Exchange-traded equity securities are measured based on quoted exchange prices, which are generally obtained from pricing services, and are categorized as Level 1 in the fair value hierarchy.

•

Non-exchange Traded Equity Securities: Non-exchange traded equity securities are measured primarily using broker quotations, pricing service data from external providers and prices observed for recently executed market transactions and are categorized within Level 2 of the fair value hierarchy. Where such information is not available, non-exchange traded equity securities are categorized as Level 3 financial instruments and measured using valuation techniques involving quoted prices of or market data for comparable companies, similar company ratios and multiples (e.g., price/EBITDA, price/book value), discounted cash flow analyses and transaction prices observed for subsequent financing or capital issuance by the company. When using pricing data of comparable companies, judgment must be applied to adjust the pricing data to account for differences between the measured security and the comparable security (e.g., issuer market capitalization, yield, dividend rate, geographical concentration).

•

Equity warrants: Non-exchange traded equity warrants are generally classified within Level 3 of the fair value hierarchy and are measured using the Black-Scholes model with key inputs impacting the valuation including the underlying security price, implied volatility, dividend yield, interest rate curve, strike price and maturity date.

Corporate Debt Securities

•

Corporate Bonds: Corporate bonds are measured primarily using broker quotations and pricing service data from external providers, where available, prices observed for recently executed market transactions of comparable size, and bond spreads or credit default swap spreads of the issuer adjusted for basis differences between the swap curve and the bond curve. Corporate bonds measured using these valuation methods are categorized within Level 2 of the fair value hierarchy. If broker quotes, pricing data or spread data is not available, alternative valuation techniques are used including cash flow models incorporating interest rate curves, single name or index credit default swap curves for comparable issuers and recovery rate assumptions. Corporate bonds measured using alternative valuation techniques are classified within Level 3 of the fair value hierarchy and comprise a limited portion of our corporate bonds.

•

High Yield Corporate and Convertible Bonds: A significant portion of our high yield corporate and convertible bonds are classified within Level 2 of the fair value hierarchy and are measured primarily using broker quotations and pricing service data from external providers, where available, and prices observed for recently executed market transactions of comparable size. Where pricing data is less observable, valuations are classified in Level 3 and are based on pending transactions involving the issuer or comparable issuers, prices implied from an issuer’s subsequent financings or recapitalizations, models incorporating financial ratios and projected cash flows of the issuer and market prices for comparable issuers.

•

Auction Rate Securities: Auction rate securities (“ARS”) included within corporate debt securities include ARS backed by pools of student loans and auction rate preferred securities issued by closed end mutual funds. ARS are measured using market data provided by external service providers, as available. The fair value of ARS is also determined by benchmarking to independent market data and adjusting for projected cash flows, level of seniority in the capital structure, leverage, liquidity and credit rating, as appropriate. ARS are classified within

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(Unaudited)

Level 3 of the fair value hierarchy based on our assessment of the transparency of the external market data received.

Collateralized Debt Obligations

Collateralized debt obligations are measured based on valuations received from third party brokers and classified within Level 3 of the fair value hierarchy due to the unobservable nature of the pricing inputs underlying the broker valuations.

U.S. Government and Federal Agency Securities

•

U.S. Treasury Securities: U.S. Treasury securities are measured based on quoted market prices and categorized in Level 1 of the fair value hierarchy.

•

U.S. Agency Issued Debt Securities: Callable and non-callable U.S. agency issued debt securities are measured primarily based on quoted market prices obtained from external pricing services. Non-callable U.S. agency securities are generally classified within Level 1 of the fair value hierarchy and callable U.S. agency securities are classified within Level 2.

Municipal Securities

Municipal securities are measured based on quoted prices obtained from external data providers and generally classified within Level 2 of the fair value hierarchy.

Sovereign Obligations

•

G-7 Government and non-G-7 Government Bonds: G-7 government and non-G-7 government bonds are measured based on quoted market prices obtained from external pricing services. G-7 government bonds are categorized within Level 1 of the fair value hierarchy and non-G-7 government bonds are categorized within Level 2.

•

Emerging Market Sovereign Debt Securities: Valuations are primarily based on market price quotations from external data providers, where available, or recently executed independent transactions of comparable size. To the extent market price quotations are not available or recent transactions have not been observed, valuation techniques incorporating foreign currency curves, interest rate yield curves and country spreads for bonds of similar issuers, seniority and maturity are used to determine fair value. Emerging market sovereign debt securities are generally classified within Level 2 of the fair value hierarchy.

Residential Mortgage-Backed Securities

•

Agency Residential Mortgage-Backed Securities: Agency residential mortgage-backed securities include mortgage pass-through securities (fixed and adjustable rate), collateralized mortgage obligations, interest-only and principal-only securities and to-be-announced securities and are generally measured using market price quotations from external data providers and categorized within Level 2 of the fair value hierarchy.

•

Agency Residential Inverse Interest-Only Securities (“Agency Inverse IOs”): The fair value of agency inverse IOs is estimated using expected future cash flow techniques that incorporate prepayment models and other prepayment assumptions to amortize the underlying mortgage loan collateral. We use prices observed for recently executed transactions to develop market-clearing spread and yield curve assumptions. Valuation inputs with regard to underlying collateral incorporate weighted average coupon, loan-to-value, credit scores, geographic location, maximum and average loan size, originator, servicer, and weighted average loan age. Agency inverse IOs are categorized within Level 2 of the fair value hierarchy. We also use vendor data in developing assumptions, as appropriate.

•

Non-Agency Residential Mortgage-Backed Securities: Fair values are determined primarily using discounted cash flow methodologies and securities are categorized within Level 2 or Level 3 of the fair value hierarchy based

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on the observability of the pricing inputs used. Performance attributes of the underlying mortgage loans are evaluated to estimate pricing inputs, such as prepayment rates, default rates and the severity of credit losses. Attributes of the underlying mortgage loans that affect the pricing inputs include, but are not limited to, weighted average coupon; average and maximum loan size; loan-to-value; credit scores; documentation type; geographic location; weighted average loan age; originator; servicer; historical prepayment, default and loss severity experience of the mortgage loan pool; and delinquency rate. Yield curves used in the discounted cash flow models are based on observed market prices for comparable securities and published interest rate data to estimate market yields.

Commercial Mortgage-Backed Securities

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Agency Commercial Mortgage-Backed Securities: GNMA project loan bonds and FNMA DUS mortgage-backed securities are generally measured by using prices observed for recently executed market transactions to estimate market-clearing spread levels for purposes of estimating fair value. GNMA project loan bonds and FNMA DUS mortgage-backed securities are categorized within Level 2 of the fair value hierarchy.

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Non-Agency Commercial Mortgage-Backed Securities: Non-agency commercial mortgage-backed securities are measured using pricing data obtained from third party services and prices observed for recently executed market transactions and are categorized within Level 2 and Level 3 of the fair value hierarchy.

Other Asset-Backed Securities

Other asset-backed securities include, but are not limited to, securities backed by auto loans, credit card receivables and student loans and are categorized within Level 2 of the fair value hierarchy. Valuations are determined using pricing data obtained from third party services and prices observed for recently executed market transactions.

Loans and Other Receivables

•

Corporate Loans: Corporate loans categorized within Level 2 of the fair value hierarchy are measured based on market price quotations from external data providers where sufficient observability exists as to the extent of market transaction data supporting the pricing data. Corporate loans categorized within Level 3 are measured based on market price quotations that are considered to be less transparent, market prices for debt securities of the same creditor, and estimates of future cash flow incorporating assumptions regarding creditor default and recovery rates and consideration of the issuer’s capital structure.

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Participation Certificates in GNMA Project and Construction Loans: Valuations of participation certificates in GNMA project and construction loans are based on observed market prices of recently executed purchases of similar loans which are then used to derive a market implied spread. The market implied spread is used as the primary input in estimating the fair value of loans at the measurement date. The loan participation certificates are categorized within Level 2 of the fair value hierarchy given the observability and volume of recently executed transactions.

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Escrow and Trade Claim Receivables: Escrow and trade claim receivables are categorized within Level 3 of the fair value hierarchy with fair value estimated based on reference to market prices and implied yields of debt securities of the same or similar issuers.

Derivatives

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Listed Derivative Contracts: Listed derivative contracts are measured based on quoted exchange prices, which are generally obtained from pricing services, and are categorized as Level 1 in the fair value hierarchy.

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OTC Derivative Contracts: OTC derivative contracts are generally valued using models, whose inputs reflect assumptions that we believe market participants would use in valuing the derivative in a current period transaction. Inputs to valuation models are appropriately calibrated to market data. For many OTC derivative contracts, the valuation models do not involve material subjectivity as the methodologies do not entail significant judgment and the inputs to valuation models do not involve a high degree of subjectivity as the valuation model

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inputs are readily observable or can be derived from actively quoted markets. OTC derivative contracts are primarily categorized in Level 2 of the fair value hierarchy given the observability of the inputs to the valuation models.

OTC options include OTC equity and commodity options measured using Black-Scholes models with key inputs impacting the valuation including the underlying security or commodity price, implied volatility, dividend yield, interest rate curve, strike price and maturity date. Discounted cash flow models are utilized to measure certain OTC derivative contracts including the valuations of our interest rate swaps, which incorporate observable inputs related to interest rate curves, and valuations of our foreign exchange forwards and swaps, which incorporate observable inputs related to foreign currency spot rates and forward curves. Credit defaults swaps include both index and single-name credit default swaps. External prices are available as inputs in measuring index credit default swaps. For single-name credit default swaps, fair value is determined based on valuation statements provided by the counterparty. For commodity and equity total return swaps, market prices are observable for the underlying asset and used as the basis for measuring the fair value of the derivative contracts. Total return swaps executed on other underlyings are measured based on valuations received from third parties.

Investments at Fair Value

Investments at fair value include primarily investments in hedge funds, fund of funds and private equity funds, which are measured based on the net asset value of the funds provided by the fund managers and categorized within Level 3 of the fair value hierarchy. Additionally, investments at fair value include direct equity investments in private companies, which are measured using valuation techniques involving quoted prices of or market data for comparable companies, similar company ratios and multiples (e.g., price/EBITDA, price/book value), discounted cash flow analyses and transaction prices observed for subsequent financing or capital issuance by the company. Direct equity investments in private companies are categorized within Level 3 of the fair value hierarchy.

At August 31, 2010 and December 31, 2009, our Financial instruments owned and Financial instruments sold, not yet purchased are measured using different valuation basis as follows:

							Financial
			Financial				Instruments Sold,
Valuation Basis at			Instruments				Not Yet
August 31, 2010			Owned				Purchased
Exchange closing prices				11	%			19	%
Recently observed transaction prices				3	%			1	%
Data providers/pricing services				68	%			65	%
Broker quotes				12	%			14	%
Valuation techniques				6	%			1	%
				100	%			100	%

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							Financial
Valuation Basis at			Financial				Instruments Sold,
December 31, 2009			Instruments Owned				Not Yet Purchased
Exchange closing prices				15	%			25	%
Recently observed transaction prices				2	%			2	%
Data providers/pricing services				55	%			48	%
Broker quotes				12	%			23	%
Valuation techniques				16	%			2	%
				100	%			100	%

Pricing information obtained from external data providers may incorporate a range of market quotes from dealers, recent market transactions and benchmarking model derived prices to quoted market prices and trade data for comparable securities. External pricing data is subject to evaluation for reasonableness using a variety of means including comparisons of prices to those of similar product types, quality and maturities, consideration of the narrowness or wideness of the range of prices obtained, knowledge of recent market transactions and an assessment of the similarity in prices to comparable dealer offerings in a recent time period.

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 months ended August 31, 2010 and September 30, 2009 (in thousands):

		Three Months Ended August 31, 2010
																										Change in
						Total gains/																				unrealized gains/
						losses				Purchases,																(losses) relating to
		Balance,				(realized and				sales,				Transfers				Transfers				Balance,				instruments still held
		May 31,				unrealized)				settlements,				into				out of				August 31,				at August 31, 2010
		2010				(1)				and issuances				Level 3				Level 3				2010				(1)
Assets:
Financial instruments owned:
Corporate equity securities		$	21,918			$	1,327			$	2,751			$	—			$	(417	)		$	25,579			$	(789	)
Corporate debt securities			100,275				(714	)			3,149				54				(1,480	)			101,284				(813	)
Collateralized debt obligations			21,957				(495	)			352				4,492				—				26,306				(615	)
U.S. issued municipal securities			436				(7	)			—				—				—				429				(7	)
Residential mortgage-backed securities			148,833				5,914				(8,770	)			23,143				(1,281	)			167,839				404
Commercial mortgage-backed securities			1,000				—				50				—				(1,000	)			50				—
Other asset-backed securities			369				—				(369	)			—				—				—				—
Loans and other receivables			145,181				(4,735	)			(55,105	)			—				—				85,341				(4,139	)
Investments at fair value			72,297				8,060				(3,724	)			2,723				—				79,356				9,145
Liabilities:
Financial instruments sold, not yet purchased:
Corporate equity securities		$	38			$	—			$	—			$	58			$	—			$	96			$	—
Corporate debt securities			14,365				(1,275	)			(13,090	)			—				—				—				—
Net derivatives (2)			1,271				523				—				—				(500	)			1,294				523
Loans			68,242				—				(42,130	)			—				—				26,112				—