Edgar Filing: JEFFERIES GROUP INC /DE/

Form 10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended August 31, 2012

¨ 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 incorporation or organization)		(I.R.S. Employer Identification No.)

520 Madison Avenue, 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 x No ¨

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 x No ¨

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 x		Accelerated filer ¨		Non-accelerated filer ¨		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 ¨ No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. 203,124,613 shares as of the close of business on September 19, 2012.

JEFFERIES GROUP, INC.

INDEX TO QUARTERLY REPORT ON FORM 10-Q

August 31, 2012


	PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements:
	Consolidated Statements of Financial Condition (Unaudited) - August 31, 2012 and November 30, 2011	2
	Consolidated Statements of Earnings (Unaudited) - Three and Nine Months Ended August 31, 2012 and August 31, 2011	5
	Consolidated Statements of Comprehensive Income (Unaudited) - Three and Nine Months Ended August 31, 2012 and August 31, 2011	6
	Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) - Nine Months Ended August 31, 2012 and Twleve Months Ended November 30, 2011	7
	Consolidated Statements of Cash Flows (Unaudited) - Nine Months Ended August 31, 2012 and August 31, 2011	8
	Notes to Consolidated Financial Statements (Unaudited)	10
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.	70
Item 3.	Quantitative and Qualitative Disclosures About Market Risk.	112
Item 4.	Controls and Procedures	112

	PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	112
Item 1A.	Risk Factors	112
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	112
Item 6.	Exhibits	113

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

JEFFERIES GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED)

(In thousands)


	August 31,		November 30,
	2012		2011
ASSETS
Cash and cash equivalents	$	2,844,513	$	2,393,797
Cash and securities segregated and on deposit for regulatory purposes or deposited with clearing and depository organizations		3,752,782		3,344,960
Financial instruments owned, at fair value, including securities pledged of $12,720,617 and $12,452,970 at August 31, 2012 and November 30, 2011, respectively:
Corporate equity securities		1,632,178		1,235,079
Corporate debt securities		2,531,046		2,868,304
Government, federal agency and other sovereign obligations		4,335,015		7,471,563
Mortgage- and asset-backed securities		4,232,036		3,923,303
Loans and other receivables		524,009		376,146
Derivatives		358,823		525,893
Investments, at fair value		144,888		105,585
Physical commodities		159,011		172,668

Total financial instruments owned, at fair value		13,917,006		16,678,541
Investments in managed funds		60,121		70,740
Loans to and investments in related parties		703,923		594,538
Securities borrowed		5,218,205		5,169,689
Securities purchased under agreements to resell		3,942,915		2,893,043
Securities received as collateral		484		21,862
Receivables:
Brokers, dealers and clearing organizations		1,636,335		1,235,393
Customers		892,051		1,116,982
Fees, interest and other		191,968		163,092
Premises and equipment		175,880		175,139
Goodwill		365,456		365,574
Other assets		705,719		748,072

Total assets	$	34,407,358	$	34,971,422

Continued on next page.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION — CONTINUED (UNAUDITED)

(In thousands)


	August 31, 2012			November 30, 2011
LIABILITIES AND STOCKHOLDERS’ EQUITY
Short-term borrowing	$	250,000		$	52,721
Financial instruments sold, not yet purchased, at fair value:
Corporate equity securities		1,541,892			1,330,096
Corporate debt securities		1,793,417			1,614,493
Government, federal agency and other sovereign obligations		4,386,204			3,209,713
Mortgage- and asset-backed securities		217,172			50,517
Loans		136,060			151,117
Derivatives		233,716			249,037
Physical commodities		45,508			—

Total financial instruments sold, not yet purchased, at fair value		8,353,969			6,604,973
Securities loaned		2,061,548			1,706,308
Securities sold under agreements to repurchase		8,216,852			9,620,663
Obligation to return securities received as collateral		484			21,862
Payables:
Brokers, dealers and clearing organizations		611,155			2,816,877
Customers		5,004,324			4,763,364
Accrued expenses and other liabilities		876,741			803,219
Long-term debt		4,860,917			4,608,926
Mandatorily redeemable convertible preferred stock		125,000			125,000
Mandatorily redeemable preferred interests of consolidated subsidiaries		339,825			310,534

Total liabilities		30,700,815			31,434,447

STOCKHOLDERS’ EQUITY
Common stock, $.0001 par value. Authorized 500,000,000 shares; issued 203,202,305 shares at August 31, 2012 and 197,197,848 shares at November 30, 2011		20			20
Additional paid-in capital		2,194,142			2,207,410
Retained earnings		1,227,357			1,067,858
Treasury stock, at cost, 131,952 shares at August 31, 2012 and 37,842 shares at November 30, 2011		(1,845	)		(486	)
Accumulated other comprehensive loss:
Currency translation adjustments		(39,727	)		(39,520	)
Additional minimum pension liability		(10,970	)		(10,970	)

Total accumulated other comprehensive loss		(50,697	)		(50,490	)

Total common stockholders’ equity		3,368,977			3,224,312
Noncontrolling interests		337,566			312,663

Total stockholders’ equity		3,706,543			3,536,975

Total liabilities and stockholders’ equity	$	34,407,358		$	34,971,422

Continued on next page.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION — CONTINUED (UNAUDITED)

(In thousands)

The table below presents the carrying amount and classification of assets of consolidated variable interest entities (“VIEs”) that can be used only to settle obligations of the consolidated VIEs and the liabilities of consolidated VIEs for which creditors (or beneficial interest holders) do not have recourse to our general credit. The assets and liabilities of these consolidated VIEs are included in the Consolidated Statements of Financial Condition and are presented net of intercompany eliminations.


	August 31, 2012		November 30, 2011
Assets
Cash and cash equivalents	$	445,860	$	345,959
Financial instruments owned, at fair value
Corporate equity securities		106,855		61,670
Corporate debt securities		337,046		326,549
Mortgage- and asset-backed securities		44,052		41,004
Loans and other receivables		304,214		281,416
Derivatives		506		569
Investments, at fair value		5,296		1,570

Total financial instruments owned, at fair value		797,969		712,778
Receivables:
Brokers, dealers and clearing organizations		137,645		150,592
Fees, interest and other		7,720		7,396
Other assets		463		385

Total assets		1,389,657		1,217,110

Liabilities
Financial instruments sold, not yet purchased, at fair value:
Corporate equity securities		10,587		7,122
Corporate debt securities		330,516		200,223
Loans		125,175		117,958
Derivatives		310		935

Total financial instruments sold, not yet purchased, at fair value		466,588		326,238
Payables:
Brokers, dealers and clearing organizations		110,925		105,165
Accrued expenses and other liabilities		12,677		9,740
Mandatorily redeemable preferred interests of consolidated subsidiaries		339,825		310,534

Total liabilities	$	930,015	$	751,677

See accompanying unaudited notes to consolidated financial statements.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)

(In thousands, except per share amounts)


	Three Months Ended					Nine Months Ended
	August 31, 2012		August 31, 2011			August 31, 2012		August 31, 2011
Revenues:
Commissions	$	119,200	$	154,896		$	358,495	$	404,108
Principal transactions		297,037		(74,003	)		793,834		391,464
Investment banking		260,163		293,750			842,921		861,230
Asset management fees and investment income from managed funds		3,116		3,086			10,648		37,501
Interest		242,625		353,006			788,935		930,647
Other		22,911		63,369			103,102		105,948

Total revenues		945,052		794,104			2,897,935		2,730,898
Interest expense		206,114		284,822			668,000		736,068

Net revenues		738,938		509,282			2,229,935		1,994,830
Interest on mandatorily redeemable preferred interests of consolidated subsidiaries		8,304		(14,671	)		34,604		6,183

Net revenues, less mandatorily redeemable preferred interests		730,634		523,953			2,195,331		1,988,647

Non-interest expenses:
Compensation and benefits		440,391		299,640			1,310,394		1,174,468
Non-compensation expenses:
Floor brokerage and clearing fees		30,280		32,959			91,039		92,475
Technology and communications		58,681		60,039			180,460		153,563
Occupancy and equipment rental		24,077		22,581			71,582		60,997
Business development		27,736		21,853			72,362		64,248
Professional services		14,667		19,061			45,656		48,437
Other		12,433		12,582			46,018		45,805

Total non-compensation expenses		167,874		169,075			507,117		465,525

Total non-interest expenses		608,265		468,715			1,817,511		1,639,993

Earnings before income taxes		122,369		55,238			377,820		348,654
Income tax expense		44,048		1,228			134,403		107,899

Net earnings		78,321		54,010			243,417		240,755
Net earnings (loss) to noncontrolling interests		8,150		(14,265	)		32,612		4,523

Net earnings to common shareholders	$	70,171	$	68,275		$	210,805	$	236,232

Earnings per common share:
Basic	$	0.31	$	0.30		$	0.92	$	1.07
Diluted	$	0.31	$	0.30		$	0.91	$	1.07
Dividends declared per common share	$	0.075	$	0.075		$	0.225	$	0.225
Weighted average common shares:
Basic		214,756		218,426			216,509		209,544
Diluted		218,867		222,541			220,621		213,661

See accompanying unaudited notes to consolidated financial statements.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

(In thousands)


	Three Months Ended					Nine Months Ended
	August 31, 2012		August 31, 2011			August 31, 2012			August 31, 2011
Net earnings	$	78,321	$	54,010		$	243,417		$	240,755

Other comprehensive income, net of tax:
Currency translation adjustments		6,519		(6,266	)		(207	)		17,231

Total other comprehensive income (loss), net of tax(1)		6,519		(6,266	)		(207	)		17,231

Comprehensive income		84,840		47,744			243,210			257,986
Net earnings (loss) attributable to noncontrolling interests		8,150		(14,265	)		32,612			4,523

Comprehensive income to common shareholders	$	76,690	$	62,009		$	210,598		$	253,463

(1)	Total other comprehensive income, net of tax, is attributable to common shareholders. No other comprehensive income is attributable to noncontrolling interests.

See accompanying unaudited notes to consolidated financial statements.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)

(In thousands, except per share amounts)


	Nine Months Ended August 31, 2012			Twelve Months Ended November 30, 2011
Common stock, par value $0.0001 per share
Balance, beginning of period	$	20		$	20
Issued		1			2
Retired		(1	)		(2	)

Balance, end of period		20			20

Additional paid-in capital
Balance, beginning of period		2,207,410			2,218,123
Benefit plan share activity(1)		9,984			31,176
Share-based expense, net of forfeitures and clawbacks		61,923			134,076
Proceeds from exercise of stock options		104			95
Acquisitions and contingent consideration		—			419
Tax benefit for issuance of share-based awards		19,433			32,200
Equity component of convertible debt, net of tax		(427	)		(217	)
Dividend equivalents on share-based plans		5,008			8,883
Issuance of treasury stock		—			97,770
Retirement of treasury stock		(109,293	)		(315,115	)

Balance, end of period		2,194,142			2,207,410

Retained earnings
Balance, beginning of period		1,067,858			850,654
Net earnings to common shareholders		210,805			284,618
Dividends		(51,306	)		(67,414	)

Balance, end of period		1,227,357			1,067,858

Treasury stock, at cost
Balance, beginning of period		(486	)		(539,530	)
Purchases		(104,202	)		(152,827	)
Returns / forfeitures		(6,451	)		(20,368	)
Issued		—			397,122
Retirement of treasury stock		109,294			315,117

Balance, end of period		(1,845	)		(486	)

Accumulated other comprehensive loss
Balance, beginning of period		(50,490	)		(51,278	)
Currency adjustment		(207	)		3,339
Pension adjustment, net of tax		—			(2,551	)

Balance, end of period		(50,697	)		(50,490	)

Total common stockholders’ equity		3,368,977			3,224,312

Noncontrolling interests
Balance, beginning of period		312,663			332,976
Net earnings to noncontrolling interests		32,612			1,750
Contributions		—			1,713
Distributions		(7,709	)		(22,056	)
Deconsolidation of asset management entity		—			(1,720	)

Balance, end of period		337,566			312,663

Total stockholders’ equity	$	3,706,543		$	3,536,975

(1)	Includes grants related to the Incentive Plan, Deferred Compensation Plan, and Directors’ Plan.

See accompanying unaudited notes to consolidated financial statements.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In thousands)


	Nine Months Ended
	August 31, 2012			August 31, 2011
Cash flows from operating activities:
Net earnings	$	243,417		$	240,755

Adjustments to reconcile net earnings to net cash provided by (used in) operating activities:
Depreciation and amortization		54,836			53,786
Bargain purchase gain		(3,368	)		(52,509	)
Gain on repurchase of long-term debt		(9,898	)		—
Fees related to assigned management agreements		(2,780	)		(2,728	)
Interest on mandatorily redeemable preferred interests of consolidated subsidiaries		34,604			6,183
Accruals related to various benefit plans and stock issuances, net of forfeitures		65,457			56,601
Increase in cash and securities segregated and on deposit for regulatory purposes or deposited with clearing and depository organizations		(408,445	)		(555,008	)
(Increase) decrease in receivables:
Brokers, dealers and clearing organizations		(401,758	)		(840,670	)
Customers		224,761			185,110
Fees, interest and other		(28,921	)		(56,909	)
(Increase) decrease in securities borrowed		(48,893	)		375,677
Decrease (increase) in financial instruments owned		2,758,173			(1,124,290	)
Increase in loans to and investments in related parties		(109,997	)		(353,053	)
Decrease in investments in managed funds		10,619			57,685
Increase in securities purchased under agreements to resell		(1,050,263	)		(1,229,802	)
Decrease (increase) in other assets		26,957			(153,776	)
(Decrease) increase in payables:
Brokers, dealers and clearing organizations		(2,204,936	)		810,130
Customers		241,725			610,233
Increase in securities loaned		355,679			197,357
Increase in financial instruments sold, not yet purchased		1,750,709			797,320
(Decrease) increase in securities sold under agreements to repurchase		(1,402,558	)		219,933
Increase (decrease) in accrued expenses and other liabilities		74,927			(251,027	)

Net cash provided by (used in) operating activities		170,047			(1,009,002	)

Cash flows from investing activities:
Net payments on premises and equipment		(39,848	)		(60,275	)
Cash received (paid) in connection with acquisition during the period, net of cash acquired		2,257			(318,196	)
Cash received from contingent consideration		2,774			2,733
Cash paid from contingent consideration		(1,172	)		(754	)

Net cash used in investing activities		(35,989	)		(376,492	)

Continued on next page.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS — CONTINUED (UNAUDITED)

(In thousands)


	Nine Months Ended
	August 31, 2012			August 31, 2011
Cash flows from financing activities:
Excess tax benefits from the issuance of share-based awards	$	30,576		$	33,311
Proceeds from short-term borrowings		9,563,063			2,881,000
Payments on short-term borrowings		(9,370,557	)		(2,829,027	)
Proceeds from secured credit facility		680,000			—
Payments on secured credit facility		(370,000	)		—
Repayment of long-term debt		(253,232	)		—
Payments on repurchase of long-term debt		(1,435	)		—
Payments on mandatorily redeemable preferred interest of consolidated subsidiaries		(5,313	)		(8,973	)
Payments on repurchase of common stock		(104,202	)		(96,929	)
Payments on dividends		(46,298	)		(43,417	)
Proceeds from exercise of stock options, not including tax benefits		104			95
Net proceeds from (payments on):
Issuance of common shares		—			494,895
Issuance of senior notes, net of issuance costs		201,010			794,587
Noncontrolling interest		(7,709	)		(20,343	)

Net cash provided by financing activities		316,007			1,205,199

Effect of foreign currency translation on cash and cash equivalents		651			6,247

Net increase (decrease) in cash and cash equivalents		450,716			(174,048	)
Cash and cash equivalents at beginning of period		2,393,797			2,188,998

Cash and cash equivalents at end of period	$	2,844,513		$	2,014,950

Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest	$	648,394		$	667,376
Income taxes, net of refunds		12,816			143,058

See accompanying unaudited notes to consolidated financial statements.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Index


Note		Page
Note 1.	Organization and Basis of Presentation		11
Note 2.	Summary of Significant Accounting Policies		12
Note 3.	Acquisitions		20
Note 4.	Cash, Cash Equivalents and Short-Term Investments		21
Note 5.	Fair Value Disclosures		22
Note 6.	Derivative Financial Instruments		38
Note 7.	Collateralized Transactions		42
Note 8.	Securitization Activities		43
Note 9.	Variable Interest Entities		44
Note 10.	Investments		49
Note 11.	Goodwill and Other Intangible Assets		52
Note 12.	Short-Term Borrowings		55
Note 13.	Long-Term Debt		56
Note 14.	Mandatorily Redeemable Convertible Preferred Stock		57
Note 15.	Noncontrolling Interest and Mandatorily Redeemable Preferred Interests of Consolidated Subsidiaries		57
Note 16.	Benefit Plans		58
Note 17.	Compensation Plans		59
Note 18.	Earnings per Share		62
Note 19.	Income Taxes		64
Note 20.	Commitments, Contingencies and Guarantees		64
Note 21.	Net Capital Requirements		67
Note 22.	Segment Reporting		68
Note 23.	Related Party Transactions		69

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

(Unaudited)

Note 1.

Organization and Basis of Presentation

Organization

The accompanying unaudited Consolidated Financial Statements include the accounts of Jefferies Group, Inc. and all our subsidiaries (together, “we” or “us”), including Jefferies & Company, Inc. (“Jefferies”), Jefferies Execution Services, Inc., (“Jefferies Execution”), Jefferies Bache, LLC, Jefferies International Limited, Jefferies Bache, Limited, Jefferies Hong Kong Limited, CoreCommodity Management, LLC (formerly Jefferies Asset Management, LLC), Jefferies Bache Financial Services, Inc. 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”).

We operate in two business segments, Capital Markets and Asset Management. Capital Markets includes our securities, commodities, futures and foreign exchange trading (including the results of our indirectly partially owned subsidiary, Jefferies High Yield Trading, LLC) and investment banking activities, which provides the research, sales, trading and origination effort for various equity, fixed income and advisory products and services. Asset Management provides investment management services to various private investment funds, separate accounts and mutual funds.

On July 1, 2011, we acquired Prudential Bache’s Global Commodities Group (“Global Commodities Group” or “Jefferies Bache”) from Prudential Financial Inc. (“Prudential”). The Global Commodities Group provides execution and clearing services (including sales and trading activities) covering a wide variety of commodity, financial and foreign exchange futures, swaps and forward contracts to an institutional client base. On February 1, 2012, we acquired the corporate broking business of Hoare Govett from The Royal Bank of Scotland Group plc (“RBS”). The acquired business represents the corporate broking business carried on under the name RBS Hoare Govett in the United Kingdom and comprises corporate broking advice and services. See Note 3, Acquisitions for further details.

Basis of Presentation

The accompanying unaudited Consolidated Financial Statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) 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. GAAP for complete financial statements and should be read in conjunction with our Annual Report on Form 10-K for the year ended November 30, 2011.

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. GAAP. The most important of these estimates and assumptions relate to fair value measurements, compensation and benefits, goodwill, the ability to realize deferred tax assets and the recognition and measurement of uncertain tax positions. Although these and other estimates and assumptions are based on the best available information, actual results could be materially different from these estimates.

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, we consolidate entities which meet the definition of a variable interest entity 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. For consolidated entities that are less than wholly owned, the third-party’s holding of equity interest is presented as Noncontrolling interests in the Consolidated Statements of Financial Condition and Consolidated Statements of Changes in Stockholders’ Equity. The portion of net earnings attributable to the noncontrolling interests are presented as Net earnings to noncontrolling interests in the Consolidated Statements of Earnings.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

(Unaudited)

In situations where we have significant influence, but not control, of an entity that does not qualify as a variable interest entity, we apply either the equity method of accounting or fair value accounting pursuant to the fair value option election under U.S. GAAP, with our portion of net earnings or gains and losses recorded within Other Revenues. We also have formed nonconsolidated investment vehicles with third-party investors that are typically organized as partnerships or limited liability companies and are carried at fair value. 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.

Intercompany accounts and transactions are eliminated in consolidation.

Note 2.

Summary of Significant Accounting Policies

Revenue Recognition Policies

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. We permit institutional customers to allocate a portion of their gross commissions to pay for research products and other services provided by third parties. The amounts allocated for those purposes are commonly referred to as soft dollar arrangements. Soft dollar expenses amounted to $7.1 million and $22.9 million for the three and nine months ended August 31, 2012, respectively and $14.1 million and $36.4 million for the three and nine months ended August 31, 2011, respectively. These arrangements are accounted for on an accrual basis and, as we are not the primary obligor for these arrangements, expenses relating to soft dollars are netted against commission revenues. The commissions and related expenses on client transactions executed by Jefferies Bache, LLC, a futures commission merchant, are recorded on a half-turn basis.

Principal Transactions. Financial instruments owned and Financial instruments sold, but not yet purchased (all of which are recorded on a trade-date basis) are carried at fair value with gains and losses reflected in Principal transactions in the Consolidated Statements of Earnings on a trade date basis. Fees received on loans carried at fair value are also recorded within Principal transactions.

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 related-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 or an agreed upon notional amount 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. 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 (or reversed) on a monthly basis based on measuring performance to date versus any relevant benchmark return hurdles stated in the investment management agreement. Performance fees are not subject to adjustment once the measurement period ends (generally annual periods) and the performance fees have been realized.

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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 and recognized in Principal transactions in the Consolidated Statements of Earnings rather than as a component of interest revenue or expense. We account for our short-term borrowings, 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

Cash equivalents include highly liquid investments, including money market funds, 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 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. Jefferies Bache, LLC, as a futures commission merchant, is obligated by rules mandated by the Commodities Futures Trading Commission under the Commodities Exchange Act, to segregate or set aside cash or qualified securities to satisfy such regulations, which regulations have been promulgated to protect customer assets. Certain other entities are also obligated by rules mandated by their primary regulators to segregate or set aside cash or equivalent securities to satisfy regulations, promulgated to protect customer assets.

Financial Instruments

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).

Fair Value Hierarchy

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.

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.

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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.

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, the financial instrument is valued at the point within the bid-ask range that meets our best estimate of fair value. We use prices and inputs that are current as of the measurement date. 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 of financial instruments may include the use of valuation models and other techniques. Adjustments to valuations derived from valuation models may be made when, in management’s judgment, features of the financial instrument such as its complexity, the market in which the financial instrument is traded and risk uncertainties about market conditions require that an adjustment be made to the value derived from the models. 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. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment.

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. 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. The degree of judgment exercised in determining fair value is greatest for instruments categorized in Level 3.

Valuation Process for Financial Instruments

The Independent Price Verification (“IPV”) Group, which is part of Finance, in partnership with Market Risk Management, is responsible for establishing our valuation policies and procedures. The IPV Group and Market Risk Management, which are independent of our business functions, play an important role and serve as a control function in determining that our financial instruments are appropriately valued and that fair value measurements are reliable. This is particularly important where prices or valuations that require inputs are less observable. In the event that observable inputs are not available, the control processes are designed to assure that the valuation approach utilized is appropriate and consistently applied and that the assumptions are reasonable. The IPV Group reports to the Global Controller and is subject to the oversight of the IPV Committee, which is comprised of the Chief Financial Officer, Global Controller, Global Head of Product Control, Chief Risk Officer and the Principal Accounting Officer, among other personnel. Our independent price verification policies and procedures are reviewed, at a minimum, annually and changes to the policies require the approval of the IPV Committee.

Price Testing Process. The business units are responsible for determining the fair value of our financial instruments using approved valuation models and methodologies. In order to ensure that the business unit valuations represent a fair value exit price, the IPV Group tests and validates the fair value of our financial instruments inventory. In the testing process, the IPV Group obtains prices and valuation inputs from sources independent of Jefferies, consistently adheres to established procedures set forth in our valuation policies for sourcing prices and valuation inputs and utilizing valuation methodologies. Sources used to validate fair value prices and inputs include, but are not limited to, exchange data, recently executed transactions, pricing data obtained from third party vendors, pricing and valuation services, broker quotes and observed comparable transactions.

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To the extent discrepancies between the business unit valuations and the pricing or valuations resulting from the price testing process are identified, such discrepancies are investigated by the IPV Group and fair values are adjusted, as appropriate. The IPV Group maintains documentation of its testing, results, rationale and recommendations and prepares a monthly summary of its valuation results. This process also forms the basis for our classification of fair values within the fair value hierarchy (i.e., Level 1, Level 2 or Level 3). The IPV Group utilizes the additional expertise of Market Risk Management personnel in valuing more complex financial instruments and financial instruments with less or limited pricing observability. The results of the valuation testing are reported to the IPV Committee on a monthly basis, which discusses the results and is charged with the final conclusions as to the financial instrument fair values in the consolidated financial statements. This process specifically assists the Chief Financial Officer in asserting as to the fair presentation of our financial condition and results of operations as included within our Quarterly Reports on Form 10-Q and Annual Report on Form 10-K. At each quarter end, the overall valuation results, as concluded upon by the IPV Committee, are presented to the Audit Committee.

Judgment exercised in determining Level 3 fair value measurements is supplemented by daily analysis of profit and loss performed by the Product Control functions. Gains and losses, which result from changes in fair value, are evaluated and corroborated daily based on an understanding of each of the trading desks’ overall risk positions and developments in a particular market on the given day. Valuation techniques generally rely on recent transactions of suitably comparable financial instruments and use the observable inputs from those comparable transactions as a validation basis for Level 3 inputs. Level 3 fair value measurements are further validated through subsequent sales testing and market comparable sales, if such information is available. Level 3 fair value measurements require documentation of the valuation rationale applied, which is reviewed for consistency in application from period to period; and the documentation includes benchmarking the assumptions underlying the valuation rationale against relevant analytic data.

Third Party Pricing Information. Pricing information obtained from external data providers and pricing services 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. We have a process whereby we challenge the appropriateness of pricing information obtained from data providers and pricing services in order to validate the data for consistency with the definition of a fair value exit price. Our process includes understanding and evaluating the service providers’ valuation methodologies. For corporate, U.S. government and agency, and municipal debt securities (excluding auction rate securities), and loans, to the extent pricing services or broker quotes are utilized in our valuation process, the vendor services are collecting and aggregating observable market information as to recent trade activity and active bid-ask submissions. The composite pricing information received from the independent pricing service is not based on unobservable inputs or proprietary models. For mortgage- and other asset-backed securities and collateralized debt obligations, our independent pricing service uses a matrix evaluation approach incorporating both observable yield curves and market yields on comparable securities as well as implied inputs from observed trades for comparable securities in order to determine prepayment speeds, cumulative default rates and loss severity. Further, we consider pricing data from multiple service providers as available as well as compare pricing data to prices we have observed for recent transactions, if any, in order to corroborate our valuation inputs.

Model Review Process. Where a pricing model is to be used to determine fair value, the pricing model is reviewed for theoretical soundness and appropriateness by Market Risk Management, independent from the trading desks, and then approved to be used in the valuation process. Review and approval of a model for use includes benchmarking the model against relevant third party valuations, testing sample trades in the model, backtesting the results of the model against actual trades and stress-testing the sensitivity of the valuation model using varying inputs and assumptions. In addition, recently executed comparable transactions and other observable market data are considered for purposes of validating assumptions underlying the model. Models are independently reviewed and validated annually or more frequently if market conditions or use of the valuation model changes.

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Investments in Managed Funds

Investments in managed funds include our investments in funds managed by us and our investments in related-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 at fair value with gains or losses included in Asset management fees and investment income from managed funds in the Consolidated Statements of Earnings.

Loans to and Investments in Related Parties

Loans to and investments in related parties include investments in private equity and other operating entities made in connection with our capital markets activities in which we exercise significant influence over operating and capital decisions and loans issued in connection with such activities. Loans to and investments in related parties are accounted for using the equity method or at cost, as appropriate. Revenues on Loans to and investments in related parties are included in Other income in the Consolidated Statements of Earnings. See Note 10, Investments, for additional information regarding certain of these investments.

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 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

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

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 resale or repurchase amount plus accrued interest. We earn and incur interest over the term of the repo, which is reflected in Interest income and Interest expense on our Consolidated Statements of Earnings on an accrual basis. Repos are presented in the Consolidated Statements of Financial Condition on a net-basis-by counterparty, where permitted by generally accepted accounting principles. 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.

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

Goodwill and Intangible Assets

Goodwill. 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 carrying value. If the estimated fair value exceeds the carrying value, goodwill at the reporting unit level is not impaired. If the estimated fair value is less than carrying value, further analysis is necessary to determine the amount of impairment, if any. The methodologies we utilize in estimating the fair value of reporting units include market capitalization, price-to-book multiples of comparable exchange traded companies and multiples of merger and acquisitions of similar businesses. Periodically estimating the fair value of a reporting unit requires significant judgment and often involves the use of estimates and assumptions that could have a significant effect on whether or not an impairment charge is recorded and the magnitude of such a charge. Our annual goodwill impairment testing date is June 1. Refer to Note 11, Goodwill and Other Intangible Assets for further details on our assessment of goodwill.

Intangible Assets. Intangible assets deemed to have finite lives are amortized on a straight line basis over their estimated useful lives, where the useful life is the period over which the asset is expected to contribute directly, or indirectly, to our future cash flows. Intangible assets are reviewed for impairment on an interim basis when certain events or circumstances exist. For amortizable intangible assets, impairment exists when the carrying amount of the intangible asset exceeds its fair value. At least annually, the remaining useful life is evaluated.

An intangible asset with an indefinite useful life is not amortized but assessed annually, or more frequently when certain events or circumstances exist, for impairment. Impairment exists when the carrying amount exceeds its fair value. To the extent an impairment loss is recognized, the loss establishes the new cost basis of the asset that is amortized over the remaining useful life of that asset. Subsequent reversal of impairment losses is not permitted. Our annual indefinite-lived intangible asset impairment testing date is June 1.

Income Taxes

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 of a change in tax rates on deferred tax assets and liabilities 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 of 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 Statements of Changes in Stockholders’ Equity.

Legal Reserves

In the normal course of business, we have been named, from time to time, as a defendant in legal and regulatory proceedings. We are also involved, from time to time, in other exams, investigations and similar reviews (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.

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We recognize a liability for a contingency in Accrued expenses and other liabilities when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. If the reasonable estimate of a probable loss is a range, we accrue the most likely amount of such loss, and if such amount is not determinable, then we accrue the minimum in the range as the loss accrual. 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 regulatory proceedings and any other exams, investigations or similar reviews (both formal and informal) should not have a material adverse effect on our consolidated results of operations, cash flows or financial condition. In addition, we believe that any amount that could be reasonably estimated of potential loss or range of potential loss in excess of what has been provided in the consolidated financial statements is not material.

Share-based Compensation

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.

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

Earnings per Common Share

Basic earnings per share (“EPS”) is computed by dividing net earnings 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 available to common shareholders represent net earnings 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 (“RSUs”) 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 RSUs 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 RSUs meet the definition of a participating security. As such, we calculate Basic and Diluted earnings per share under the two-class method.

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Securitization Activities

We engage in securitization activities related to commercial mortgage loans and mortgage-backed and other asset-backed securities. Such transfers of financial assets are 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 Statements 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 Statements 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.

Accounting Developments

Accounting Standards to be Adopted in Future Periods

Indefinite-Lived Intangible Asset Impairment. In July 2012, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2012-02, Testing Indefinite-Lived Intangible Assets for Impairment. The guidance permits an entity to first assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset, other than goodwill, is impaired as a basis for determining whether it is necessary to perform the quantitative impairment test. The update does not revise the requirement to test indefinite-lived intangible assets annually for impairment, or more frequently if deemed appropriate. The new guidance is effective for annual and interim tests performed for fiscal years beginning after September 15, 2012, with early adoption permitted (fiscal year ended November 30, 2013). The adoption of this guidance will not affect our financial condition, results of operations or cash flows as it does not affect how impairment is calculated.

Balance Sheet Offsetting Disclosures. In December 2011, the FASB issued ASU No. 2011-11, Disclosures about Offsetting Assets and Liabilities. The update requires new disclosures regarding balance sheet offsetting and related arrangements. For derivatives and financial assets and liabilities, the amendments require disclosure of gross asset and liability amounts, amounts offset on the balance sheet, and amounts subject to the offsetting requirements but not offset on the balance sheet. The guidance is effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods (fiscal year ended November 30, 2014), and is to be applied retrospectively. This guidance does not amend the existing guidance on when it is appropriate to offset; as a result, this guidance will not affect our financial condition, results of operation or cash flows.

Goodwill Testing. In September 2011, the FASB issued ASU No. 2011-08, Testing Goodwill for Impairment. The update outlines amendments to the two step goodwill impairment test permitting an entity to first assess qualitative factors in determining whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step quantitative goodwill impairment test. The update is effective for annual and interim goodwill tests performed for fiscal years beginning after December 15, 2011, with early adoption permitted (fiscal year ended November 2013). The adoption of this guidance will not affect our financial condition, results of operation or cash flows as it does not change how goodwill is calculated nor assigned to reporting units.

Adopted Accounting Standards

Comprehensive Income. In June 2011, the FASB issued ASU No. 2011-05, Presentation of Comprehensive Income. The update requires entities to report comprehensive income either (1) in a single continuous statement of comprehensive income or (2) in two separate but consecutive statements. We adopted the guidance on March 1, 2012, and elected the two separate but consecutive statements approach. Accordingly, we now present our Consolidated Statements of Comprehensive Income immediately following our Consolidated Statements of Earnings within our consolidated financial statements.

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Fair Value Measurements and Disclosures. In May 2011, the FASB issued ASU No. 2011-04 Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. The amendments prohibit the use of blockage factors at all levels of the fair value hierarchy and provide guidance on measuring financial instruments that are managed on a net portfolio basis. Additional disclosure requirements include transfers between Levels 1 and 2; and for Level 3 fair value measurements, a description of our valuation processes and additional information about unobservable inputs impacting Level 3 measurements. We adopted this guidance on March 1, 2012 and have reflected the new disclosures in our consolidated financial statements. The adoption of this guidance did not have an impact on our financial condition, results of operations or cash flows.

Reconsideration of Effective Control for Repurchase Agreements. In April 2011, the FASB issued ASU No. 2011-03, Reconsideration of Effective Control for Repurchase Agreements. In assessing whether to account for repurchase and other agreements that both entitle and obligate the transferor to repurchase or redeem financial assets before their maturity as sales or as secured financing, this guidance removes from the assessment of effective control 1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms and 2) the collateral maintenance implementation guidance related to that criterion. The guidance is effective prospectively for transactions beginning on or after January 1, 2012. The adoption of this guidance did not have an impact on our financial condition, results of operations or cash flows.

Note 3.

Acquisitions

Global Commodities Group

On July 1, 2011, we acquired Prudential Bache’s Global Commodities Group from Prudential. Total cash payments made as consideration for the acquisition were $422.0 million. The acquisition included 100% of the equity interests in Prudential Bache Commodities LLC, a US-based full-service futures commission merchant; Prudential Bache Securities LLC, a US-based registered broker-dealer, which has since merged with Jefferies; Bache Commodities Limited, a UK-based global commodities and financial derivatives broker; Prudential Bache Asset Management, Inc., a US-based registered investment advisor and commodity trading advisor, Prudential Bache Financial Services, Inc., a global over-the-counter commodities dealer; and Bache Commodities (Hong Kong) Ltd., a Hong Kong-based licensed futures dealer. In addition, we acquired related information technology assets and contracts used by the Global Commodities Group. We refer to this business collectively as “Jefferies Bache.”

For further information on the acquisition, see Note 3, Acquisition of the Global Commodities Group to the consolidated financial statements for the year ended November 30, 2011 included in our Annual Report on Form 10-K.

Hoare Govett

On February 1, 2012, we acquired the corporate broking business of Hoare Govett from RBS. Total cash consideration paid by us to RBS for the acquisition was £1. In addition, under the terms of the purchase agreement RBS agreed to pay us approximately £1.9 million towards retention payments made to certain employees, which constituted a reduction of the final purchase price. The business acquired represents the corporate broking business carried on under the name RBS Hoare Govett in the United Kingdom and comprises corporate broking advice and services, as well as certain equity sales and trading activities. The acquisition included the Hoare Govett trade name, domain name, client

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agreements and the exclusive right to carry on the business in succession to RBS. The acquisition of Hoare Govett provides us with the opportunity to continue our growth in corporate broking and significantly expand the capabilities and reach of our established European Investment Banking and Equities businesses.

We accounted for the acquisition under the acquisition method of accounting. Accordingly, the assets acquired, including identifiable intangible assets, and liabilities assumed were recorded at their respective fair values as of the date of acquisition. The fair values of the net assets acquired, including identifiable intangible assets, was approximately $0.3 million, which exceeded the negative purchase price of $3.1 million (cash consideration paid of £1 less remittance from RBS of £1.9 million), resulting in a bargain purchase gain of approximately $3.4 million. The bargain purchase gain is included within Other Revenues in the Consolidated Statement of Earnings and is presented within the Capital Markets business segment. Approximately $0.4 million was recognized at the date of acquisition as the fair value of the Hoare Govett trade name. See Note 11, Goodwill and Other Intangible Assets for further details. The fair value of the intangible asset is amortized on a straight line basis over a useful life of 5 years. Additionally, on February 1, 2012, we recognized a deferred tax liability of approximately $0.1 million, recorded within Accrued expenses and other liabilities on the Consolidated Statement of Financial Condition.

Our results of operations for the nine months ended August 31, 2012 include the results of operations of Hoare Govett for the period from February 1, 2012 to August 31, 2012. The acquisition closed on February 29, 2012.

Note 4.

Cash, Cash Equivalents and Short-Term Investments

We generally invest our excess cash in money market funds and in other short-term instruments. Cash equivalents include highly liquid investments not held for resale and with original maturities of three months or less. The following are financial instruments, classified as cash and cash equivalents, that are deemed by us to be generally readily convertible into cash as of August 31, 2012 and November 30, 2011 (in thousands):


	August 31, 2012		November 30, 2011
Cash and cash equivalents:
Cash in banks	$	567,030	$	846,990
Money market investments		2,277,483		1,546,807

Total cash and cash equivalents	$	2,844,513	$	2,393,797

Cash and securities segregated(1)	$	3,752,782	$	3,344,960

(1)

Consists of deposits at exchanges and clearing organizations, as well as deposits in accordance with Rule 15c3-3 of the Securities Exchange Act of 1934, which subjects Jefferies as a broker-dealer carrying client accounts to requirements related to maintaining cash or qualified securities in a segregated reserve account for the exclusive benefit of its clients, and Jefferies Bache, LLC which, as a futures commission merchant, is subject to the segregation requirements pursuant to the Commodity Exchange Act.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

(Unaudited)

Note 5.

Fair Value Disclosures

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, 2012 and November 30, 2011 by level within the fair value hierarchy (in thousands):


	August 31, 2012
	Level 1(1)		Level 2(1)		Level 3			Counterparty and Cash Collateral Netting(2)			Total
Assets:
Financial instruments owned:
Corporate equity securities	$	1,289,905	$	322,490	$	19,783		$	—		$	1,632,178
Corporate debt securities		—		2,523,488		7,558			—			2,531,046
Collateralized debt obligations		—		67,778		81,598			—			149,376
U.S. government and federal agency securities		999,618		100,006		—			—			1,099,624
Municipal securities		—		435,009		83			—			435,092
Sovereign obligations		1,846,487		953,812		—			—			2,800,299
Residential mortgage-backed securities		—		3,399,387		144,988			—			3,544,375
Commercial mortgage-backed securities		—		461,359		31,513			—			492,872
Other asset-backed securities		—		45,205		208			—			45,413
Loans and other receivables		—		415,220		108,789			—			524,009
Derivatives		416,652		1,769,428		340			(1,827,597	)		358,823
Investments at fair value		—		52,909		91,979			—			144,888
Physical commodities		—		159,011		—			—			159,011

Total financial instruments owned	$	4,552,662	$	10,705,102	$	486,839		$	(1,827,597	)	$	13,917,006

Level 3 financial instruments for which the firm does not bear economic exposure(3)						(50,799	)

Level 3 financial instruments for which the firm bears economic exposure					$	436,040

Cash and cash equivalents	$	2,844,513	$	—	$	—		$	—		$	2,844,513
Investments in managed funds	$	—	$	—	$	60,121		$	—		$	60,121
Cash and securities segregated and on deposit for regulatory purposes(4)	$	3,752,782	$	—	$	—		$	—		$	3,752,782
Securities received as collateral	$	484	$	—	$	—		$	—		$	484

Total Level 3 assets for which the firm bears economic exposure					$	496,161

Liabilities:
Financial instruments sold, not yet purchased:
Corporate equity securities	$	1,440,045	$	101,809	$	38		$	—		$	1,541,892
Corporate debt securities		—		1,793,417		—			—			1,793,417
U.S. government and federal agency securities		1,674,682		—		—			—			1,674,682
Sovereign obligations		1,858,650		852,872		—			—			2,711,522
Residential mortgage-backed securities		—		216,939		—			—			216,939
Commercial mortgage-backed securities		—		233		—			—			233
Loans		—		131,775		4,285			—			136,060
Derivatives		363,860		1,853,769		12,087			(1,996,000	)		233,716
Physical commodities		—		45,508		—			—			45,508

Total financial instruments sold, not yet purchased	$	5,337,237	$	4,996,322	$	16,410		$	(1,996,000	)	$	8,353,969

Obligation to return securities received as collateral	$	484	$	—	$	—		$	—		$	484

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

(Unaudited)

(1)	There were no transfers between Level 1 and Level 2 for the nine months ended August 31, 2012.

(2)	Represents counterparty and cash collateral netting across the levels of the fair value hierarchy for positions with the same counterparty.

(3)	Consists of Level 3 assets attributable to third party or employee noncontrolling interests in certain consolidated entities.

(4)	Includes U.S. government securities segregated for regulatory purposes with a fair value of $299.3 million.


	As of November 30, 2011
	Level 1(1)		Level 2(1)		Level 3			Counterparty and Cash Collateral Netting(2)			Total
Assets:
Financial instruments owned:
Corporate equity securities	$	1,088,358	$	133,232	$	13,489		$	—		$	1,235,079
Corporate debt securities		1,521		2,818,643		48,140			—			2,868,304
Collateralized debt obligations		—		102,209		47,988			—			150,197
U.S. government and federal agency securities		5,443,721		266,460		—			—			5,710,181
Municipal securities		—		582,497		6,904			—			589,401
Sovereign obligations		737,082		434,759		140			—			1,171,981
Residential mortgage-backed securities		—		2,961,682		149,965			—			3,111,647
Commercial mortgage-backed securities		—		582,974		52,407			—			635,381
Other asset-backed securities		—		22,794		3,284			—			26,078
Loans and other receivables		—		278,855		97,291			—			376,146
Derivatives		632,148		2,344,625		124			(2,451,004	)		525,893
Investments at fair value		—		27,259		78,326			—			105,585
Physical commodities		—		172,668		—			—			172,668

Total financial instruments owned	$	7,902,830	$	10,728,657	$	498,058		$	(2,451,004	)	$	16,678,541

Level 3 financial instruments for which the firm does not bear economic exposure(3)					$	(45,901	)

Level 3 financial instruments for which the firm bears economic exposure					$	452,157

Cash and cash equivalents	$	2,393,797	$	—	$	—		$	—		$	2,393,797
Investments in managed funds	$	—	$	—	$	70,740		$	—		$	70,740
Cash and securities segregated and on deposit for regulatory purposes(4)	$	3,344,960	$	—	$	—		$	—		$	3,344,960
Securities received as collateral	$	21,862	$	—	$	—		$	—		$	21,862

Total Level 3 assets for which the firm bears economic exposure					$	522,897

Liabilities:
Financial instruments sold, not yet purchased:
Corporate equity securities	$	1,266,096	$	64,000	$	—		$	—		$	1,330,096
Corporate debt securities		—		1,614,419		74			—			1,614,493
U.S. government and federal agency securities		2,032,091		9,685		—			—			2,041,776
Municipal securities		—		90		—			—			90
Sovereign obligations		790,568		377,279		—			—			1,167,847
Residential mortgage-backed securities		—		50,517		—			—			50,517
Loans		—		140,960		10,157			—			151,117
Derivatives		535,503		2,289,759		9,409			(2,585,634	)		249,037

Total financial instruments sold, not yet purchased	$	4,624,258	$	4,546,709	$	19,640		$	(2,585,634	)	$	6,604,973

Obligation to return securities received as collateral	$	21,862	$	—	$	—		$	—		$	21,862

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

(Unaudited)

(1)	There were no transfers between Level 1 and Level 2 for the twelve months ended November 30, 2011.

(2)	Represents counterparty and cash collateral netting across the levels of the fair value hierarchy for positions with the same counterparty.

(3)	Consists of Level 3 assets attributable to third party or employee noncontrolling interests in certain consolidated entities.

(4)	Includes U.S. government securities segregated for regulatory purposes with a fair value of $115.0 million.

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 external pricing services, and are categorized within Level 1 of the fair value hierarchy.

•

Non-exchange Traded Equity Securities: Non-exchange traded equity securities are measured primarily using broker quotations, pricing data from external pricing services 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 within Level 3 of the fair value hierarchy 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 categorized 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 pricing data from external pricing services and broker quotations, 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 categorized 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 categorized within Level 2 of the fair value hierarchy and are measured primarily using broker quotations and pricing data from external pricing services, where available, and prices observed for recently executed market transactions of comparable size. Where pricing data is less observable, valuations are categorized within 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.

Collateralized Debt Obligations

Collateralized debt obligations are measured based on prices observed for recently executed market transactions or based on valuations received from third party brokers and are categorized within Level 2 or Level 3 of the fair value hierarchy depending on the observability of the pricing inputs.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

(Unaudited)

U.S. Government and Federal Agency Securities

•

U.S. Treasury Securities: U.S. Treasury securities are measured based on quoted market prices and categorized within 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 categorized within Level 1 and callable U.S. agency securities are categorized within Level 2 of the fair value hierarchy.

Municipal Securities

Municipal securities are measured based on quoted prices obtained from external pricing services and are generally categorized within Level 2 of the fair value hierarchy.

Sovereign Obligations

Foreign sovereign government obligations are measured based on quoted market prices obtained from external pricing services, where available, or recently executed independent transactions of comparable size. To the extent external price quotations are not available or recent transactions have not been observed, valuation techniques incorporating interest rate yield curves and country spreads for bonds of similar issuers, seniority and maturity are used to determine fair value of sovereign bonds or obligations. Foreign sovereign government obligations are classified in Level 1, 2 or Level 3 of the fair value hierarchy, primarily based on the country of issuance.

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 pricing services 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 the 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 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.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

(Unaudited)

Commercial Mortgage-Backed Securities

•

Agency Commercial Mortgage-Backed Securities: GNMA project loan bonds and FNMA Delegated Underwriting and Servicing (“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.

•

Non-Agency Commercial Mortgage-Backed Securities: Non-agency commercial mortgage-backed securities are measured using pricing data obtained from external pricing 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 and Level 3 of the fair value hierarchy. Valuations are determined using pricing data obtained from external pricing 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 pricing services where sufficient observability exists as to the extent of market transaction data supporting the pricing data. Corporate loans categorized within Level 3 of the fair value hierarchy, 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.

•

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, which in turn 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.

•

Project Loans: Valuation of project loans are based on benchmarks of prices for recently executed transactions of related realized collateralized securities and are categorized within Level 2 of the fair value hierarchy.

•

Escrow and Trade Claim Receivables: Escrow and trade claim receivables are categorized within Level 3 of the fair value hierarchy where fair value is estimated based on reference to market prices and implied yields of debt securities of the same or similar issuers. Escrow and trade claim receivables are categorized within Level 2 of the fair value hierarchy where fair value is based on recent trade activity in the same security.

Derivatives

•

Listed Derivative Contracts: Listed derivative contracts are measured based on quoted exchange prices, which are generally obtained from external pricing services, are categorized within Level 1 of the fair value hierarchy. Listed derivatives for which there is limited trading activity are measured based on incorporating the closing auction price of the underlying equity security and are categorized within Level 2 of the fair value hierarchy.

•

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 inputs are readily observable or can be derived from actively quoted markets. OTC derivative contracts are primarily categorized within Level 2 of the fair value hierarchy given the observability of the inputs to the valuation models. Where significant inputs to the valuation are unobservable derivative instruments are categorized within Level 3 of the fair value hierarchy.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

(Unaudited)

OTC options include OTC equity, foreign exchange and commodity options measured using Black-Scholes models with key inputs impacting the valuation including the underlying security, foreign exchange spot rate 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, valuations of our foreign exchange forwards and swaps, which incorporate observable inputs related to foreign currency spot rates and forward curves and valuations of our commodity swaps, which incorporate observable inputs related to commodity spot prices 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 and single-name credit default swaps. 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 external pricing services.

Physical Commodities

Physical commodities include base and precious metals and are measured using observable inputs including spot prices and published indices. Physical commodities are categorized within Level 2 of the fair value hierarchy.

Investments at Fair Value and Investments in Managed Funds

Investments at fair value and Investments in managed funds include investments in hedge funds, fund of funds, private equity funds, convertible bond funds and commodity funds, which are measured at fair value based on the net asset value of the funds provided by the fund managers and are categorized within Level 2 or Level 3 of the fair value hierarchy. Investments at fair value also include direct equity investments in private companies, which are measured at fair value 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. Additionally, investments at fair value include investments in insurance contracts relating to our defined benefit plan in Germany and shares in non-US exchanges and clearing houses. Fair value for the insurance contracts is determined using a third party and are categorized within Level 3 of the fair value hierarchy. Fair value for the shares in non-US exchanges and clearing houses is determined based on recent transactions or third party model valuations and are categorized within Level 2 or Level 3 of the fair value hierarchy. The following tables present information about our investments in entities that have the characteristics of an investment company at August 31, 2012 and November 30, 2011 (in thousands):


	August 31, 2012
	Fair Value (7)		Unfunded Commitments		Redemption Frequency (if currently eligible)
Equity Long/Short Hedge Funds(1)	$	28,793	$	—	Monthly, Quarterly
High Yield Hedge Funds(2)		767		—	—
Fund of Funds(3)		722		106	—
Equity Funds(4)		75,367		59,272	—
Convertible Bond Funds(5)		2,970		—	At Will
Other Investments(6)		19		—	Bi-Monthly

Total(8)	$	108,638	$	59,378

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

(Unaudited)


	November 30, 2011
	Fair Value (7)		Unfunded Commitments		Redemption Frequency (if currently eligible)
Equity Long/Short Hedge Funds(1)	$	27,604	$	—	Monthly, Quarterly
High Yield Hedge Funds(2)		938		—	—
Fund of Funds(3)		772		126	—
Equity Funds(4)		88,294		74,283	—
Convertible Bond Funds(5)		2,827		—	At Will
Other Investments(6)		19		—	Bi-Monthly

Total(8)	$	120,454	$	74,409

(1)

This category includes investments in hedge funds that invest, long and short, in equity securities in domestic and international markets in both the public and private sectors. At August 31, 2012 and November 30, 2011, investments representing approximately 99% and 98%, respectively, of the fair value of investments in this category are redeemable with 30 — 65 days prior written notice, and includes investments in private asset management funds managed by us with an aggregate fair value of $10.7 million and $10.7 million, respectively. The remaining investments in this category cannot be redeemed as they are in liquidation and distributions will be received through the liquidation of the underlying assets of the funds. We are unable to estimate when the underlying assets will be liquidated.

(2)

Includes investments in three funds that invest in domestic and international public high yield debt, private high yield investments, senior bank loans, public leveraged equities, distressed debt, and private equity investments. There are no redemption provisions. The underlying assets of the funds are being liquidated and we are unable to estimate when the underlying assets will be fully liquidated.

(3)

Includes investments in fund of funds that invest in various private equity funds. At August 31, 2012 and November 30, 2011, approximately 95% of the fair value of investments in this category is managed by us and has no redemption provisions, instead distributions are received through the liquidation of the underlying assets of the fund of funds, which are estimated to be liquidated in one to two years. As of August 31, 2012 and November 30, 2011, we have requested redemption for investments representing approximately 5% of the fair value of investments in this category; however, we are unable to estimate when these funds will be returned.

(4)

At August 31, 2012 and November 30, 2011, investments representing approximately 94% and 96% of the fair value of investments in this category include investments in equity funds that invest in the equity of various U.S. and foreign private companies in the energy, technology, internet service and telecommunication service industries. At August 31, 2012 and November 30, 2011, a fund that invests in Croatian companies represents approximately 4% of the total investment in equity funds. These investments cannot be redeemed instead distributions are received through the liquidation of the underlying assets of the funds which are expected to liquidate in one to eight years. At August 31, 2012, investments representing approximately 3% of the fair value of investments in equity funds are in liquidation and we are unable to estimate when the underlying assets will be fully liquidated. At August 31, 2012 and November 30, 2011, this category includes investments in equity funds managed by us with a fair value of $58.2 million and $69.1 million and unfunded commitments of $56.9 million and $70.7 million, respectively.

(5)	Investment in the Jefferies Umbrella Fund, an open-ended investment company managed by us that invests primarily in convertible bonds. This investment is redeemable with 5 days prior written notice.

(6)	Other investments at August 31, 2012 and November 30, 2011 included investments in funds that invest in commodity futures and options contracts.

(7)	Fair value has been estimated using the net asset value derived from each of the funds’ capital statements.

(8)	Investments at fair value in the Consolidated Statements of Financial Condition at August 31, 2012 and November 30, 2011 include $96.4 million and $55.9 million, respectively, of direct investments which are not investment companies and therefore not included within this table.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

(Unaudited)

Pricing information

At August 31, 2012 and November 30, 2011, our Financial instruments owned and Financial instruments sold, not yet purchased are measured using different valuation bases as follows:


	August 31, 2012						November 30, 2011
	Financial Instruments Owned			Financial Instruments Sold, Not Yet Purchased			Financial Instruments Owned			Financial Instruments Sold, Not Yet Purchased
Exchange closing prices		11	%		19	%		7	%		19	%
Recently observed transaction prices		3	%		1	%		2	%		1	%
External pricing services		70	%		77	%		77	%		75	%
Broker quotes		2	%		0	%		1	%		0	%
Valuation techniques		14	%		3	%		13	%		5	%

		100	%		100	%		100	%		100	%

The following is a summary of changes in fair value of our financial assets and liabilities that have been categorized within Level 3 of the fair value hierarchy for the three months ended August 31, 2012 (in thousands):


	Three Months Ended August 31, 2012
	Balance, May 31, 2012		Total gains/ losses (realized and unrealized) (1)			Purchases			Sales			Settlements			Net transfers into/ (out of) Level 3			Balance, August 31, 2012		Change in unrealized gains/ (losses) relating to instruments still held at August 31, 2012
Assets:
Financial instruments owned:
Corporate equity securities	$	25,789	$	260		$	2,991		$	(15,418	)	$	—		$	6,161		$	19,783	$	(907	)
Corporate debt securities		7,972		(101	)		521			(1,118	)		—			284			7,558		(136	)
Collateralized debt obligations		84,006		6,710			—			(11,008	)		—			1,890			81,598		5,836
Municipal securities		465		5			—			(387	)		—			—			83		5
Residential mortgage-backed securities		123,555		2,542			27,401			(65,422	)		(5,216	)		62,128			144,988		359
Commercial mortgage-backed securities		40,594		(1,327	)		2,092			(1,307	)		(450	)		(8,089	)		31,513		(1,310	)
Other asset-backed securities		1,273		—			—			—			(291	)		(774	)		208		—
Loans and other receivables		108,674		(528	)		57,790			(30,632	)		(56,404	)		29,889			108,789		(237	)
Investments, at fair value		91,836		(202	)		1,120			—			(775	)		—			91,979		(466	)
Investments in managed funds		68,314		(5,389	)		2,173			—			(4,987	)		10			60,121		(5,382	)
Liabilities:
Financial instruments sold, not yet purchased:
Corporate equity securities	$	12,039	$	(410	)	$	(11,782	)	$	191		$	—		$	—		$	38	$	—
Corporate debt securities		74		(15	)		(59	)		—			—			—			—		—
Net derivatives(2)		4,395		7,342			—			—			—			10			11,747		6,209
Loans		—		—			—			4,285			—			—			4,285		—

(1)	Realized and unrealized gains/losses are reported in Principal transactions in the Consolidated Statements of Earnings.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

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(Unaudited)

(2)	Net derivatives represent Financial instruments owned – Derivatives and Financial instruments sold, not yet purchased – Derivatives.

Analysis of Level 3 Assets and Liabilities for the Three Months Ended August 31, 2012

During the three months ended August 31, 2012, transfers of assets of $156.5 million from Level 2 to Level 3 are primarily attributed to:

•

Non-agency residential mortgage-backed securities of $74.5 million and Commercial mortgage-backed securities of $9.0 million for which no recent trade activity was observed for purposes of determining observable inputs;

•

Loans and other receivables of $53.0 million due to a lack of observable market transactions or vendor quotes during the period to support classification within Level 2 as less market interest likely existed for the specific loans during the period;

•

Collateralized debt obligations of $9.3 million which have no recent trade activity; and

•

Corporate equity securities of $6.3 million and Corporate debt securities of $4.4 million due to lack of observable market transactions.

During the three months ended August 31, 2012, transfers of assets of $65.0 million from Level 3 to Level 2 are primarily attributed to:

•

Loans and other receivables of $23.1 million due to a greater number of contributors for certain vendor quotes supporting classification into Level 2 as greater market interest likely existed for the specific loans during the quarter;

•

Commercial mortgage-backed securities of $17.1 million, Non-agency residential mortgage-backed securities of $12.4 million and Other asset-backed securities of $0.8 million for which market trades were observed in the period for either identical or similar securities or for which vendor prices were corroborated to actual market transactions;

•

Collateralized debt obligations of $7.4 million due to a greater number of contributors for certain vendor quotes supporting classification into Level 2 during the period; and

•

Corporate equity securities of $0.1 million and Corporate debt securities of $4.1 million due to an increase in observable broker levels and recent trade activity in certain bonds and private equity positions.

During the three months ended August 31, 2012 there were no transfers of liabilities from Level 2 to Level 3 and transfers of $0.01 million from Level 3 to Level 2.

Net gains on Level 3 assets were $2.0 million and net losses on Level 3 liabilities were $6.9 million for the three months ended August 31, 2012. Net gains on Level 3 assets were primarily due to increased valuations of certain collateralized debt obligations and residential mortgage backed securities. These gains were partially offset by decreased valuations of investments in managed funds, commercial mortgage backed securities and loans and other receivables. Net losses on Level 3 liabilities were primarily due to decreased valuations of certain derivative instruments.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

(Unaudited)


	Three Months Ended August 31, 2011
	Balance, May 31, 2011		Total gains/ losses (realized and unrealized) (1)			Purchases, sales, settlements, and issuances			Transfers into Level 3		Transfers out of Level 3			Balance, August 31, 2011		Change in unrealized gains/ (losses) relating to instruments still held at August 31, 2011
Assets:
Financial instruments owned:
Corporate equity securities	$	18,230	$	1,720		$	2,631		$	861	$	(12,030	)	$	11,412	$	(154	)
Corporate debt securities		39,688		(4,069	)		6,230			14,425		(1,044	)		55,230		(7,349	)
Collateralized debt obligations		84,046		(3,417	)		9,325			19,029		(12,319	)		96,664		(5,413	)
Municipal securities		858		11			(183	)		—		—			686		1
Sovereign obligations		—		—			128			—		—			128		—
Residential mortgage-backed securities		206,721		(12,527	)		15,276			41,510		(79,461	)		171,519		(12,917	)
Commercial mortgage-backed securities		33,516		(3,652	)		(292	)		17,364		(6,741	)		40,195		(3,690	)
Other asset-backed securities		9,352		(329	)		2,773			99		(8,417	)		3,478		(329	)
Loans and other receivables		261,056		710			(92,362	)		27,077		(32,318	)		164,163		(116	)
Investments at fair value		71,008		2,397			19,045			11		(33	)		92,428		(938	)
Investments in managed funds		125,303		(83	)		(51,320	)		—		—			73,900		62
Liabilities:
Financial instruments sold, not yet purchased:
Corporate equity securities	$	38	$	21		$	—		$	—	$	—		$	59	$	20
Net derivatives(2)		2,739		696			—			—		11			3,446		687
Loans		6,398		(230	)		5,290			—		—			11,458		(230	)

(1)	Realized and unrealized gains/losses are reported in Principal transactions in the Consolidated Statements of Earnings.

(2)	Net derivatives represent Financial instruments owned – Derivatives and Financial instruments sold, not yet purchased – Derivatives.

Analysis of Level 3 Assets and Liabilities for the Three Months Ended August 31, 2011

During the three months ended August 31, 2011, transfers of assets of $120.4 million from Level 2 to Level 3 are primarily attributed to:

•

Non-agency residential mortgage-backed securities, collateralized debt obligations, and commercial mortgage backed securities due to less observable trading activity and vendor quotes that were not corroborated to market transactions;

•

Loans and other receivables due to lower number of contributors comprising vendor quotes to support classification in Level 2; and

•

Corporate debt securities due to lack of observable market transactions.

During the three months ended August 31, 2011, transfers of assets of $152.4 million from Level 3 to Level 2 are primarily attributed to:

•

Non-agency residential mortgage-backed securities, collateralized debt obligations, other asset-backed securities, and commercial mortgage backed securities for which market trades were observed in the period for either identical or similar securities or for which vendor prices were corroborated to actual market transactions;

•

Loans and other receivables due to greater number of contributors comprising vendor quotes supporting classification into Level 2; and

•

Corporate equity securities due to announced market transactions or more observable market data on comparable securities used as a benchmark.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

(Unaudited)

During the three months ended August 31, 2011 there were no transfers of liabilities from Level 2 to Level 3 and $.01 million transfers of liabilities from Level 3 to Level 2.

Net losses on Level 3 assets were $19.2 million and net losses on Level 3 liabilities were $0.5 million for the three months ended August 31, 2011. Net losses on Level 3 assets were primarily due to decreased valuations of various residential mortgage-backed securities, corporate debt, collateralized debt obligations, and commercial mortgage-backed securities, offset by sales of certain investments at fair value, corporate debt, and collateralized debt obligations.

The following is a summary of changes in fair value of our financial assets and liabilities that have been categorized within Level 3 of the fair value hierarchy for the nine months ended August 31, 2012 (in thousands):


	Nine Months Ended August 31, 2012
	Balance, November 30, 2011		Total gains/ losses (realized and unrealized) (1)			Purchases			Sales			Settlements			Net transfers into/ (out of) Level 3			Balance, August 31, 2012		Change in unrealized gains/ (losses) relating to instruments still held at August 31, 2012 (1)
Assets:
Financial instruments owned:
Corporate equity securities	$	13,489	$	(2,580	)	$	20,676		$	(13,437	)	$	—		$	1,635		$	19,783	$	(4,636	)
Corporate debt securities		48,140		85			7,228			(39,367	)		(1,276	)		(7,252	)		7,558		(656	)
Collateralized debt obligations		47,988		4,278			8,479			(18,699	)		(3,892	)		43,444			81,598		3,515
Municipal securities		6,904		(74	)		—			(1,366	)		—			(5,381	)		83		5
Sovereign obligations		140		—			—			—			—			(140	)		—		—
Residential mortgage-backed securities		149,965		(17,833	)		59,477			(101,039	)		(8,489	)		62,907			144,988		(8,884	)
Commercial mortgage-backed securities		52,407		(2,221	)		5,090			(5,441	)		(115	)		(18,207	)		31,513		(2,769	)
Other asset-backed securities		3,284		141			19,397			(20,351	)		(51	)		(2,212	)		208		3
Loans and other receivables		97,291		(2,674	)		158,305			(60,111	)		(104,476	)		20,454			108,789		(4,109	)
Investments, at fair value		78,326		15,076			1,909			(6	)		(3,326	)		—			91,979		14,412
Investments in managed funds		70,740		(17,765	)		12,683			—			(5,537	)		—			60,121		(17,765	)
Liabilities:
Financial instruments sold, not yet purchased:
Corporate equity securities	$	—	$	38		$	—		$	—		$	—		$	—		$	38	$	38
Corporate debt securities		74		(15	)		(59	)		—			—			—			—		—
Net derivatives(2)		9,285		5,064			(389	)		—			—			(2,213	)		11,747		6,087
Loans		10,157		—			(10,157	)		4,285			—			—			4,285		—

(1)	Realized and unrealized gains/losses are reported in Principal transactions in the Consolidated Statements of Earnings.

(2)	Net derivatives represent Financial instruments owned – Derivatives and Financial instruments sold, not yet purchased – Derivatives.

Analysis of Level 3 Assets and Liabilities for the Nine Months Ended August 31, 2012

During the nine months ended August 31, 2012, transfers of assets of $184.2 million from Level 2 to Level 3 of the fair value hierarchy are attributed to:

•

Non-agency residential mortgage-backed securities of $67.5 million, Commercial mortgage-backed securities of $11.7 million for which no recent trade activity was observed for purposes of determining observable inputs;

•

Loans and other receivables of $55.2 million due to a lower number of contributors comprising vendor quotes to support classification within Level 2 as less market interest likely existed for the specific loans during the period;

•

Collateralized debt obligations of $47.3 million which have little to no transparency in trade activity; and

•

Corporate equity securities of $1.7 million and Corporate debt securities of $0.6 million due to lack of observable market transactions.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

(Unaudited)

During the nine months ended August 31, 2012, transfers of assets of $88.9 million from Level 3 to Level 2 are attributed to:

•

Loans and other receivables of $34.8 million and Collateralized debt obligations of $3.9 million due to a greater number of contributors for certain vendor quotes supporting classification into Level 2;

•

Commercial mortgage-backed securities of $29.9 million, Non-agency residential mortgage-backed securities of $4.5 million and $2.4 million of Other asset-backed securities for which market trades were observed in the period for either identical or similar securities or for which vendor prices were corroborated to actual market transactions; and

•

Corporate debt securities of $7.9 million and Municipal securities of $5.4 million due to increased observability of trades in certain debt and municipal securities.

During the nine months ended August 31, 2012, there were no transfers of liabilities from Level 2 to Level 3 and there were $2.2 million transfers of net derivative liabilities from Level 3 to Level 2 due to an increase in observable significant inputs used in valuing the derivative contracts.

Net losses on Level 3 assets were $23.6 million and net losses on Level 3 liabilities were $5.1 million for the nine months ended August 31, 2012. Net losses on Level 3 assets were primarily due to decreased valuations of certain residential mortgage-backed securities, investments in managed funds, loans and other receivables, commercial mortgage backed securities and corporate equity securities, offset by an increase in valuation of certain investments at fair value and collateralized debt obligations. Net losses on Level 3 liabilities were primarily due to decreased valuations of certain derivative instruments.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

(Unaudited)


	Nine Months Ended August 31, 2011
	Balance, November 30, 2010		Total gains/ losses (realized and unrealized) (1)			Purchases, sales, settlements, and issuances			Transfers into Level 3		Transfers out of Level 3			Balance, August 31, 2011		Change in unrealized gains/ (losses) relating to instruments still held at August 31, 2011
Assets:
Financial instruments owned:
Corporate equity securities	$	22,619	$	2,905		$	(3,040	)	$	816	$	(11,888	)	$	11,412	$	(422	)
Corporate debt securities		73,408		(487	)		(22,533	)		6,304		(1,462	)		55,230		(5,906	)
Collateralized debt obligations		31,121		10,423			54,351			779		(10	)		96,664		9,632
Municipal securities		472		89			125			—		—			686		78
Sovereign obligations		—		—			128			—		—			128		—
Residential mortgage-backed securities		132,359		(8,354	)		64,906			29,901		(47,293	)		171,519		(25,284	)
Commercial mortgage-backed securities		6,004		1,625			25,574			6,992		—			40,195		112
Other asset-backed securities		567		(604	)		3,156			926		(567	)		3,478		(604	)
Loans and other receivables		227,596		2,476			(57,473	)		9,006		(17,442	)		164,163		(1,452	)
Investments at fair value		77,784		9,326			8,421			—		(3,103	)		92,428		6,495
Investments in managed funds		131,585		15,159			(72,844	)		—		—			73,900		14,575
Liabilities:
Financial instruments sold, not yet purchased:
Corporate equity securities	$	38	$	21		$	—		$	—	$	—		$	59	$	20
Net derivatives(2)		2,346		1,100			—			—		—			3,446		1,200
Loans		47,228		(230	)		(35,540	)		—		—			11,458		(230	)

(1)	Realized and unrealized gains/losses are reported in Principal transactions in the Consolidated Statements of Earnings.

(2)	Net derivatives represent Financial instruments owned – Derivatives and Financial instruments sold, not yet purchased – Derivatives.

Analysis of Level 3 Assets and Liabilities for the Nine Months Ended August 31, 2011

During the nine months ended August 31, 2011, transfers of assets of $54.7 million from Level 2 to Level 3 are primarily attributed to:

•

Non-agency residential mortgage-backed securities and commercial asset backed securities due to a tightening in the historical trading period used for corroborating market data and a greater scrutiny of vendor prices;

•

Loans and other receivables due to lower number of contributors comprising vendor quotes to support classification in Level 2; and

•

Corporate debt securities due to lack of observable market transactions.

During the nine months ended August 31, 2011, transfers of assets of $81.8 million from Level 3 to Level 2 are primarily attributed to:

•

Non-agency residential mortgage-backed securities for which market trades were observed in the period for either identical or similar securities or for which vendor prices were corroborated to actual market transactions;

•

Loans and other receivables due to greater number of contributors comprising vendor quotes supporting classification into Level 2; and

•

Corporate equity securities due to announced market transactions or more observable market data on comparable securities used as a benchmark.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

(Unaudited)

During the nine months ended August 31, 2011 there were no transfers of liabilities from Level 2 to Level 3 or from Level 3 to Level 2.

Net gains on Level 3 assets were $32.6 million and net losses on Level 3 liabilities were $0.9 million for the nine months ended August 31, 2011. Net gains on Level 3 assets were primarily due to sales or settlements of various residential mortgage-backed securities, corporate debt securities, loans and other receivables, investments at fair value, and corporate equity securities, increased valuations of certain collateralized debt obligations and investments at fair value, offset by decreased valuations of certain residential mortgage-backed securities and corporate debt securities.

Components or portions of interest rate and credit risk related to mortgage-backed securities categorized within Level 3 of the fair value hierarchy are frequently economically hedged with U.S. Treasury and Eurodollar futures and short U.S. Treasury securities, which are categorized within Level 1 liabilities, and with interest rate swaps and, to a lesser extent, index credit default swaps categorized within Level 2 assets or liabilities. Accordingly, a portion of the gains and losses on mortgage-backed securities reported in Level 3 are offset by gains and losses from the economic hedges attributed to instruments categorized within Level 1 and Level 2. Economic hedging is often executed on a macro-basis for a given asset class rather than an instrument-specific basis. Valuation inputs and prices for hedging instruments categorized within Level 1 and Level 2 provide a level of observability used in valuing Level 3 mortgage-backed securities; however, other inputs, such as prepayment, default rates and other credit specific factors are significant to the valuation and are not derived from the prices of the hedging instruments. Basis risk differences may also arise between the Level 3 mortgage-backed securities and the Level 1 and Level 2 hedging instruments due to the underlying interest rates and the underlying credits comprising the referenced credit index. Hedge effectiveness is limited by factors that include idiosyncratic collateral performance and basis risk as well as the sizing of the macro-hedge.

Quantitative Information about Significant Unobservable Inputs used in Level 3 Fair Value Measurements at August 31, 2012

The tables below present information on the valuation techniques, significant unobservable inputs and their ranges for our financial assets and liabilities, subject to threshold levels related to the market value of the positions held, measured at fair value on a recurring basis with a significant Level 3 balance. The range of unobservable inputs could differ significantly across different firms given the range of products across different firms in the financial services sector. The inputs are not representative of the inputs that could have been used in the valuation of any one financial instruments; i.e., the input used for valuing one financial instrument within a particular class of financial instruments may not be appropriate for valuing other financial instruments within that given class. Additionally, the ranges of inputs presented below should not be construed to represent uncertainty regarding the fair values of our financial instruments.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

(Unaudited)


Financial Instruments Owned	Market Value (in thousands)			Valuation Technique	Significant Unobservable Input(s)	Range

Corporate debt securities	$	7,558
				Comparable pricing	Comparable bond price	$0 to $83.50
				Discounted cash flows	Constant prepayment rate	0%
					Constant default rate	2%
					Loss severity	58%
					Yield	18%

Corporate equity securities	$	19,783
Non-exchange traded securities				Market approach	EBITDA (a) multiple	5.0 to 16.8
				Scenario analysis	Estimated recovery percentage	40%
Warrants				Option model	Volatility	39.12

Investments at fair value	$	35,588
Private equity securities				Market approach	EBITDA (a) multiple	5.9 to 7.8
				Market approach	Price per acre	$40,000.00
				Comparable pricing	Comparable share price	$328.00

Loans and other receivables	$	105,689
				Comparable pricing	Comparable bond or loan price	$85.71 to $101.25
				Discounted cash flows	Yield	18%
					Cumulative loss rate	0%
				Market approach	Yield	5% to 13%
				Scenario analysis	Estimated recovery percentage	15%

Collateralized debt obligations	$	71,427
				Discounted cash flows	Constant prepayment rate	0% to 5%
					Constant default rate	0% to 10%
					Loss severity	0% to 85%
					Yield	10% to 84%
				Liquidation value	Comparable loan price	$68.33 to $110.38

Commercial mortgage-backed securities	$	31,513
				Discounted cash flows	Yield	20% to 36%
					Cumulative loss rate	3% to 20%

Residential mortgage-backed securities	$	144,988
				Discounted cash flows	Constant prepayment rate	0% to 30%
					Constant default rate	0% to 14%
					Loss severity	0% to 70%
					Yield	1% to 46%

Financial Instruments Sold, Not Yet Purchased	Market Value (in thousands)			Valuation Technique	Significant Unobservable Input(s)	Range

Derivatives
Equity options	$	(12,087	)	Option model	Volatility	40.25
Loan commitments				Comparable pricing	Comparable bond or loan price	$100.88

(a)	Earnings before interest, taxes, depreciation and amortization (“EBITDA”).

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

(Unaudited)

The fair values of certain Level 3 assets that were determined based on third-party pricing information, unadjusted past transaction prices, reported net asset value or a percentage of the reported enterprise fair value are excluded from the above table. At August 31, 2012, the exclusions consisted of $65.9 million primarily comprised of investments in private equity and hedge funds, investments in reinsurance contracts, certain collateralized debt obligations and corporate loans. The provisions of ASU No. 2011-04 were adopted on a prospective basis during the second quarter of fiscal 2012 and accordingly, disclosures for prior periods are not presented.

Sensitivity of Fair Values to Changes in Significant Unobservable Inputs

For recurring fair value measurements categorized within Level 3 of the fair value hierarchy, the sensitivity of the fair value measurement to changes in significant unobservable inputs and interrelationships between those unobservable inputs (if any) are described below:

•

Corporate bonds, private equity securities, loans and other receivables and collateralized debt obligations using comparable pricing valuation techniques. A significant increase (decrease) in the comparable bond or loan price in isolation would result in a significant higher (lower) fair value measurement.

•

Non-exchange traded securities, private equity securities and loans and other receivables using a market approach valuation technique. A significant increase (decrease) in the EBITDA or other multiples in isolation would result in a significantly higher (lower) fair value measurement.

•

Non-exchange traded securities and loans and other receivables using scenario analysis. A significant increase (decrease) in the possible recovery rates of the cash flow outcomes underlying the investment would result in a significantly higher (lower) fair value measurement for the financial instrument.

•

Corporate bonds, collateralized debt obligations, residential and commercial mortgage-backed securities using a discounted cash flow valuation technique. A significant increase (decrease) in isolation in the constant default rate, loss severities or cumulative loss rate and discount rate would result in a significantly lower (higher) fair value measurement. The impact of changes in the constant prepayment rate would have differing impacts depending on the capital structure of the security. A significant increase (decrease) in the bond yield would result in a significant lower (higher) fair value measurement.

•

Short derivative equity options using an option model. A significant increase (decrease) in volatility would result in a significant lower (higher) fair value measurement.

•

Collateralized debt obligations using a liquidation valuation technique. A significant increase (decrease) in the comparable loan prices in would result in a significant higher (lower) fair value measurement.

Fair Value Option Election

We have elected the fair value option for all loans and loan commitments made by our capital markets businesses. These loans and loan commitments include loans entered into by our investment banking division in connection with client bridge financing and loan syndications, loans purchased by our leveraged credit trading desk as part of its bank loan trading activities and mortgage loan commitments and fundings in connection with mortgage-backed securitization activities. Loans and loan commitments originated or purchased by our leveraged credit and mortgage-backed businesses are managed on a fair value basis. Loans are included in Financial instruments owned and loan commitments are included in Financial instruments owned-derivatives and Financial instruments sold, not yet purchased — derivatives on the Consolidated Statements of Financial Condition. The fair value option election is not applied to loans made to affiliate entities as such loans are entered into as part of ongoing, strategic business ventures. Loans to affiliate entities are included within Loans to and investments in related parties on the Consolidated Statements of Financial Condition and are accounted for on an amortized cost basis. We have elected the fair value option for our investment in Knight Capital Group, Inc., which is included in Financial Instruments owned — Corporate equity securities on the Consolidated Statement of Financial Condition. See Note 10, Investments for further details regarding our investment in Knight Capital Group, Inc. We also have elected the fair value option for certain financial instruments held by subsidiaries that are not registered broker-dealers as the investments are risk managed by us on a fair value basis. The fair value option has also been elected for secured financings that arise in

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

(Unaudited)

connection with our securitization activities. 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 summary of gains and (losses) due to changes in instrument specific credit risk on loans and other receivables and loan commitments measured at fair value under the fair value option (in thousands):


	Three Months Ended August 31, 2012			Nine Months Ended August 31, 2012
Financial Instruments Owned:
Loans and other receivables	$	5,012		$	9,664
Financial Instruments Sold:
Loans	$	(320	)	$	(466	)
Loan commitments		(5.213	)		(7,088	)

The following is a summary of the amount by which contractual principal exceeds fair value for loans and other receivables measured at fair value under the fair value option (in thousands):


	August 31,		November 30,
	2012		2011
Financial Instruments Owned:
Loans and other receivables(2)	$	269,801	$	277,336
Loans greater than 90 days past due(1)(2)	$	5,699	$	2,253

(1)	The aggregate fair value of loans that were 90 or more days past due was $20.2 million and $5.5 million at August 31, 2012 and November 30, 2011.

(2)	Interest income is recognized separately from other changes in fair value and is included within Interest revenues on the Consolidated Statements of Earnings.

There were no loans or other receivables on nonaccrual status at August 31, 2012 and November 30, 2011.

Note 6.

Derivative Financial Instruments

Off-Balance Sheet Risk

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

Derivative Financial Instruments

Our derivative activities are recorded at fair value in the Consolidated Statements of Financial Condition in Financial instruments owned — derivatives and Financial instruments sold, not yet purchased — derivatives net of cash paid or received under credit support agreements and on a net counterparty basis when a legal right to offset exists under a master netting agreement. Net realized and unrealized gains and losses are recognized in Principal transactions in the Consolidated Statements of Earnings on a trade date basis and as a component of cash flows from operating activities in the Consolidated Statements of Cash Flows. Acting in a trading capacity, we may enter into derivative transactions to satisfy the needs of our clients and to manage our own exposure to market and credit risks resulting from our trading activities. (See Note 5, Fair Value Disclosures and Note 20, Commitments, Contingencies and Guarantees for additional disclosures about derivative instruments.)

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

(Unaudited)

Derivatives are subject to various risks similar to other financial instruments, including market, credit and operational risk. The risks of derivatives should not be viewed in isolation, but rather should be considered on an aggregate basis along with our other trading-related activities. We manage the risks associated with derivatives on an aggregate basis along with the risks associated with proprietary trading as part of our firm wide risk management policies. In connection with our derivative activities, we may enter into master netting agreements and collateral arrangements with counterparties. These agreements provide us with the ability to offset a counterparty’s rights and obligations, request additional collateral when necessary or liquidate the collateral in the event of counterparty default.

The following table presents the fair value and related number of derivative contracts at August 31, 2012 and November 30, 2011 categorized by predominant risk exposure. The fair value of assets/liabilities related to derivative contracts represents our receivable/payable for derivative financial instruments, gross of counterparty netting and cash collateral received and pledged (in thousands, except contract amounts):


	August 31, 2012
	Assets					Liabilities
	Fair Value			Number of Contracts		Fair Value			Number of Contracts
Interest rate contracts	$	917,424			86,810	$	1,050,973			106,403
Foreign exchange contracts		526,363			101,140		468,695			100,721
Equity contracts		368,222			1,376,634		315,503			1,280,589
Commodity contracts		359,206			644,588		378,706			638,297
Credit contracts		15,205			21		15,839			27

Total		2,186,420			2,209,193		2,229,716			2,126,037

Counterparty/cash-collateral netting		(1,827,597	)				(1,996,000	)

Total per Consolidated Statement of Financial Condition	$	358,823				$	233,716


	November 30, 2011
	Assets					Liabilities
	Fair Value			Number of Contracts		Fair Value			Number of Contracts
Interest rate contracts	$	542,221			63,751	$	636,692			66,027
Foreign exchange contracts		1,009,765			102,578		1,015,900			119,780
Equity contracts		638,228			2,364,390		548,195			2,119,165
Commodity contracts		725,927			434,428		598,166			421,330
Credit contracts		60,756			59		35,718			39

Total		2,976,897			2,965,206		2,834,671			2,726,341

Counterparty/cash-collateral netting		(2,451,004	)				(2,585,634	)

Total per Consolidated Statement of Financial Condition	$	525,893				$	249,037

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

(Unaudited)

The following table presents unrealized and realized gains and (losses) on derivative contracts for the three and nine months ended August 31, 2012 and 2011 (in thousands):


	Three Months Ended						Nine Months Ended
	August 31, 2012 Gains (Losses)			August 31, 2011 Gains (Losses)			August 31, 2012 Gains (Losses)			August 31, 2011 Gains (Losses)
Interest rate contracts	$	38,067		$	(103,572	)	$	(39,667	)	$	(190,800	)
Foreign exchange contracts		(4,616	)		2,200			4,193			(5,981	)
Equity contracts		(46,930	)		(74,564	)		(72,691	)		(178,433	)
Commodity contracts		11,074			8,512			57,586			41,102
Credit contracts		(5,887	)		11,383			(15,274	)		17,123

Total	$	(8,292	)	$	(156,041	)	$	(65,853	)	$	(316,989	)

OTC Derivatives. The following tables set forth the remaining contract maturity of the fair value of OTC derivative assets and liabilities as of August 31, 2012 (in thousands):


	OTC derivative assets(1)(2)(4)
	0-12 Months		1-5 Years		Greater Than 5 Years		Cross-Maturity Netting(3)			Total
Commodity swaps, options and forwards	$	108,376	$	784	$	—	$	(701	)	$	108,459
Credit default swaps		—		8,914		5,140		(478	)		13,576
Equity swaps and options		696		—		—		—			696
Total return swaps		218		—		—		—			218
Foreign currency forwards, swaps and options		122,956		30,747		—		(38	)		153,665
Fixed income forwards		1,249		—		—		—			1,249
Interest rate swaps and options		13,047		47,941		207,828		(78,316	)		190,500

Total	$	246,542	$	88,386	$	212,968	$	(79,533	)		468,363

Cross product counterparty netting											(17,224	)

Total OTC derivative assets included in Financial instruments owned										$	451,139

(1)	At August 31, 2012, we held exchange traded derivative assets and other credit enhancements with a fair value of $80.8 million, which are not included in this table.

(2)	OTC derivative assets in the table above are gross of collateral received. OTC derivative assets are recorded net of collateral received on the Consolidated Statements of Financial Condition. At August 31, 2012, cash collateral received was $173.1 million.

(3)	Amounts represent the netting of receivable balances with payable balances for the same counterparty within product category across maturity categories.

(4)	Derivative fair values include counterparty netting within product category.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

(Unaudited)


	OTC derivative liabilities(1)(2)(4)
	0-12 Months		1-5 Years		Greater Than 5 Years		Cross-Maturity Netting(3)			Total
Commodity swaps, options and forwards	$	119,708	$	80	$	—	$	(701	)	$	119,087
Credit default swaps		397		445		6,322		(478	)		6,686
Equity swaps and options		7,739		4,376		—		—			12,115
Total return swaps		534		—		—		—			534
Foreign currency forwards, swaps and options		71,988		27,440		—		(38	)		99,390
Interest rate swaps and options		10,484		125,569		268,028		(78,316	)		325,765

Total	$	210,850	$	157,910	$	274,350	$	(79,533	)		563,577

Cross product counterparty netting											(17,224	)

Total OTC derivative liabilities included in Financial instruments sold, not yet purchased										$	546,353

(1)	At August 31, 2012, we held exchange traded derivative liabilities and other credit enhancements with a fair value of $28.9 million, which are not included in this table.

(2)	OTC derivative liabilities in the table above are gross of collateral pledged. OTC derivative liabilities are recorded net of collateral pledged on the Consolidated Statements of Financial Condition. At August 31, 2012, cash collateral pledged was $341.5 million.

(3)	Amounts represent the netting of receivable balances with payable balances for the same counterparty within product category across maturity categories.

(4)	Derivative fair values include counterparty netting within product category.

At August 31, 2012, the counterparty credit quality with respect to the fair value of our OTC derivatives assets was as follows (in thousands):


Counterparty credit quality(1):
A- or higher	$	307,387
BBB- to BBB+		63,638
BB+ or lower		50,265
Unrated		29,849

Total	$	451,139

(1)

We utilize the credit ratings of external rating agencies when available. When external credit ratings are not available, we may utilize internal credit ratings determined by our Credit Risk Management. Credit ratings determined by Credit Risk Management use methodologies that produce ratings generally consistent with those produced by external rating agencies.

Contingent Features

Certain of our derivative instruments contain provisions that require our debt to maintain an investment grade credit rating from each of the major credit rating agencies. If our debt were to fall below investment grade, it would be in violation of these provisions, and the counterparties to the derivative instruments could request immediate payment or demand immediate and ongoing full overnight collateralization on our derivative instruments in liability positions. The aggregate fair value of all derivative instruments with such credit-risk-related contingent features that are in a liability position at August 31, 2012 and November 30, 2011 is $154.4 million and $141.2 million, respectively, for which we have posted collateral of $109.4 million and $129.8 million, respectively, in the normal course of business. If the credit-risk-related contingent features underlying these agreements were triggered on August 31, 2012 and November 30, 2011, we would have been required to post an additional $48.8 million and $19.5 million, respectively, of collateral to our counterparties.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

(Unaudited)

Note 7.

Collateralized Transactions

We enter into secured borrowing and lending arrangements to obtain collateral necessary to effect settlement, finance inventory positions, meet customer needs or re-lend as part of our dealer operations. We manage our exposure to credit risk associated with these transactions by entering into master netting agreements. We also monitor the fair value of the securities loaned and borrowed on a daily basis as compared with the related payable or receivable, and request additional collateral or return excess collateral, as appropriate. We pledge financial instruments as collateral under repurchase agreements, securities lending agreements and other secured arrangements, including clearing arrangements. Our agreements with counterparties generally contain contractual provisions allowing the counterparty the right to sell or repledge the collateral. Pledged securities owned that can be sold or repledged by the counterparty are included within Financial instruments owned and noted parenthetically as Securities pledged on our Consolidated Statements of Financial Condition.

We receive securities as collateral under resale agreements, securities borrowing transactions and customer margin loans. We also receive securities as collateral in connection with certain securities for securities transactions in which we are the lender of securities. In many instances, we are permitted by contract or custom to rehypothecate the securities received as collateral. These securities may be used to secure repurchase agreements, enter into securities lending or derivative transactions or cover short positions. At August 31, 2012 and November 30, 2011, the approximate fair value of securities received as collateral by us that may be sold or repledged was $22.8 billion and $17.9 billion, respectively. The fair value of securities received as collateral at August 31, 2012 and November 30, 2011 that pertains to our securities financing activities at August 31, 2012 and November 30, 2011 are as follows (in thousands):


	August 31, 2012		November 30, 2011
Carrying amount:
Securities purchased under agreements to resell	$	3,942,915	$	2,893,043
Securities borrowed		5,218,205		5,169,689
Securities received as collateral		484		21,862

Total assets on Consolidated Statement of Financial Condition		9,161,604		8,084,594
Netting of securities purchased under agreements to resell (1)		10,747,668		7,498,439

		19,909,272		15,583,033
Fair value of collateral received in excess of contract amount (2)		2,852,396		2,386,921

Fair value of securities received as collateral	$	22,761,668	$	17,969,954

(1)	Represents the netting of securities purchased under agreements to resell with securities sold under agreements to repurchase balances for the same counterparty under legally enforceable netting agreements.

(2)

Includes collateral received from customers for margin balances unrelated to arrangements for securities purchased under agreements to resell or securities borrowed with a fair value of $1,393.8 million and $1,578.3 million at August 31, 2012 and November 30, 2011, respectively, of which $663.8 million and $780.5 million had been rehypothecated.

At August 31, 2012 and November 30, 2011, a substantial portion of the securities received by us had been sold or repledged.

In instances where we are permitted to sell or repledge the securities received as collateral, we report the fair value of the collateral received and the related obligation to return the collateral in the Consolidated Statements of Financial Condition. At August 31, 2012 and November 30, 2011, $0.5 million and $21.9 million, respectively, were reported as Securities received as collateral and as Obligation to return securities received as collateral.

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

(Unaudited)

Note 8.

Securitization Activities

We engage in securitization activities related to commercial mortgage loans and mortgage-backed and other asset-backed securities. In our securitization transactions, we transfer these assets to special purpose entities (“SPEs”) and act as the placement or structuring agent for the beneficial interests issued to investors by the SPE. A significant portion of our securitization transactions are securitization of assets issued or guaranteed by U.S. government agencies. Our securitization vehicles generally meet the criteria of variable interest entities; however we generally do not consolidate our securitization vehicles as we are not considered the primary beneficiary for these vehicles. See Note 9, Variable Interest Entities for further discussion on variable interest entities and our determination of the primary beneficiary.

We account for our securitization transactions as sales provided we have relinquished control over the transferred assets. If we have not relinquished control over the transferred assets, the assets continue to be recognized in Financial instruments owned and a corresponding secured borrowing is recognized in Other liabilities. Transferred assets are carried at fair value with unrealized gains and losses reflected in Principal transactions revenues prior to securitization. Net underwriting revenues are recognized in connection with the securitization activities.

We generally receive cash proceeds in connection with the transfer of assets as the security interests issued by the securitization vehicles are sold to investors. We may, however, have continuing involvement with the transferred assets, which is limited to retaining one or more tranches of the securitization (primarily senior and subordinated debt securities), which are included within Financial instruments owned and limited to retaining servicing rights for military housing loan securitizations, which are included within Other assets. We apply fair value accounting to the securities. The servicing rights, where they are retained by us, are amortized over the period of the estimated future net servicing income.

The following table presents activity related to our securitizations that were accounted for as sales in which we had continuing involvement (in millions):

Three Months Ended

Nine Months Ended

August 31, 2012

August 31, 2011

August 31, 2012