10-K

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

þ	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
	For the fiscal year ended December 31, 2005
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
	For the transition period from          to

Commission File Number: 1-14947

JEFFERIES GROUP, INC.

(Exact name of registrant as specified in its charter)

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

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

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

Title of Each Class:	Name of Each Exchange on Which Registered:
Common Stock, $.0001 par value	New York Stock Exchange

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

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.

Yes o     No þ

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

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

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

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

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

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. $1,839,011,156 as of June 30, 2005.

Indicate the number of shares outstanding of the registrant’s class of common stock, as of the latest practicable date. 59,360,130 shares as of the close of business February 6, 2006.

DOCUMENTS INCORPORATED BY REFERENCE

Information from the Registrant’s Definitive Proxy Statement with respect to the 2006 Annual Meeting of Stockholders to be held on May 22, 2006 to be filed with the Commission is incorporated by reference into Part III of this Form 10-K.

LOCATION OF EXHIBIT INDEX

The index of exhibits is contained in Part IV herein on page 81.

JEFFERIES GROUP, INC.

2005 FORM 10-K ANNUAL REPORT

TABLE OF CONTENTS

		Page
PART I
Item 1.	Business		1
Item 1A	Risk Factors		9
Item 2.	Properties		12
Item 3.	Legal Proceedings		13
Item 4.	Submission of Matters to a Vote of Security Holders		13
PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		14
Item 6.	Selected Financial Data		15
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		16
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk		33
Item 8.	Financial Statements and Supplementary Data		37
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		80
Item 9A.	Controls and Procedures		80
Item 9B.	Other Information		80
PART III
Item 10.	Directors and Executive Officers of the Registrant		80
Item 11.	Executive Compensation		80
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		80
Item 13.	Certain Relationships and Related Transactions		80
Item 14.	Principal Accounting Fees and Services		80
PART IV
Item 15.	Exhibits and Financial Statement Schedules		81
Exhibit 10.2
Exhibit 10.15
Exhibit 12.1
Exhibit 21
Exhibit 23
Exhibit 31.1
Exhibit 31.2
Exhibit 32

Exhibit Index located on page 81 of this report.

PART I

Item 1.   Business.

Jefferies Group, Inc. and its subsidiaries (the “Company” or “we”) operate as a full-service investment bank and institutional securities firm focused on growing and mid-sized companies and their investors. We offer capital raising, mergers and acquisitions, restructuring and other financial advisory services to small and mid-sized companies and provide trade execution in equity, high yield, investment grade fixed income, convertible and international securities, as well as fundamental research and asset management capabilities, to institutional investors. We also offer correspondent clearing, prime brokerage, private client and securities lending services.

As of December 31, 2005, we had 2,045 employees. We maintain offices throughout the world and have our executive offices located at 520 Madison Avenue, New York, New York 10022. Our telephone number is (212) 284-2550 and our Internet address is www.jefferies.com.

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

•  Code of Ethics and Standards of Employee Conduct;

•  Reportable waivers, if any, from our Code of Ethics and Standards of Employee Conduct by our executive officers;

•  Board of Directors Corporate Governance Guidelines;

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

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

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

•  Annual reports on Form 10-K;

•  Quarterly reports on Form 10-Q;

•  Current reports on Form 8-K; and

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

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

Our Major Operating Companies

Jefferies & Company, Inc.

Jefferies & Company, Inc. (“Jefferies”) is our principal operating subsidiary. Founded in 1962, Jefferies provides clients with investment banking services, sales and trading, research, asset management as well as correspondent clearing, prime brokerage and securities lending services. The firm is a leading provider of trade execution in equity, high yield, investment grade fixed income, convertible and international securities serving institutional investors and high net worth individuals.

Jefferies International Limited

Jefferies International Limited (“JIL”) is an investment bank and institutional securities firm offering investment banking, sales and trading, securities research and investment management to mid-sized and growing companies, and their investors, primarily in Europe. Established in 1985, JIL is a leader in the global convertible securities markets, providing a variety of leading-edge solutions in sales, trading, analysis and investment management. JIL also offers client service in the trading of US, European and Japanese equities, as well as high

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yield and distressed securities. The investment banking team offers European clients advisory capabilities in M&A, private placements, high yield capital markets origination and corporate restructuring. JIL is incorporated in the UK.

Jefferies Execution Services, Inc.

Jefferies Execution Services, Inc. (“Jefferies Execution”), formerly Helfant Group, Inc., provides agency-only execution services for stocks and options listed on the NYSE, AMEX, and all other major exchanges, as well as over-the-counter (“OTC”). In 2005, the firm traded over 37 billion shares utilizing its execution platform which includes floor brokerage, electronic connectivity, direct access and listed options trading. Jefferies Execution is one of the largest execution services providers on the New York Stock Exchange. With 15 seats and operating from 36 booths on the floor, the firm executes approximately 9 percent of the average daily reported volume of the NYSE. Jefferies Execution operates as a separate broker-dealer serving over 130 institutional clients and other broker-dealers.

Jefferies Asset Management, LLC

Jefferies Asset Management, LLC (“JAM”) acts as investment manager to various private investment funds. JAM’s private fund products include three long-short equity funds and a real asset fund. These funds are not registered under federal or state securities laws, are made available only to certain sophisticated investors and are not offered or sold to the general public. In 2005, JAM continued to build the infrastructure for a substantial asset management business. JAM continues to use proprietary capital to incubate new portfolio managers and strategies, with the goal of making these strategies available to outside investors in the future.

Jefferies Financial Products LLC

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

Our Sources of Revenues

Commissions

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

Principal Transactions

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

Investment Banking

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

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Interest

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

Asset Management Fees and Investment Income from Managed Funds

Asset management fees and investment income from managed funds include revenues we receive from asset management, administrative and performance fees from funds managed by us, revenues from asset management and performance fees we receive from third-party managed funds, and investment income from our investments in these funds. We receive fees in connection with management and investment advisory services we perform for various domestic and international funds and managed accounts. These fees are based on the value of assets under management and may include performance fees based upon the performance of the funds.

Business Segment

We currently have one reportable business segment, Capital Markets. The Capital Markets reportable segment includes our traditional securities brokerage and investment banking activities. Our operating segments have been aggregated where they have similar economic characteristics and are similar in each of the following areas: (i) the nature of the services they provide, (ii) their methods of distribution, (iii) the types of clients they serve and (iv) the regulatory environments in which they operate. In addition, we choose to voluntarily disclose the Asset Management segment even though it is currently an “immaterial non-reportable” segment as defined by FASB 131, Disclosures about Segments of an Enterprise and Related Information. The Asset Management segment is primarily comprised of revenue and expenses related to our non-integrated asset management businesses including the Jackson Creek CDO, Victoria Falls CLO, Summit Lake CLO, Jefferies RTS Fund, Jefferies Paragon Fund and the Jefferies Real Asset Fund.

Financial information regarding our business segments as of December 31, 2005, December 31, 2004, and December 31, 2003 and for the fiscal years ended December 31, 2005, December 31, 2004, and December 31, 2003 is set forth in Note 18 of Notes to Consolidated Financial Statements, titled “Segment Reporting” and is incorporated herein by reference.

CAPITAL MARKETS SEGMENT

The Capital Markets reportable segment includes our traditional securities brokerage and investment banking activities including equity sales and trading, execution, convertibles, high yield, convertibles, investment grade fixed income and investment banking activities, including capital market transactions, mergers and acquisitions and advisory transactions. In addition, the Capital Markets reportable segment includes securities lending and commodity trading (JFP). The majority of our business units are focused on institutional customers.

The High Yield Funds and the international convertible bond activities are also a component of the Capital Markets reportable segment because asset management activities related to these businesses are managed by the high yield and convertible segment managers, respectively.

EQUITIES

Our Equities Division consists of equity sales and trading, Jefferies Execution and convertibles.

Equity Sales and Trading

The equity sales and trading unit is one of the primary foundations of our platform. Our clients include domestic and international investors such as investment advisors, banks, mutual funds, insurance companies, hedge funds, and pension and profit sharing plans. These investors normally purchase and sell securities in block transactions, the execution of which requires special marketing and trading expertise. We are one of the leading firms in the execution of equity block transactions and believe that our institutional customers are attracted by the quality of our execution (with respect to considerations of quantity, timing and price) and our competitive

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commission rates, which are negotiated on the basis of market conditions, the size of the particular transaction and other factors. We have a small Private Client Services group that focuses on transactions with retail customers, including high net worth clients.

All of our institutional equity account executives are electronically interconnected through systems permitting simultaneous verbal and graphic communication of trading and order information by all participants. We believe that our execution capability is significantly enhanced by these systems, which permit our account executives to respond to each other and to negotiate order indications directly with customers rather than through a separate trading department.

We have an over forty-year history in equity trading and one of the largest, most experienced institutional sales forces on Wall Street providing a major source of liquidity for institutional investors. Our equity sales representatives connect a network of more than 2,000 institutional investors around the globe and excel at providing seamless execution with a focus on minimal market impact. We specialize in listed block trades, NASDAQ market making, bulletin board trading, and portfolio and electronic trading. We consistently rank highly versus our peers as a trader of equity securities and are often the No. 1 trader of the stocks in which we make a market.

Jefferies Execution

Jefferies Execution provides agency-only execution services for stocks and options listed on the NYSE, AMEX, and all other major exchanges, as well as OTC. In 2005, the firm traded over 37 billion shares utilizing its execution platform which includes floor brokerage, electronic connectivity, direct access and listed options trading. Jefferies Execution is one of the largest execution services providers on the New York Stock Exchange. Jefferies Execution operates as a separate broker-dealer serving over 130 institutional clients and other broker-dealers.

Convertible Securities

We offer expertise in the sale, trading and analysis of domestic and international convertible bonds, convertible preferred shares and closed-end funds, warrants and structured products. Jefferies trades in more than 1,000 different issues and maintains active relationships with more than 500 institutional and corporate clients. We focus on smaller, often less traded securities, providing liquidity for these issues for which an active secondary market seldom exists. Our professionals possess an average of more than 15 years of experience in the sales and trading of convertible securities, with a strong international trading and research focus.

Research

Encompassed within equity sales and trading, high yield and convertibles is research and research sales. We have expanded our research platform over the last few years, with more than 120 equity, high yield and convertible research professionals covering over 1,100 companies worldwide, and nearly 40 dedicated research sales professionals. We provide long- and short-term investment ideas, utilizing the latest technologies to deliver a product that is differentiated and tailored to each customer. Our analysts use a variety of quantitative and qualitative tools, integrating field analysis, proprietary channel checks and ongoing dialogue with the managements of the companies they cover.

FIXED INCOME AND COMMODITIES

Our Fixed Income and Commodities Division consists of our high yield department, our investment grade fixed income department and JFP (our commodity trading group).

High Yield

We are a recognized leader in high yield securities, with a team of more than 50 professionals encompassing integrated sales, trading, research, and capital markets. We are a top trader in the secondary high yield and distressed markets, trading in more than 1000 issues with over 300 institutions globally. Our high yield professionals have long

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term relationships with institutional high yield and distressed investors with focus on secondary trading and new issues.

At December 31, 2005, the aggregate long and short market values of our holdings of high yield securities were $123.0 million and $34.9 million, respectively. Risk of loss upon default by the borrower is significantly greater with respect to unrated or less than investment grade corporate debt securities than with other corporate debt securities. These securities are generally unsecured and are often subordinated to other creditors of the issuer. These issuers usually have high levels of indebtedness and may be more sensitive to adverse economic conditions, such as recession or increasing interest rates, than are investment grade issuers.

In January 2000, we created three broker-dealer entities that employ a trading and investment strategy substantially similar to that historically employed by Jefferies High Yield department. Although we often refer to these three broker-dealer entities as funds, they are registered with the Commission as broker-dealers. Two of these funds, the Jefferies Partners Opportunity Fund and the Jefferies Opportunity Fund II, are principally capitalized with equity contributions from institutional and high net worth investors. The third fund, Jefferies Employees Opportunity Fund (and collectively with the two Jefferies Partners Opportunity Funds, referred to as the “High Yield Funds”), is principally capitalized with equity investments from our employees and is therefore consolidated into our consolidated financial statements. Our senior management (including our Chief Executive Officer and Chief Financial Officer) and certain of our employees have direct investments in these funds on terms identical to other fund participants. We have a 17% aggregate interest in these funds, senior management has a 3% interest and all employees (exclusive of senior management) have a 6% interest. The High Yield division and each of the funds share gains or losses on trading and investment activities of the High Yield division on the basis of a pre-established sharing arrangement related to the amount of capital each has committed. The sharing arrangement is modified from time to time to reflect changes in the respective amounts of committed capital. As of December 31, 2005, on a combined basis, the High Yield division had in excess of $945 million of combined pari passu capital available (including unfunded commitments and availability under the fund revolving credit facility) to deploy and execute the division’s investment and trading strategy. The High Yield Funds are managed by Richard Handler, our Chief Executive Officer.

Investment Grade Fixed Income

We provide fixed income transaction execution for institutions acting as principal, through a combination of professional sales and trading coverage, and a technology platform that enables true on-line real-time trading. The division has more than 90 professionals and are active traders of corporate, treasury, and mortgage fixed income securities.

Jefferies Financial Products LLC

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

INVESTMENT BANKING

Our Investment Banking Division offers our clients, primarily growing and mid-sized companies, a full range of financial advisory services, as well as debt, equity, and convertible financing services. These services include acquisition financing, bridge and senior loan financing, private placements and public offerings of debt and equity securities, debt refinancings, private equity fund placement, merger and acquisition and exclusive sales advice, structured financings and securitizations, consent and waiver solicitations, and company and bondholder representations in corporate restructurings. Our nearly 400 banking professionals operate throughout the United States, in Europe and in Asia and have expertise in a range of industries including aerospace & defense, consumer/retail,

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energy, gaming, general industrials, healthcare, maritime/shipping, media & entertainment, financial and business services, technology and telecommunications, as well as a group dedicated to the coverage of financial sponsors. The division has grown dramatically over the last four years both organically and through acquisitions. A short summary of our recent acquisitions follows:

Jefferies Quarterdeck

Jefferies Quarterdeck is a specialized group of investment bankers focused on providing services to aerospace, defense and federal IT companies and was formed as a result of our December 2002 acquisition of Quarterdeck Investment Partners, LLC.

Jefferies Broadview

Jefferies Broadview consist of a group of approximately 100 investment banking professionals focused on serving IT, communications, healthcare technology and digital media companies. The group was formed as a result of our acquisition of Broadview International in December 2003.

Randall & Dewey

In February 2005 we acquired the assets and business of Randall & Dewey, a leading M&A advisor in the global oil and gas industries. Randall & Dewey, a division within our Investment Banking Department, serves an international client base that includes multinationals and major integrated enterprises, national oil companies and public and private independent exploration and production companies.

Helix Associates Limited

In May 2005, we acquired London-based Helix Associates Limited (Helix), a leading private equity fund placement firm. Helix is a leading global placement agent serving private equity general partners. Helix is well known for the quality of the firms it represents and for its high standards of research and marketing materials.

INTEREST

We derive interest income from a number of venues including our securities lending unit, short term cash investments and deposits with clearing and depository organizations.

Securities Lending

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

ASSET MANAGEMENT SEGMENT

We voluntarily disclose an Asset Management segment even though it is currently an “immaterial non-reportable” segment as defined by FASB 131, Disclosures about Segments of an Enterprise and Related Information. The Asset Management segment is primarily comprised of revenue and expenses related to our “non-integrated” asset management businesses including the Jackson Creek CDO, Victoria Falls CLO, Summit Lake

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CLO, Jefferies RTS Fund, Jefferies Paragon Fund and the Jefferies Real Asset Fund. The segment does not include activity associated with our high yield or international asset management as they are managed by the respective desk managers and included as an integrated component of the Capital Markets segment.

Jefferies Asset Management

Jefferies Asset Management, LLC (“JAM”) acts as investment manager to various private investment funds. JAM’s private fund products include three long-short equity funds and a real asset fund. These funds are not registered under federal or state securities laws, are made available only to certain sophisticated investors and are not offered or sold to the general public. In 2005, JAM continued to build the infrastructure for a substantial asset management business. JAM continues to use proprietary capital to incubate new portfolio managers and strategies, with the goal of making these strategies available to outside investors in the future.

Competition

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

Regulation

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

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

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

Net Capital Requirements.  Every U.S. registered broker-dealer doing business with the public is subject to the Commission’s Uniform Net Capital Rule (the “Rule”), which specifies minimum net capital requirements.

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Jefferies Group, Inc. is not a registered broker-dealer and is therefore not subject to the Rule; however, its United States broker-dealer subsidiaries are registered and are subject to the Rule.

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

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

As of December 31, 2005, Jefferies’, and Jefferies Execution’s net capital and excess net capital were as follows (in thousands of dollars):

	Net Capital		Excess Net Capital
Jefferies	$	259,213	$	245,083
Jefferies Execution		14,212		13,962

NYSE Regulations.  Our common stock is listed on the New York Stock Exchange. As a listed company, we are required to comply with the NYSE’s rules and regulations, including rules pertaining to corporate governance matters. As required by the NYSE on an annual basis, in 2005 our Chief Executive Officer, Richard Handler, certified to the NYSE that he was not aware of any violation by us of the NYSE’s corporate governance listing standards.

Business Risks

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

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

Margin Risk

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

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

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

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

Underwriting Risk

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

Item 1A.   Risk Factors

Factors Affecting Our Business

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

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

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

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

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

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of the transactions in which we participate and could therefore be adversely affected by unfavorable financial or economic conditions.

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

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

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

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

Increased competition may adversely affect our revenues and profitability.

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

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

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

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

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

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

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

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

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

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

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

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

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

The securities industry in the United States is subject to extensive regulation under both federal and state laws. The Securities and Exchange Commission is the federal agency responsible for the administration of federal securities laws. In addition, self-regulatory organizations, principally NASD and the securities exchanges, are

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

Our business is substantially dependent on our Chief Executive Officer.

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

Legal liability may harm our business.

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

Our business is subject to significant credit risk.

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

Item 2.   Properties.

We maintain offices throughout the world including New York, Atlanta, Boston, Chicago, Dallas, Houston, Jersey City, London, Los Angeles, Nashville, New Orleans, Richmond, Silicon Valley, Paris, San Francisco, Short

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Hills, Stamford, Tokyo, Washington, D.C. and Zurich. In addition, we maintain back-up facilities with redundant technologies in Dallas. We lease all of our office space which management believes is adequate for our business. For information concerning leasehold improvements and rental expense, see notes 1, 6 and 13 of Notes to Consolidated Financial Statements.

Item 3.   Legal Proceedings.

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

The NASD, SEC and Department of Justice are conducting investigations into possible violations of law and regulations relating to travel and entertainment expenses and the giving of gifts to employees of a mutual fund complex, as well as trading with and for the mutual fund complex, which involve Jefferies and other NASD member firms. We are cooperating fully with these investigations.

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

None.

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PART II

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

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

	High		Low
2005
Fourth Quarter	$	47.87	$	38.60
Third Quarter		43.56		37.13
Second Quarter		39.00		33.55
First Quarter		40.76		36.26
2004
Fourth Quarter	$	43.20	$	33.67
Third Quarter		36.00		27.75
Second Quarter		36.84		29.15
First Quarter		39.72		32.65

There were approximately 750 holders of record of our common stock at February 6, 2006.

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

During 2004, we increased our quarterly dividend to $0.10 per share. During the first quarter of 2005, we announced a 20% increase in our quarterly dividend to $0.12 per share and then in the fourth quarter of 2005, we announced an additional 25% increase in our quarterly dividend to $0.15 per share.

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

	First		Second		Third		Fourth
	Quarter		Quarter		Quarter		Quarter
2005	$	.12	$	.12	$	.12	$	.15
2004	$	.08	$	.08	$	.10	$	.10

Issuer Purchases of Equity Securities

	(a)		(b)		(c)		(d)
					Total Number of		Maximum Number
	Total				Shares Purchased as		of Shares That May
	Number of		Average		Part of Publicly		Yet Be Purchased
	Shares		Price Paid		Announced Plans or		Under the Plans or
Period	Purchased(1)		per Share		Programs(2)		Programs
October 1 - October 31, 2005		137,480		41.89		—		3,000,000
November 1 - November 30, 2005		12,927		44.95		—		3,000,000
December 1 - December 31, 2005		—		—		—		3,000,000
Total		150,407		42.15		—		3,000,000

(1)

We repurchased an aggregate of 150,407 shares during the fourth quarter other than as part of a publicly announced plan or program. We repurchased these securities in connection with our equity compensation plans which allow participants to use shares to pay the exercise price of options exercised and to use shares to satisfy tax liabilities arising from the exercise of options or the vesting of restricted stock. This number does not include unvested shares forfeited back to us pursuant to the terms of our equity compensation plans.

(2)

On July 26, 2005, we issued a press release announcing the authorization by our Board of Directors to repurchase, from time to time, up to an aggregate of 3,000,000 shares.

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Item 6.   Selected Financial Data.

The selected data presented below as of and for each of the years in the five-year period ended December 31, 2005, are derived from the consolidated financial statements of Jefferies Group, Inc. and its subsidiaries, which financial statements have been audited by KPMG LLP, our independent registered public accounting firm. The data should be read in connection with the consolidated financial statements including the related notes contained on pages 37 through 79. On July 14, 2003, we declared a 2-for-1 split of all outstanding shares of common stock, payable August 15, 2003 to stockholders of record as of July 31, 2003. The stock split was effected as a stock dividend of one share for each one share outstanding on the record date. All share, share price and per share information has been restated to retroactively reflect the effect of the two-for-one stock split. Certain reclassifications have been made to the prior period amounts to conform to the current period’s presentation.

	Year Ended December 31,
	2005			2004			2003			2002			2001
	(In Thousands, Except Per Share Amounts)
Earnings Statement Data
Revenues:
Commissions	$	246,943		$	258,838		$	250,191		$	268,984		$	233,860
Principal transactions		349,489			358,213			301,299			227,664			265,634
Investment banking		495,014			352,804			229,608			139,828			124,099
Asset management fees and investment income from managed funds		82,052			81,184			32,769			19,643			25,789
Interest		304,053			134,450			102,403			92,027			131,408
Other		20,322			13,150			10,446			6,630			4,201
Total revenues		1,497,873			1,198,639			926,716			754,776			784,991
Interest expense		293,173			140,394			97,102			80,087			114,709
Revenues, net of interest expense		1,204,700			1,058,245			829,614			674,689			670,282
Non-interest expenses:
Compensation and benefits		669,957			595,887			474,709			385,585			400,159
Floor brokerage and clearing fees		46,644			52,922			48,217			54,681			47,451
Technology and communications		67,666			64,555			58,581			52,216			44,583
Occupancy and equipment rental		47,040			39,553			32,534			26,156			22,916
Business development		42,512			35,006			26,481			22,973			21,349
Other		62,474			43,333			44,559			29,386			31,172
Total non-interest expenses		936,293			831,256			685,081			570,997			567,630
Earnings before income taxes and minority interest		268,407			226,989			144,533			103,692			102,652
Income taxes		104,089			83,955			52,851			41,121			43,113
Earnings before minority interest		164,318			143,034			91,682			62,571			59,539
Minority interest in earnings of consolidated subsidiaries, net		6,875			11,668			7,631			—			—
Net earnings	$	157,443		$	131,366		$	84,051		$	62,571		$	59,539
Earnings per share of Common Stock:
Basic	$	2.55		$	2.29		$	1.58		$	1.27		$	1.21
Diluted	$	2.32		$	2.06		$	1.42		$	1.14		$	1.14
Weighted average shares of Common Stock:
Basic		61,823			57,453			53,090			49,232			49,225
Diluted		67,784			63,908			59,266			55,020			52,263
Cash dividends per common share	$	0.51		$	0.36		$	0.21		$	0.10		$	0.10
Selected Balance Sheet Data
Total assets	$	12,780,931		$	13,824,628		$	10,992,283		$	6,898,691		$	5,344,737
Long-term debt	$	779,873		$	789,067		$	443,148		$	452,606		$	153,797
Total stockholders’ equity	$	1,286,850		$	1,039,133		$	838,371		$	628,517		$	565,656
Book value per share of Common Stock	$	22.14		$	18.14		$	14.79		$	11.66		$	10.54
Shares outstanding		58,110			57,289			56,702			53,904			53,672
Other Data (Unaudited)
Fixed charge coverage ratio(1)		5.5	X		5.6	X		5.6	X		4.5	X		7.0	X

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

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

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

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

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

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

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

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

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

Critical Accounting Policies

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

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

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

Fair Value of Financial Instruments

Investments are stated at fair value as determined in good faith by management. Factors considered in valuing individual investments include, without limitation, available market prices, reported net asset values, type of security, purchase price, purchases of the same or similar securities by other investors, marketability, restrictions on disposition, current financial position and operating results, and other pertinent information.

Furthermore, judgment is used to value certain securities (e.g., private securities, 144A securities, less liquid securities) if quoted current market prices are not available. These valuations are made with consideration for various assumptions, including time value, yield curve, volatility factors, liquidity, market prices on comparable securities and other factors. The subjectivity involved in this process makes these valuations inherently less reliable

16

than quoted market prices. We believe that our comprehensive risk management policies and procedures serve to monitor the appropriateness of the assumptions used. The use of different assumptions, however, could produce materially different estimates of fair value.

Fair Value of Derivatives

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

Compensation and Benefits

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

Subsequent Events

Debt Issuance — 30 Year Senior Debentures

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

Massachusetts Mutual Life Insurance Company

In February 2006, Massachusetts Mutual Life Insurance Company (“MassMutual”) purchased in a private placement $125 million of our Series A convertible preferred stock. The principal terms of the Series A Preferred include a 3.25% annual, cumulative cash dividend with a conversion price of $62 per share. The preferred stock is callable after 10 years and will mature in 2036.

In February 2006, we and MassMutual also entered into an agreement to double our equity commitments to Jefferies Babson Finance LLC, the joint venture we and MassMutual formed in October 2004. With an incremental $125 million from each of us and MassMutual, the new total committed equity capitalization of the joint venture finance company is $500 million.

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The incremental capital will allow Jefferies Babson Finance to continue to grow its business of offering senior loans to middle market and growth companies, originated primarily through our investment banking efforts. Babson Capital Management LLC, a MassMutual affiliate, will continue to provide primary credit analytics and portfolio management services. We will continue to account for our 50% economic and voting interest in Jefferies Babson Finance on the equity method of accounting. In addition, origination and syndication fees earned by our investment banking effort will be recorded as a component of investment banking revenue.

Business Segments

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

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

	Year Ended December 31,
	2005					2004					2003
			% of Total					% of Total					% of Total
	Amount		Revenues			Amount		Revenues			Amount		Revenues
	(Dollars in thousands)
Equity	$	475,547		32	%	$	550,452		46	%	$	493,086		53	%
Fixed Income & Commodities		141,207		9			79,749		7			68,850		8
Total		616,754		41			630,201		53			561,936		61
Investment banking		495,014		33			352,804		29			229,608		25
Asset management fees and investment income from managed funds:
Asset management fees		50,943		4			38,208		3			17,268		2
Investment income from managed funds		31,109		2			42,976		4			15,501		1
Total		82,052		6			81,184		7			32,769		3
Interest		304,053		20			134,450		11			102,403		11
Total revenues	$	1,497,873		100	%	$	1,198,639		100	%	$	926,716		100	%

2005 Compared to 2004

Overview

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

Equity Revenue

Equity revenue is comprised of equity, convertible, and execution product revenues. Equity revenue was $475.5 million, down 14% from 2004.

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Equity Product Revenue

Equity product revenue is composed of commissions and principal transaction trading revenues, net of soft dollar expenses. Equity product revenue was $392.8 million, down 12% from 2004. The decrease in equity product revenue was due a decline in block trading volumes, which we consider a benchmark for institutional equity trading, fewer large block trade opportunities, and reduced principal trading results.

Convertible Product Revenue

Convertible product revenue was $37.1 million, down 18% from 2004 due to decreased customer activity and the impact of the roll out of NASD’s Trade Reporting and Compliance Engine (“TRACE”) resulting in tighter trading spreads.

Execution Product Revenue

Execution product revenue was $23.0 million, down 29% from 2004. The decrease in execution revenue was due to declines in volume traded by our hedge fund customers, our sell-side $2 broker customers, and our Canadian-US arbitrage trading customers.

Fixed Income & Commodities Revenue

Fixed Income and Commodities revenue is comprised of High Yield, Investment Grade Fixed Income and Commodities product revenue. Fixed Income and Commodities revenue was $141.2 million, up 77% over last year.

High Yield Product Revenue

High yield product revenue, not including origination revenues, was $61.9 million, up 38% over last year. This increase was generally due to increased trading activity as a result of increased origination activity and an increase in proprietary trading profits offset by the impact of the roll out of NASD’s Trade Reporting and Compliance Engine (“TRACE”) resulting in tighter trading spreads.

Investment Grade Fixed Income Product Revenue

Investment Grade Fixed Income product revenue was $28.7 million, down 30% from 2004. The decrease was driven by the decreased demand for “odd lot” corporate bonds, reduced client activity in treasuries and the impact of the roll out of TRACE, resulting in tighter spreads.

Commodities Revenue

Commodities revenue includes revenues from the commodity index swap, option and futures transactions of Jefferies Financial Products, LLC (“JFP”). Commodities revenue was $41.7 million, versus $6.9 million in 2004. The increase in commodities revenue was due to the expansion of JFP as well as increased activity and volatility in most commodities markets, including energy related commodities markets.

Investment Banking Product Revenue

	Year Ended
	December 31,		December 31,		Percentage
	2005		2004		Change
	(Dollars in thousands)
Capital markets	$	221,479	$	171,654		29%
Advisory		273,535		181,150		51%
Total	$	495,014	$	352,804		40%

Capital markets revenues, which consist primarily of debt, equity and convertible financing services were $221.5 million, an increase of 29% from 2004. The increase in capital markets revenues is attributed primarily to the

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increase in lead or co-manager assignments for high yield and equity offerings in the consumer, energy and financial service sectors.

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

Asset Management Revenue

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

Changes in Assets Under Management

					Percent
	2005		2004		Change
	(In billions)
Opening balance	$	3,770	$	2,169		74	%
Net cash flow		185		1,108		(83	)%
Net market appreciation		305		493		(38	)%
		490		1,601		(69	)%
Ending balance	$	4,260	$	3,770		13	%

Net Interest Revenue

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

Compensation and Benefits

Compensation and benefits increased $74.1 million, or 12%, versus the 14% increase in net revenues. Employee headcount increased 14.7% from 1,783 to 2,045 at December 31, 2005. The majority of the increase is a result of our acquisitions of Randall & Dewey and Helix Associates earlier in 2005. The ratio of compensation to net revenues was approximately 56% for both 2005 and 2004.

Issuance of Stock-Based Compensation to Employees

Restricted stock and restricted stock units (“RSU’s”) are an important component of employee compensation. We believe they motivate employees and encourage long term commitment to us. Generally we issue these awards in lieu of cash compensation. Restricted stock and RSU’s are awarded to employees subject to risk of forfeiture and/or vesting conditions. Typically the vesting occurs over a prescribed period of time and requires continued service and employment by the recipient. Restricted stock and RSU’s are valued at the date of grant and are amortized over the vesting period which is typically three to five years.

We also have a voluntary deferred compensation plan (“DCP”) whereby our employees may defer cash compensation and the related taxes and elect any one of a number of investment alternatives. The employees are taxed when they receive distributions from the plan. One of the alternatives available is the ability to invest in equity units that are exchangeable into one share of our stock upon distribution. The equity units are credited to an employees DCP account at a discount to the current market price of our common stock. In 2005, 2004 and 2003, the discounts were 10% to the then current market prices of our common stock. All deferred compensation and any discount is expensed in the period earned.

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In addition, shares of our common stock may be purchased by employees pursuant to our Employee Stock Purchase Plan (“ESPP”). The ESPP allows qualified employees to purchase up to $25,000 in our stock at a 15% discount to the current stock price.

The following table summarizes certain selected financial ratios related to the issuance of stock-based compensation to our employees (dollars in thousands):

	2005			2004
Stock based compensation(1)	$	84,235		$	86,321
Net revenues	$	1,204,700		$	1,058,245
Compensation and benefits	$	669,957		$	595,887
Stock based compensation/net revenues		7	%		8	%
Stock based compensation/compensation and benefits		13	%		14	%

(1)  Stock based compensation is the pre-tax expense associated with all of our employee stock-based compensation plans, including the discount on DCP deferred shares, restricted stock amortization, discounts on employee stock purchase plans and ESOP contributions.

Stock based compensation/net revenues and stock based compensation/total compensation are comparable for the periods ending 2005 and 2004.

Additional information relating to issuances pursuant to our employee stock-based compensation plans is contained in Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income (Loss) on page 43, Stock-Based Compensation included in note 1 of the Notes to the Consolidated Financial Statements, and Benefit Plans included in note 10 of the Notes to the Consolidated Financial Statements.

Non-Personnel Expenses

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

Earnings before Income Taxes and Minority Interest

Earnings before income taxes and minority interest were up $41.4 million, or 18%, to $268.4 million, compared to $227.0 million for 2004. The effective tax rates were approximately 38.8% for 2005 and 37% in 2004. This increase in rates is due primarily to the 2004 tax rate being positively impacted by the favorable determination of several state tax issues.

Minority Interest

Minority interest was down $4.8 million, or 41%, to $6.9 million, compared to $11.7 million for 2004. Jefferies RTS Fund (RTS) and Asymmetric Capital Management Limited (ACM) were de-consolidated in the second quarter of 2004 due to changes in the capital structure of those two entities.

Earnings per Share

Basic net earnings per share were $2.55 for 2005 on 61,823,000 shares compared to $2.29 in 2004 on 57,453,000 shares. Diluted net earnings per share were $2.32 for 2005 on 67,784,000 shares compared to $2.06 in 2004 on 63,908,000 shares.

2004 Compared to 2003

Overview

Revenues, net of interest expense, increased $228.6 million, or 28%, to $1,058.2 million, compared to $829.6 million for 2003. The increase was primarily due to an $123.2 million, or 54%, increase in investment banking, a $65.6 million, or 12%, increase in trading revenues (commissions and principal transactions), and a

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$48.4 million, or 148%, increase in asset management fees and investment income from managed funds partially offset by a $11.2 million decrease in net interest revenues (interest income less interest expense) over last year.

Our overall financial results continue to be highly and directly correlated to the diversification of our platform. While the equity markets were strong for most of fiscal 2004, we also achieved record revenues and earnings as a result of new product offerings, acquisitions of strategic investment banking businesses, strategic hirings and operational improvements.

There were several factors which depressed investor activity during 2004. The anticipation of rising interest rates dampened the demand for fixed income products, and the Federal Reserve commenced a series of rate hikes during the year. The demanding regulatory environment remained in the spotlight and focused on the financial services industry, resulting in an increase in the cost of compliance and an impact on public trust and confidence. Finally, there was uncertainty over the Presidential election, the war in Iraq and the various economic policies that might be endorsed.

Equity Revenue

Equity revenue is comprised of equity, convertible, and execution product revenues Equity revenue for 2004 was $550.5 million, up 12% over last year.

Equity Product Revenue

Equity product revenue is composed of commissions and principal transaction trading revenues, net of soft dollar expenses. Despite downturns in industry block trading volumes, which were down 10% for the NYSE trading and down nearly 14% in NASDAQ trading on a year-over-year basis, equity revenue for 2004 was $446.6 million, up 13% over last year. Equity revenue increased for the following reasons: (i) we engaged in several large block-trading opportunities generated from investment banking relationships that are not necessarily repeatable and (ii) we experienced continued growth in strategic efforts, including sector trading, private client services, and equity research sales.

Convertible Product Revenue

Convertible product revenue, not including new issuance revenues, was $45.0 million, down 12% from last year. The decrease relates to a reduction in trading volume caused by overall reduced volatility in the convertible market.

Execution Product Revenue

Execution product revenue was nearly $32.5 million, up over 37% over last year. The increase in execution revenue was due to the expansion of direct access execution services to a limited number of institutional customers. For the full year 2004, we executed over 36 billion shares as compared to 37 billion for the comparable period in 2003.

Fixed Income & Commodities Revenue

Fixed Income and Commodities revenue is comprised of High Yield, Investment Grade Fixed Income and Commodities product revenue. Fixed Income and Commodities revenue was $79.7 million, up 16% over last year.

High Yield Revenue

High yield product revenue, not including new issuance revenues, was $44.9 million, up 11% over last year. The increase in high yield revenue was primarily a result of an increase in new issues and tight spreads versus comparable investment grade securities.

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Investment Grade Fixed Income Revenue

Investment Grade Fixed Income revenue was $41.0 million, up 51% over last year. The growth was driven by the fixed income business acquired from Mellon Securities LLC in 2003 and the expansion of products offered, including the trading of government agencies, treasuries and mortgage-backed securities on an agency basis. The client base grew from 1,000 institutions at December 31, 2003 to over 1,300 at December 31, 2004.

Commodities Revenue

Commodities revenue includes revenues from the commodity index swap, option and futures transactions of Jefferies Financial Products, LLC (“JFP”). Commodities revenue was $6.9 million, versus a $.2 million loss in 2003. The increase in commodities revenue was due to JFP’s commencement of operations in the fourth quarter of 2003 and its expansion during 2004.

Investment Banking Product Revenue

	Year Ended
	December 31,		December 31,		Percentage
	2004		2003		Change
	(Dollars in thousands)
Capital Markets	$	171,654	$	123,294		39%
Advisory		181,150		106,314		70%
Total	$	352,804	$	229,608		54%

Capital markets revenues which consist primarily of debt, equity and convertible financing services were $171.7 million, an increase of 39% from the prior year. The increase reflected higher industry-wide new issuance activity compared to 2003. The higher volume of offerings in 2004 was across several sectors, including energy, consumer, gaming, financial services and aerospace and defense.

Revenues from advisory activities were $181.2 million, an increase of 70% from 2003. The increase reflected a higher level of merger and acquisition activity generated primarily by Broadview in the information technology sector.

Asset Management Revenue

Asset management revenue includes revenues we receive from management and performance fees from funds managed by us, revenues from asset management and performance fees we receive from third-party managed funds, and investment revenue from our investments in these funds. Some of our revenues from asset management and performance fees are derived from our own investments in these funds. Asset management revenues were $81.2 million for 2004, up 148% over 2003. The increase in asset management revenue was a result of management and performance fees on a higher base of assets under management (up 74% versus the 2003 assets under management) and solid performance on our increased investments in managed funds (our investments in managed funds were 121% higher than 2003).

Changes in Assets Under Management

					Percent
	2004		2003		Change
	(In billions)
Opening balance	$	2,169	$	1,638		32%
Net cash flow		1,108		250		343%
Net market appreciation		493		281		75%
		1,601		531		202%
Ending balance	$	3,770	$	2,169		74%

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Interest Income and Expense

Interest income increased $32.0 million primarily as a result of increased stock lending activity, and interest expense increased by $43.0 million primarily as a result of increased stock borrowing activity and additional interest expense associated with the issuance of the $350 million in long-term debt in March of 2004.

Compensation and Benefits

Compensation and benefits expense was $596 million and $475 million in 2004 and 2003, respectively. Compensation and benefits expense as a percentage of net revenues was 56% in 2004 and 57% in 2003. Compensation and benefits expense includes the cost of salaries, bonuses, the amortization of restricted stock awards and employee benefit plans. The decrease in compensation and benefits as a percentage of net revenues is attributable primarily to two factors:

•  Investment banking revenues increased approximately 54% versus 2003. As revenues increased, we were able to leverage the fixed costs associated with the support and management of the investment banking department. The improvement attributable to this may not be sustainable depending on the recurring level and mix of investment banking revenues or the possible need for incremental infrastructure to support more activity.

•  Asset management revenues include investment income from our investment in various managed funds. Relatively, there is less compensation associated with these revenues. The compensation ratio improvement attributable to the asset management business may not be sustainable as it is highly dependent on performance that is likely to vary.

Issuance of Stock-Based Compensation to Employees

The following table summarizes certain selected financial ratios related to the issuance of stock-based compensation to our employees (dollars in thousands):

	2004			2003
Stock based compensation(1)	$	86,321		$	72,790
Net revenues	$	1,058,245		$	829,614
Compensation and benefits	$	595,887		$	474,709
Stock based compensation/net revenues		8	%		9	%
Stock based compensation/compensation and benefits		14	%		15	%

(1)  Stock based compensation is the pre-tax expense associated with all of our employee stock-based compensation plans, including the discount on DCP deferred shares, restricted stock amortization, discounts on employee stock purchase plans and ESOP contributions.

The 19% increase in stock based compensation from 2003 to 2004 is consistent with the increase in average employees for the comparable period. Stock based compensation/net revenues and stock based compensation/compensation and benefits are comparable for the periods ending 2004 and 2003.

Non-Personnel Expenses

Technology and communications increased $6.0 million, or 10%, mostly due to increased headcount and the addition of Broadview. Floor brokerage and clearing fees increased $4.7 million, or 10%, primarily due to increased trade volumes. Other expenses decreased $1.2 million, or 3%, mostly due to lower litigation related costs. Occupancy and equipment rental expense increased $7.0 million. Our occupancy costs in 2003 included a one-time $1.9 million expense attributable to the write-down of our San Francisco lease. The increase in 2004 versus 2003 was attributable to higher costs associated with the addition of Broadview combined with increased headcount throughout the firm. Business development expenses increased $8.5 million, or 32%, due to increased headcount, related travel and expanded marketing costs.

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Earnings before Income Taxes and Minority Interest

Earnings before income taxes and minority interest were up $82.5 million, or 57%, to $227.0 million, compared to $144.5 million for 2003. The effective tax rate was approximately 37% for both 2004 and 2003.

Minority Interest

Minority interest increased $4.0 million to $11.7 million, compared to 2003. The increase in minority interest largely relates to the minority interest in RTS, JEOF, and ACM recorded in the first quarter of 2004. RTS and ACM were de-consolidated in the second quarter of 2004 due to changes in the capital structure of those two entities. We purchased the remainder of Bonds Direct’s minority interest in the fourth quarter of 2004 for approximately $20.6 million.

	Year Ended
	December 31,			December 31,
	2004			2003		Difference
	(Amounts in thousands)
JEOF	$	4,310		$	2,666	$	1,644
RTS		4,503			1,881		2,622
Bonds Direct		1,315			2,180		(865	)
ACM		1,839			904		935
Other		(299	)		—		(299	)
Total	$	11,668		$	7,631	$	4,037

Earnings per Share

Basic net earnings per share were $2.29 for 2004 on 57,453,000 shares compared to $1.58 in 2003 on 53,090,000 shares. Diluted net earnings per share were $2.06 for 2004 on 63,908,000 shares compared to $1.42 in 2003 on 59,266,000 shares.

Liquidity, Financial Condition and Capital Resources

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

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

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Liquidity

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

	December 31,		December 31,
	2005		2004
Cash and cash equivalents:
Cash in banks	$	85,191	$	105,814
Money market investments		170,742		178,297
Total cash and cash equivalents		255,933		284,111
Cash and securities segregated(1)		629,360		553,720
Short-term bond funds		7,037		6,861
Auction rate preferreds(2)		28,756		50,365
Mortgage-backed securities(2)		13,458		27,511
Asset-backed securities(2)		33,159		21,093
	$	967,703	$	943,661

(1)	In accordance with Rule 15c3-3 of the Securities Exchange Act of 1934, Jefferies, as a broker-dealer carrying client accounts, is subject to requirements related to maintaining cash or qualified securities in a segregated reserve account for the exclusive benefit of its clients. In addition, deposits with clearing and depository organizations are included in this caption.
(2)	Items are included in Securities Owned and Securities Pledged to Creditors (see note 5 of the Notes to the Consolidated Financial Statements). Items are financial instruments utilized in the Company’s overall cash management activities and are readily convertible to cash.

Unsecured bank loans are typically overnight loans used to finance securities owned or clearing related balances. Unsecured bank loans were $0 and $70 million at December 31, 2005 and December 31, 2004, respectively. Average daily bank loans for the years ended December 31, 2005 and December 31, 2004 were $11.2 million and $64.2 million, respectively.

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

Our assets are funded by equity capital, senior debt, securities loaned, customer free credit balances, bank loans and other payables. Bank loans represent temporary (usually overnight) secured and unsecured short-term borrowings, which are generally payable on demand. We have arrangements with banks for unsecured financing of up to $319 million. Also, we have $125 million in undrawn letter of credit commitments from various financial institutions. Secured bank loans are collateralized by a combination of customer, non-customer and firm securities. We have always been able to obtain necessary short-term borrowings in the past and believe that we will continue to be able to do so in the future. Additionally, we have $172.6 million in letters of credit outstanding as of December 31, 2005, which are used in the normal course of business mostly to satisfy various collateral requirements in lieu of depositing cash or securities.

Excess Liquidity

Our policy is to maintain excess liquidity to cover all expected cash outflows for one year in a stressed liquidity environment. Liquid resources consist of unrestricted cash and unencumbered assets, readily converted to cash on a secured basis on short notice. Certain investments, short term bond funds and auction rated convertibles are also

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readily convertible to cash. In addition, we have $319 million of unsecured, uncommitted lines of credits with various banks.

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

•  The repayment of our unsecured debt maturing within twelve months (no such amounts outstanding at December 31, 2005);

•  The payment of interest expense on our long term debt;

•  The anticipated funding of outstanding investment commitments;

•  The anticipated fixed costs over the next 12 months;

•  Potential stock repurchases; and

•  All current liabilities.

In addition to the liquidity pool existing as of December 31, 2005, as disclosed in note 22 of the Notes to the Consolidated Financial Statements, in January 2006, we issued $500 million of senior unsecured debentures due 2036, and in February 2005 we issued $125 million in Series A Convertible Preferred Stock which increased our cash and cash equivalent balances accordingly. In February 2006, we and MassMutual agreed to double our equity commitments to Jefferies Babson Finance LLC, the joint venture we formed with MassMutual in October 2004. With an incremental $125 million from each partner, the new total committed equity capitalization of the joint venture finance company is $500 million.

Analysis of Financial Condition and Capital Resources

Financial Condition

As previously discussed, we have historically maintained a highly liquid balance sheet, with substantial portion of our total assets consisting of cash, highly liquid marketable securities and short-term receivables, arising principally from traditional securities brokerage activity. Total assets decreased $1,043.7 million, or 8%, from $13,824.6 million at December 31, 2004 to $12,780.9 million at December 31, 2005. Securities borrowed decreased $2,089.5 million and securities loaned decreased $1,601.4 million. The decreases in securities borrowed and securities loaned are mostly related to a $1.3 billion reduction in our securities lending matched book and a change in the financing of approximately $600 million of Bonds Direct securities inventories.

The decrease in securities borrowed was partially offset by increases in the following asset categories: $544.7 million in securities owned and securities pledged to creditors, $100.4 million other assets and $85.7 million in goodwill.

The decrease in securities loaned was partially offset by increase in the following liability categories: $140.4 million in securities sold, not yet purchased and $209.0 million in accrued expenses and other liabilities.

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

	December 31,			December 31,
	2005			2004
Stockholders’ equity	$	1,286,850		$	1,039,133
Less: Goodwill		(220,607	)		(134,936	)
Tangible stockholders’ equity	$	1,066,243		$	904,197
Stockholders’ equity	$	1,286,850		$	1,039,133
Add: Projected tax benefit on vested portion of restricted stock		137,193			99,057
Pro forma stockholders’ equity	$	1,424,043		$	1,138,190
Tangible stockholders’ equity	$	1,066,243		$	904,197
Add: Projected tax benefit on vested portion of restricted stock		137,193			99,057
Pro forma tangible stockholders’ equity	$	1,203,436		$	1,003,254
Shares outstanding		58,110,392			57,289,309
Add: Shares not issued, to the extent of related expense amortization		10,546,699			8,065,362
Less: Shares issued, to the extent related expense has not been amortized		(1,309,285	)		(2,006,365	)
Adjusted shares outstanding		67,347,806			63,348,306
Book value per share(1)	$	22.14		$	18.14
Pro forma book value per share(2)	$	21.14		$	17.97
Tangible book value per share(3)	$	18.35		$	15.78
Pro forma tangible book value per share(4)	$	17.87		$	15.84

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

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

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amortized. We consider these ratios as meaningful measurements of our financial condition and believe they provide investors with additional metrics to comparatively assess the fair market value of our stock.

Capital Resources

We have total long term capital of $2.1 billion and $1.8 billion resulting in a long-term debt to total capital ratio of 38% and 43%, at year-end 2005 and 2004 respectively. Our total capital base as of December 31 was as follows (in thousands):

	Pro Forma
	December 31,		December 31,		December 31,
	2005(1)		2005		2004
Long Term Debt(2)	$	1,279,873	$	779,873	$	789,067
Series A Preferred Stock		125,000		—		—
Total Stockholders’ Equity		1,286,850		1,286,850		1,039,133
Total Capital	$	2,691,723	$	2,066,723	$	1,828,200

(1)	As disclosed in note 22 of the Notes to the Consolidated Financial Statements, in January 2006, we issued $500 million of senior unsecured debentures due 2036, and in February 2006, we issued $125 million in Series A Convertible Preferred Stock.
(2)	Long term debt includes amounts contractually due greater than one year from the as of date, less unamortized discount, and adjusted for the basis difference attributed to the application of hedge accounting.

Our ability to support increases in total assets is largely a function of our ability to obtain short term secured and unsecured funding, primarily through securities lending, and our $319 million of uncommitted unsecured bank lines. Our ability further enhanced by the cash proceeds from the $500 million senior unsecured bonds and $125 million in series A preferred stock, both issued in the first quarter of 2006.

At December 31, 2005, our senior debt, net of unamortized discount, consisted of contractual principal payments (adjusted for amortization) of $348.1 million; $331.8 million and $100.0 million due in 2016, 2012 and 2007 respectively.

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

Our long term debt ratings are as follows:

	Rating
Moody’s Investors Services		Baa1
Standard and Poor’s		BBB
Fitch Ratings (issued in January 2006)		BBB	+

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

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Net Capital

As of December 31, 2005, Jefferies’ and Jefferies Execution’s net capital and excess net capital were as follows (in thousands of dollars):

	Net Capital		Excess Net Capital
Jefferies	$	259,213	$	245,083
Jefferies Execution	$	14,212	$	13,962

Guarantees

As of December 31, 2005, we had outstanding guarantees of $24.0 million relating to undrawn bank credit obligations of two associated investment funds in which we have an interest. In addition, we guarantee up to an aggregate of approximately $30 million in bank loans committed to an employee parallel fund of Jefferies Capital Partners IV L.P (“Fund IV”).

Also, we have guaranteed the performance of JIL and JFP to their trading counterparties and various banks and other entities, which provide clearing and credit services to JIL and JFP. In addition, as of December 31, 2005, we had commitments to invest up to $160.5 million in various investments, including $113.0 million in Jefferies Babson Finance LLC, $34.6 million in Fund IV and $12.9 million in other investments.

Leverage Ratios

The following table presents total assets, adjusted assets, and net adjusted assets with the resulting leverage ratios as of December 31, 2005 and December 31, 2004. With respect to leverage ratio, we believe that net adjusted leverage is the most relevant measure, given the low-risk, collateralized nature of our securities borrowed and segregated cash assets.

	December 31,		December 31,
	2005		2004
Total assets	$	12,780,931	$	13,824,628
Adjusted assets(1)		12,151,571		13,270,908
Net adjusted assets(2)		4,008,093		3,037,958
Leverage ratio(3)		9.9		13.3
Adjusted leverage ratio(4)		9.4		12.8
Net adjusted leverage ratio(5)		3.1		2.9

(1)	Adjusted assets are total assets less cash and securities segregated.
(2)	Net adjusted assets are adjusted assets, less securities borrowed.
(3)	Leverage ratio equals total assets divided by stockholders’ equity.
(4)	Adjusted leverage ratio equals adjusted assets divided by stockholders’ equity.
(5)	Net adjusted leverage ratio equals net adjusted assets divided by stockholders’ equity.

Stock Repurchases

During 2005, we purchased 1,969,993 shares of our common stock for $76.3 million mostly in connection with our stock compensation plans which allow participants to use shares to pay the exercise price of options exercised and to use shares to satisfy tax liabilities arising from the exercise of options or the vesting of restricted stock. The number above does not include unvested shares forfeited back to us pursuant to the terms of our stock compensation plans. We believe that we have sufficient liquidity and capital resources to make these repurchases without any material adverse effect on us.

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Commitments

The tables below provide information about our commitments related to debt obligations, interest rate swaps, leases, guarantees, letters of credit and investments as of December 31, 2005. For debt obligations, leases and investments, the table presents principal cash flows with expected maturity dates. For interest rate swaps, guarantees and letters of credit, the table presents notional amounts with expected maturity dates.

	Expected Maturity Date
	2006		2007		2008		2009		2010		After 2010		Total
	(Dollars in Thousands)
Debt Obligations
Senior Notes		—	$	100,000		—		—		—	$	675,000	$	775,000
Interest rate swaps		—		—		—		—		—	$	200,000	$	200,000
Leases
Gross lease commitments	$	37,283	$	35,798	$	34,308	$	28,539	$	25,676	$	87,227	$	248,831
Sub-leases		4,543		3,003		2,188		688		434		—		10,856
Net lease commitments	$	32,740	$	32,795	$	32,120	$	27,851	$	25,242	$	87,227	$	237,975
Guarantees	$	54,000		—		—		—		—		—	$	54,000
Letters of credit	$	172,640		—		—		—		—		—	$	172,640
Commitments to invest		—		—		—		—		—	$	160,540	$	160,540

Off Balance Sheet Arrangements

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

Effects of Changes in Foreign Currency Rates

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

Effects of Inflation

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

Risk Management

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

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business functions to assist in the identification, assessment and control of various risks. Our risk management policies, procedures and methodologies are fluid in nature and are subject to ongoing review and modification.

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

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

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

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

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

Our operations rely on the secure processing, storage and transmission of confidential and other information in our computer systems and networks. Although we take protective measures and endeavor to modify them as circumstances warrant, our computer systems, software and networks may be vulnerable to unauthorized access, computer viruses or other malicious code, and other events that could have a security impact. If one or more of such events occur, this potentially could jeopardize our or our clients’ or counterparties’ confidential and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our, our clients’, our counterparties’ or third parties’ operations. We may be

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required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to litigation and financial losses that are either not insured against or not fully covered through any insurance maintained by us.

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

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

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

Recent Accounting Developments

In December 2004, the FASB issued a revision to FASB No. 123, FASB No. 123R, “Share-Based Payments.” FASB No. 123R establishes standards for accounting for transactions in which an entity exchanges its equity instruments for goods and services. FASB No. 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. On April 14, 2005, the U.S. Securities and Exchange Commission announced new rules that require companies to implement FASB No. 123R by the start of their fiscal year beginning after June 15, 2005. Among other requirements, FASB No. 123R generally requires the immediate expensing of equity-based awards granted to retirement-eligible employees. The adoption of FASB No. 123R on January 1, 2006 did not have a material impact on our consolidated financial statements.

In June 2005, the FASB issued FASB No. 154, “Accounting Changes and Error Corrections — a replacement of APB Opinion No. 20 and FASB Statement No. 3,” (“FASB No. 154”). FASB No. 154 changes the requirements for the accounting for and reporting of a change in accounting principle. FASB No. 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005. We do not expect the adoption of FASB No. 154 to have a material impact on our consolidated financial statements.

In June 2005, the FASB ratified the consensus reached by the Emerging Issues Task Force on Issue 04-5, “Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights,” (“EITF 04-5”). EITF 04-5 presumes that a general partner controls a limited partnership, and should therefore consolidate a limited partnership, unless the limited partners have the substantive ability to remove the general partner without cause based on a simple majority vote or can otherwise dissolve the limited partnership, or unless the limited partners have substantive participating rights over decision making. This guidance became effective upon ratification by the FASB on June 29, 2005 for all newly formed limited partnerships and for existing limited partnerships for which the partnership agreements have been modified. For all other limited partnerships, the guidance is effective no later than the beginning of the first reporting period in fiscal years beginning after December 15, 2005. Management is currently evaluating the effect of adoption of EITF 04-5 on our consolidated financial condition, results of operations and cash flows.

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

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

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

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

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

Value-at-Risk

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

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

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

Daily VaR(1)
(In Millions)
Value at Risk in trading portfolios

	Year Ending December 31, 2005									At December 31,
Risk Categories	Average			High			Low			2005			2004
Interest Rates	$	0.59		$	1.49		$	0.27		$	0.56		$	0.55
Equity Prices	$	2.30		$	3.38		$	1.19		$	2.11		$	1.23
Currency Rates	$	0.17		$	0.45		$	0.02		$	0.36		$	0.03
Commodity Prices	$	1.03		$	2.60		$	0.03		$	0.20		$	0.02
Diversification Effect(2)	$	(1.38	)	$	(0.16	)	$	(2.42	)	$	(1.10	)	$	(0.47	)
Firmwide	$	2.71		$	3.89		$	1.17		$	2.13		$	1.36

(1)	VaR is the potential loss in value of our trading positions due to adverse market movements over a defined time horizon with a specific confidence level. For the VaR numbers reported above, a one-day time horizon and 95% confidence level were used.
(2)	Equals the difference between firmwide VaR and the sum of the VaRs by risk categories. This effect is due to the market categories not being perfectly correlated.

We continue to enhance our VaR methodology as the diversification of our products expands. Therefore, certain reclassifications and adjustments to prior period information have been incorporated into our VaR methodology and are reflected in the table set forth above.

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

VaR Back-Testing

The comparison of daily revenue fluctuations with the daily VaR estimate is the primary method used to test the efficacy of the VaR model. Back-testing is performed at various levels of the trading portfolio, from the holding company level down to specific business lines. A back-testing exception occurs when the daily loss exceeds the daily VaR estimate. Results of the process at the aggregate level demonstrated five outliers when comparing the 95% one-day VaR with the back-testing profit and loss in 2005. An efficient model for the one-day, 95% VaR should not have more than twelve (1 out of 20) back-testing exceptions on an annual basis. Back-testing profit and loss is a subset of actual trading revenue and includes only the profit and loss effects relevant to the VaR model, excluding fees, commissions, certain provisions and any trading subsequent to the previous night’s positions. It is appropriate to compare this measure with VaR for back-testing purposes because VaR assesses only the potential change in position value due to overnight movements in financial market variables such as prices, interest rates and volatilities. The graph below illustrates the relationship between daily back-testing profit and loss and daily VaR for us in 2005.

VAR is a model that predicts the future risk based on historical data. We could incur losses greater than the reported VAR because the historical market prices and rates changes may not be an accurate measure of future market events and conditions. In addition, the VAR model measures the risk of a current static position over a 1 day horizon and might not predict the future position. When comparing our value-at-risk numbers to those of other firms, it is important to remember that different methodologies could produce significantly different results.

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Daily Trading Net Revenue
($ in millions)

Trading revenue used in the histogram below titled “2004 vs 2005 Distribution of Daily Trading Revenue” is the actual daily trading revenue, which includes not only back-testing profit and loss but also fees, commissions, certain provisions and the profit and loss effects associated with any trading subsequent to the previous night’s positions. The histogram below shows the distribution of daily trading revenue for substantially all of our trading activities.

Maturity Data

At December 31, 2005, we had $775.0 million aggregate principal amount of senior notes outstanding, with fixed interest rates. We entered into a fair value hedge with no ineffectiveness using interest rate swaps in order to convert $200.0 million aggregate principal amount of unsecured 73/4% senior notes due March 15, 2012 into floating rates based upon LIBOR. The effective interest rate on the $200.0 million aggregate principal amount of unsecured 73/4% senior notes, after giving effect to the swaps, is 6.65%. The fair value of the mark to market of the swaps was positive $12.2 million as of December 31, 2005, which was recorded as an increase in the book value of the debt and an increase in other assets.

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

	Expected Maturity Date
	2006			2007			2008			2009			2010			After 2010		Total			Fair Value
	(Dollars in Thousands)
Interest rate sensitivity
7.75% Senior Notes		—			—			—			—			—		$	325,000	$	325,000		$	360,750
7.5% Senior Notes		—		$	100,000			—			—			—			—	$	100,000		$	103,750
5.5% Senior Notes		—			—			—			—			—		$	350,000	$	350,000		$	353,500
Interest rate swaps		—			—			—			—			—		$	200,000	$	200,000		$	12,164
Exchange rate sensitivity
Foreign exchange forwards, net	$	(12,391	)		—			—			—			—			—	$	(12,391	)	$	(23	)
Price sensitivity
Futures contracts, net purchases	$	(3,402,809	)	$	(10,478	)	$	(10,474	)	$	(92,740	)	$	(1,900	)		—	$	(3,518,401	)	$	(93,287	)
Commodities related swaps, net sales	$	3,151,280			—			—			—			5,000			—	$	3,156,280		$	655,000
Option contracts, net purchases	$	40,509		$	24,000		$	62,655		$	43,000		$	23,500		$	17,139	$	210,803		$	(14,970	)

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Item 8.   Financial Statements and Supplementary Data.

INDEX TO FINANCIAL STATEMENTS

	Page
Management’s Report on Internal Control over Financial Reporting		38
Report of Independent Registered Public Accounting Firm		39
Report of Independent Registered Public Accounting Firm		40
Consolidated Statements of Financial Condition as of December 31, 2005 and 2004		41
Consolidated Statements of Earnings for Each of the Years in the Three-Year Period Ended December 31, 2005		42
Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income for Each of the Years in the Three-Year Period Ended December 31, 2005		43
Consolidated Statements of Cash Flows for Each of the Years in the Three-Year Period Ended December 31, 2005		44
Notes to Consolidated Financial Statements		46

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Management’s Report on Internal Control over Financial Reporting

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

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

Management evaluated the Company’s internal control over financial reporting as of December 31, 2005. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control — Integrated Framework. As a result of this assessment and based on the criteria in this framework, management has concluded that, as of December 31, 2005, the Company’s internal control over financial reporting was effective.

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

38

Report of Independent Registered Public Accounting Firm

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

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that Jefferies Group, Inc. and subsidiaries maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Jefferies Group, Inc. management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

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

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

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

In our opinion, management’s assessment that Jefferies Group, Inc. and subsidiaries maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Jefferies Group, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statements of financial condition of Jefferies Group, Inc. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of earnings, changes in stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2005, and our report dated February 28, 2006 expressed an unqualified opinion on those consolidated financial statements.

/s/  KPMG LLP

New York, New York

February 28, 2006

39

Report of Independent Registered Public Accounting Firm

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

We have audited the accompanying consolidated statements of financial condition of Jefferies Group, Inc. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of earnings, changes in stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2005. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Jefferies Group, Inc. and subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Jefferies Group, Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 28, 2006 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.

/s/  KPMG LLP

New York, New York

February 28, 2006

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JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Consolidated Statements of Financial Condition

December 31, 2005 and 2004

	2005			2004
	(Dollars in thousands,
	except per share amounts)
Assets
Cash and cash equivalents	$	255,933		$	284,111
Cash and securities segregated and on deposit for regulatory purposes or deposited with clearing and depository organizations		629,360			553,720
Short term bond funds		7,037			6,861
Investments		107,684			97,586
Investments in managed funds		278,116			195,982
Securities borrowed		8,143,478			10,232,950
Receivable from brokers, dealers and clearing organizations		389,994			312,973
Receivable from customers		457,839			371,842
Securities owned		1,612,782			649,299
Securities pledged to creditors		178,686			597,434
Premises and equipment		69,821			57,749
Goodwill		220,607			134,936
Other assets		429,594			329,185
Total Assets	$	12,780,931		$	13,824,628
Liabilities and Stockholders’ Equity
Bank loans	$	—		$	70,000
Securities loaned		7,729,544			9,330,980
Payable to brokers, dealers and clearing organizations		303,480			376,735
Payable to customers		813,896			702,200
Securities sold, not yet purchased		1,260,565			1,120,173
Accrued expenses and other liabilities		570,229			361,254
		10,677,714			11,961,342
Long-term debt		779,873			789,067
Minority interest		36,494			35,086
Total Liabilities		11,494,081			12,785,495
Stockholders’ equity:
Preferred stock, $.0001 par value. Authorized 10,000,000 shares; none issued		—			—
Common stock, $.0001 par value. Authorized 100,000,000 shares; issued 70,428,997 shares in 2005 and 66,700,773 shares in 2004		7			7
Additional paid-in capital		934,541			617,587
Unearned stock-based compensation		(225,094	)		(109,366	)
Retained earnings		803,262			677,464
Less:
Treasury stock, at cost; 12,318,605 shares in 2005 and 9,411,464 shares in 2004		(220,703	)		(149,039	)
Accumulated other comprehensive income (loss):
Currency translation adjustments		962			9,348
Additional minimum pension liability adjustment		(6,125	)		(6,868	)
Total accumulated other comprehensive income (loss)		(5,163	)		2,480
Total stockholders’ equity		1,286,850			1,039,133
Total liabilities and stockholders’ equity	$	12,780,931		$	13,824,628

See accompanying notes to consolidated financial statements.

41

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Consolidated Statements of Earnings

For each of the years in the three-year period ended December 31, 2005

	2005		2004		2003
	(In thousands, except per share amounts)
Revenues:
Commissions	$	246,943	$	258,838	$	250,191
Principal transactions		349,489		358,213		301,299
Investment banking		495,014		352,804		229,608
Asset management fees and investment income from managed funds		82,052		81,184		32,769
Interest		304,053		134,450		102,403
Other		20,322		13,150		10,446
Total revenues		1,497,873		1,198,639		926,716
Interest expense		293,173		140,394		97,102
Revenues, net of interest expense		1,204,700		1,058,245		829,614
Non-interest expenses:
Compensation and benefits		669,957		595,887		474,709
Floor brokerage and clearing fees		46,644		52,922		48,217
Technology and communications		67,666		64,555		58,581
Occupancy and equipment rental		47,040		39,553		32,534
Business development		42,512		35,006		26,481
Other		62,474		43,333		44,559
Total non-interest expenses		936,293		831,256		685,081
Earnings before income taxes and minority interest		268,407		226,989		144,533
Income taxes		104,089		83,955		52,851
Earnings before minority interest		164,318		143,034		91,682
Minority interest		6,875		11,668		7,631
Net earnings	$	157,443	$	131,366	$	84,051
Earnings per share:
Basic	$	2.55	$	2.29	$	1.58
Diluted	$	2.32	$	2.06	$	1.42
Weighted average shares of common stock:
Basic		61,823		57,453		53,090
Diluted		67,784		63,908		59,266

See accompanying notes to consolidated financial statements.

42

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income

For each of the years in the three-year period ended December 31, 2005

	Year Ended December 31,
	2005			2004			2003
	(Dollars in thousands, except per share amounts)
Common stock, par value $0.0001 per share
Balance, beginning of year		7			6			3
Issued/stock dividend		—			1			3
Balance, end of year		7			7			6
Additional paid in capital
Balance, beginning of year		617,587			443,022			272,020
Stock-based grants(1)		256,375			148,567			161,109
Proceeds from exercise of stock options		33,661			10,184			5,913
Tax benefits		26,918			15,814			3,980
Balance, end of year		934,541			617,587			443,022
Unearned stock-based compensation
Balance, beginning of year		(109,366	)		(78,248	)		(45,233	)
Restricted stock and RSU grants		(221,330	)		(106,670	)		(87,263	)
Restricted stock and RSU amortization expense		79,762			54,935			43,504
Previously expensed compensation		20,455			13,904			8,577
Restricted stock and RSU forfeitures		5,385			6,713			2,167
Balance, end of year		(225,094	)		(109,366	)		(78,248	)
Retained earnings
Balance, beginning of year		677,464			567,632			496,418
Net earnings		157,443			131,366			84,051
Dividends		(31,645	)		(21,534	)		(12,837	)
Balance, end of year		803,262			677,464			567,632
Treasury stock, at cost
Balance, beginning of year		(149,039	)		(91,908	)		(90,817	)
Purchases		(76,291	)		(59,492	)		(6,563	)
Returns/forfeitures		(6,717	)		(8,525	)		(10,361	)
Issued		11,344			10,886			15,833
Balance, end of year		(220,703	)		(149,039	)		(91,908	)
Accumulated other comprehensive income (loss)
Balance, beginning of year		2,480			(2,133	)		(3,874	)
Currency adjustment, net of tax		(8,386	)		4,017			3,436
Pension adjustment, net of tax		743			596			(1,695	)
Balance, end of year		(5,163	)		2,480			(2,133	)
Total Stockholders’ Equity		1,286,850			1,039,133			838,371
Comprehensive Income
Net earnings		157,443			131,366			84,051
Other comprehensive income (loss), net of tax		(7,643	)		4,613			1,741
Total Comprehensive Income		149,800			135,979			85,792

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

See accompanying notes to consolidated financial statements.

43

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Consolidated Statements of Cash Flows

Three years ended December 31, 2005

	2005			2004			2003
	(Dollars in thousands)
Cash flows from operating activities:
Net earnings	$	157,443		$	131,366		$	84,051
Adjustments to reconcile net earnings to net cash provided by (used in) operating activities:
Depreciation and amortization		15,556			14,544			15,519
Accruals related to various benefit plans, stock issuances, net of forfeitures		118,276			117,720			73,989
Deferred income taxes		(23,475	)		(31,532	)		(17,570	)
(Increase) decrease in cash and securities segregated		(75,640	)		(371,079	)		106,395
(Increase) decrease in receivables:
Securities borrowed		2,089,418			(1,864,593	)		(3,249,005	)
Brokers, dealers and clearing organizations		(92,263	)		(20,370	)		(187,936	)
Customers		(105,113	)		(88,251	)		(73,803	)
(Increase) decrease in securities owned		(964,112	)		(298,150	)		101,226
Decrease (increase) in securities pledged to creditors		418,748			(39,707	)		(501,379	)
Increase in other assets		(71,318	)		(68,114	)		(68,173	)
Increase (decrease) in payables:
Securities loaned		(1,601,436	)		1,244,397			3,381,255
Brokers, dealers and clearing organizations		(58,856	)		263,386			(89	)
Customers		127,959			211,503			9,351
Increase in securities sold, not yet purchased		140,392			446,951			433,345
Increase in accrued expenses and other liabilities		213,102			89,710			90,964
Increase (decrease) in minority interest		1,408			(14,834	)		23,538
Net cash used in (provided by) operating activities		290,089			(277,053	)		221,678
Cash flows from investing activities:
(Increase) decrease in short term bond funds		(176	)		208,929			(23,130	)
(Increase) decrease in investments		(9,277	)		(11,623	)		3,835
Increase in investments in managed funds		(82,134	)		(68,796	)		(75,003	)
Purchase of premises and equipment		(27,186	)		(17,012	)		(15,850	)
Acquisitions		(53,030	)		(8,894	)		(26,879	)
Net cash flows (used in) provided by investing activities		(171,803	)		102,604			(137,027	)
Cash flows from financing activities:
Net proceeds from (payments on) bank loans		(70,000	)		70,000			(12,000	)
Issuance of long term debt		—			347,809			—
Retirement of long term debt		—			(300	)		(1,000	)
Payments on:
Repurchase of treasury stock		(76,291	)		(59,492	)		(6,563	)
Dividends paid		(31,645	)		(21,534	)		(11,807	)
Proceeds from exercise of stock options		33,661			10,184			5,913
Common shares		—			—			5,027
Net cash (used in) provided by financing activities		(144,275	)		346,667			(20,430	)
Effect of currency translation on cash		(2,189	)		4,017			3,707
Net (decrease) increase in cash and cash equivalents		(28,178	)		176,235			67,928
Cash and cash equivalents at beginning of year		284,111			107,876			39,948
Cash and cash equivalents at end of year	$	255,933		$	284,111		$	107,876

44

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Consolidated Statements of Cash Flows — (Continued)

Three years ended December 31, 2005

	2005			2004			2003
	(Dollars in thousands)
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest	$	283,318		$	121,444		$	93,592
Income taxes		87,013			91,954			55,436
Randall & Dewey acquisition:
Fair value of assets acquired, including goodwill	$	53,503
Liabilities assumed		(8,769	)
Stock issued (456,442 shares)		(17,500	)
Cash paid for acquisition		27,234
Cash acquired in acquisition		1,435
Net cash paid for acquisition	$	25,799
Helix acquisition:
Fair value of assets acquired, including goodwill	$	41,615
Liabilities assumed		(5,085	)
Stock issued (315,597 shares)		(9,498	)
Cash paid for acquisition		27,032
Cash acquired in acquisition		—
Net cash paid for acquisition	$	27,032
Bonds Direct acquisition:
Fair value of assets acquired, including goodwill				$	20,643
Liabilities assumed					(863	)
Stock issued (311,842 shares)					(10,886	)
Cash paid for acquisition					8,894
Cash acquired in acquisition					11
Net cash paid for acquisition				$	8,883
Broadview acquisition:
Fair value of assets acquired, including goodwill							$	58,904
Liabilities assumed								(22,495	)
Stock issued (557,711 shares)								(15,833	)
Cash paid for acquisition								20,576
Cash acquired in acquisition								7,090
Net cash paid for acquisition							$	13,486

Supplemental disclosure of non-cash financing activities:

In 2003, the additional minimum pension liability included in stockholders’ equity of $7,464 resulted from an increase of $1,695 to accrued expenses and other liabilities and an offsetting decrease in stockholders’ equity.

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

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

See accompanying notes to consolidated financial statements.

45

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements
December 31, 2005 and 2004

Index

Note			Page
	(1)	Organization and Summary of Significant Accounting Policies		47
	(2)	Asset Management Fees and Investment Income From Managed Funds		55
	(3)	Cash, Cash Equivalents, and Short-Term Investments		57
	(4)	Receivable from, and Payable to, Customers		58
	(5)	Securities Owned, Securities Pledged to Creditors and Securities Sold, Not Yet Purchased		59
	(6)	Premises and Equipment		59
	(7)	Bank Loans		60
	(8)	Long-Term Debt		60
	(9)	Income Taxes		60
	(10)	Benefit Plans		62
	(11)	Minority Interest		68
	(12)	Earnings Per Share		68
	(13)	Leases		69
	(14)	Derivative Financial Instruments		69
	(15)	Other Comprehensive Gain (Loss)		72
	(16)	Net Capital Requirements		73
	(17)	Commitments and Guarantees		74
	(18)	Segment Reporting		75
	(19)	Goodwill		76
	(20)	Variable Interest Entities (“VIEs”)		77
	(21)	Related Party Disclosures		77
	(22)	Subsequent Events (Unaudited)		78
	(23)	Selected Quarterly Financial Data (Unaudited)		79

46

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

(1)   Organization and Summary of Significant Accounting Policies

Organization

The accompanying consolidated financial statements include the accounts of Jefferies Group, Inc. and all its subsidiaries (together, the “Company”), including Jefferies & Company, Inc. (“Jefferies”), Jefferies Execution Services, Inc. (“Jefferies Execution”), Jefferies International Limited, Jefferies Asset Management, LLC, Jefferies Financial Products, LLC (“JFP”) and all other entities in which the Company has a controlling financial interest or is the “primary beneficiary”, including Jefferies Employees Opportunity Fund, LLC (“JEOF”). The Company and its subsidiaries operate and are managed as a single business segment, that of an institutional securities broker-dealer, which includes several types of financial services, such as principal and agency transactions in equity, high yield, convertible and international securities, as well as investment banking and fundamental research. Since the Company’s services are provided using the same distribution channels, support services and facilities and all are provided to meet client needs, the Company does not identify assets or allocate all expenses to any service, or class of service as a separate business segment.

Summary of Significant Accounting Policies

Principles of Consolidation

The Company’s policy is to consolidate all entities in which it owns more than 50% of the outstanding voting stock and has control. In addition, in accordance with Financial Accounting Standards Board (“FASB”) Interpretation No. 46R, “Consolidation of Variable Interest Entities” (“FIN 46R”), as revised, the Company consolidates entities which lack characteristics of an operating entity or business for which it is the primary beneficiary. Under FIN 46R, the primary beneficiary is the party that absorbs a majority of the entity’s expected losses, receives a majority of its expected residual returns, or both, as a result of holding variable interests. In situations where the Company has significant influence but not control of an entity that does not qualify as a variable interest entity, the Company applies the equity method of accounting. In those cases where the Company’s investment is less than 20% and significant influence does not exist, the investments are carried at fair value. Significant influence generally is deemed to exist when we own 20% to 50% of the voting equity of a corporation, or when we hold at least 3% of a limited partnership interest. If the Company does not consolidate an entity or apply the equity method of accounting, the Company accounts for its investment at fair value. The Company also has formed nonconsolidated investment vehicles with third-party investors that are typically organized as limited partnerships and accounted for under the equity method of accounting. The Company acts as general partner for these investment vehicles and has generally provided the third-party investors with termination or “kick-out” rights as defined by EITF 04-5.

All significant intercompany accounts and transactions are eliminated in consolidation.

Change in Quarter End

Beginning with the quarter ended September 30, 2004, the Company changed its quarter end to the last day of the calendar quarter from the last Friday of the quarter. With the expansion of our businesses and products, the Company believes calendar period reporting is more consistent with its operating cycle, as well as the reporting periods of industry peers.

Revenue Recognition Policies

Commissions.  All customer securities transactions are reported on the consolidated statement of financial condition on a settlement date basis with related income reported on a trade-date basis. Under clearing agreements, the Company clears trades for unaffiliated correspondent brokers and retains a portion of commissions as a fee for its services. Correspondent clearing revenues are included in other revenue. We permit institutional customers to

47

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

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 $37.7 million, $42.5 million, and $46.2 million for the period ended 2005, 2004 and 2003, respectively. We are accounting for the cost of these arrangements on an accrual basis. Our accounting for commission revenues includes the guidance contained in Emerging Issues Task Force (“EITF”) Issue No. 99-19, “Reporting Revenues Gross versus Net”, because we are not the primary obligor of such arrangements, and accordingly, expenses relating to soft dollars are netted against the commission revenues.

Principal Transactions.  Securities and other inventory positions owned, securities and other inventory positions pledged and securities and other inventory positions sold, but not yet purchased (all of which are recorded on a trade-date basis) are valued at market or fair value, as appropriate, with unrealized gains and losses reflected in principal transactions in the Consolidated Statement of Earnings on a trade date basis. Market value generally is determined based on listed prices or broker quotes. In certain instances, such price quotations may be deemed unreliable when the instruments are thinly traded or when we hold a substantial block of a particular security and the listed price is not deemed to be readily realizable. In these instances the Company determines fair value based on management’s best estimate, giving appropriate consideration to reported prices and the extent of public trading in similar securities, the discount from the listed price associated with the cost at the date of acquisition, and the size of the position held in relation to the liquidity in the market, among other factors. When the size of our holding of a listed security is likely to impair our ability to realize the quoted market price, the Company records the position at a discount to the quoted price reflecting our best estimate of fair value. In such instances, the Company generally determines fair value with reference to the discount associated with the acquisition price of the security. When listed prices or broker quotes are not available, the Company determines fair value based on pricing models or other valuation techniques, including the use of implied pricing from similar instruments. The Company typically uses pricing models to derive fair value based on the net present value of estimated future cash flows including adjustments, when appropriate, for liquidity, credit and/or other factors.

Investment Banking.  Underwriting revenues and fees from mergers and acquisitions, restructuring and other investment banking advisory assignments are recorded when the services related to the underlying transaction are completed under the terms of the assignment or engagement. Expenses associated with such transactions are deferred until reimbursed by the client, the related revenue is recognized or the engagement is otherwise concluded. Expenses are recorded net of client reimbursements. Revenues are presented net of related unreimbursed expenses. Unreimbursed expenses with no related revenues are expensed. Reimbursed expenses totaled approximately $16.3 million, $11.6 million and $9.0 million for the years ended 2005, 2004 and 2003, respectively.

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

48

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

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

Cash Equivalents

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

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

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

Foreign Currency Translation

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

Investments

Investments include direct investments in limited liability companies and partnerships that make investments in private equity companies, strategic investments in financial service entities and other investments. In situations where the Company has significant influence but not control, the Company applies the equity method of accounting. In those cases where the Company’s investment is less than 20% and significant influence does not exist, the investments are carried at fair value. Significant influence generally is deemed to exist when we own 20% to 50% of the voting equity of a corporation or when we hold at least 3% of a limited partnership interest. Factors considered in valuing investments where significant influence does not exist include, without limitation, available market prices, reported net asset values, type of security, purchase price, purchases of the same or similar securities by other investors, marketability, restrictions on disposition, current financial position and operating results of the issuer, and other pertinent information. Investment gains/losses are included in Principal transactions on the Consolidated Statements of Earnings.

Investments in Managed Funds

Investments in managed funds includes the Company’s investments in funds managed by the Company and the Company’s investments in third-party managed funds in which the Company is entitled to a portion of the management and/or performance fees. Investments in managed funds are carried at fair value.

49

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

Receivable from, and Payable to, Customers

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

Fair Value of Financial Instruments

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

In addition to the interest rate swaps mentioned above, the Company has derivative financial instrument positions in exchange traded and over-the-counter option contracts, foreign exchange forward contracts, index futures contracts, commodities swap and option contracts and commodities futures contracts, which are measured at fair value with gains and losses recognized in earnings. The gross contracted or notional amount of these contracts is not reflected in the consolidated statements of financial condition.

The Company follows Emerging issues Task Force (“EITF”) Statement No. 02-3, “Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities.” This guidance generally eliminates the practice of recognizing profit at the inception of a derivative contract unless the fair value of the derivative is obtained from a quoted market price in an active market or is otherwise evidenced by comparison to other observable current market transactions or based on a valuation technique that incorporates observable market data.

Securities Borrowed and Securities Loaned

In connection with both trading and brokerage activities, the Company borrows securities to cover short sales and to complete transactions in which customers have failed to deliver securities by the required settlement date, and lends securities to other brokers and dealers for similar purposes. The Company has an active securities borrowed and lending matched book business (“Matched Book”), in which the Company borrows securities from one party and lends them to another party. When the Company borrows securities, the Company provides cash to the lender as collateral, which is reflected in the Company’s Consolidated Statement of Financial Condition as securities borrowed. The Company earns interest revenues on this cash collateral. Similarly, when the Company lends securities to another party, that party provides cash to the Company as collateral, which is reflected in the Company’s Consolidated Statement of Financial Condition as securities loaned. The Company pays interest expense on the cash collateral received from the party borrowing the securities. A substantial portion of the Company’s interest revenues and interest expenses results from the Matched Book activity. The initial collateral advanced or received approximates or is greater than, the fair value of the securities borrowed or loaned. The

50

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

Company monitors the fair value of the securities borrowed and loaned on a daily basis and requests additional collateral or returns excess collateral, as appropriate.

Premises and Equipment

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

Goodwill

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

Income Taxes

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

Legal Reserves

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

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

Stock-Based Compensation

On January 1, 2003, the Company adopted, on a prospective basis, the fair value method of accounting for stock-based compensation under FASB No. 123, “Accounting for Stock-Based Compensation” as amended by

51

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

FASB No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure — an amendment of FASB Statement No. 123”. Therefore, employee stock options granted on and after January 1, 2003 are expensed by the Company over the option vesting period, based on the estimated fair value of the award on the date of grant. There were no stock option grants in 2005. Additionally, in 2005 the Company recorded compensation expense of $1.8 million related to the Company’s Employee Stock Purchase Plan, based on a discount from market.

There were two significant series of grants of restricted stock and restricted stock units during 2005. The first series of grants occurred in the first quarter of 2005 and mostly related to 2004 employee compensation totaling 2,514,502 shares and $91.5 million. The second series of grants occurred in fourth quarter of 2005 and related to 2005 employee compensation totaling 3,054,745 shares and $116.0 million. In the absence of a defined service period, FASB No. 123 presumptively defines the service period (over which compensation costs should be recognized) as the vesting period, which includes the year of grant and the subsequent vesting periods. With the adoption of FASB 123R, the Company’s policy regarding the timing of expense recognition for all employees will change to recognize compensation cost over the period from the grant date through the date the employee is no longer required to provide service to earn the award.

FASB No. 123 (revised 2004), “Share-Based Payment” (“FASB 123R”), also clarifies the timing for recognizing compensation expense for awards subject to acceleration of vesting on retirement. This compensation expense must be recognized over the period from the date of grant to the date retirement eligibility is met if it is shorter than the vesting term. Upon adoption of FASB 123R, in the first quarter of 2006, the Company’s policy regarding the timing of expense recognition for employees eligible for retirement will change to recognize compensation cost over the period from the grant date through the date that the employee first becomes eligible to retire and is no longer required to provide service to earn the award. During 2005, the Company’s policy was to recognize these compensation costs over the vesting term. The adoption of FASB No. 123R on January 1, 2006 did not have a material impact on the Company’s consolidated financial statements.

In 2002 and prior years, the Company measured the cost of its stock-based compensation plans using the intrinsic value approach under Accounting Principles Board (“APB”) Opinion No. 25 rather than applying the fair value method provisions of FASB No. 123. Accordingly, the Company has not recognized compensation expense related to stock options granted prior to January 1, 2003 and shares issued to participants in the Company’s employee stock purchase plan prior to January 1, 2003. Therefore, the cost of $82.9 million and $82.0 million related to stock-based compensation included in the determination of net income for 2005 and 2004, respectively, is less than that which would have been recognized if the fair value based method had been applied to all awards since the original effective date of FASB No. 123.

52

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

Had compensation cost for the Company’s stock-based compensation plans been determined consistent with FASB No. 123, the Company’s net earnings and earnings per share would have been reduced to the pro forma amounts indicated below (in thousands of dollars, except per share amounts):

	2005			2004			2003
Net earnings, as reported	$	157,443		$	131,366		$	84,051
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects		51,144			50,575			39,959
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(51,927	)		(53,260	)		(44,911	)
Pro forma net earnings	$	156,660		$	128,681		$	79,099
Earnings per share:
Basic — as reported	$	2.55		$	2.29		$	1.58
Basic — pro forma	$	2.53		$	2.24		$	1.49
Diluted — as reported	$	2.32		$	2.06		$	1.42
Diluted — pro forma	$	2.31		$	2.01		$	1.33

Earnings per Common Share

Basic earnings per share of common stock are computed by dividing net earnings by the average number of shares outstanding and certain other shares committed to be, but not yet issued. Diluted earnings per share of common stock are computed by dividing net earnings by the average number of shares outstanding of common stock and all dilutive common stock equivalents outstanding during the period.

Effects of Recently Issued Accounting Standards

In December 2004, the FASB issued a revision to FASB No. 123, FASB No. 123R, “Share-Based Payments.” FASB No. 123R establishes standards for accounting for transactions in which an entity exchanges its equity instruments for goods and services. FASB No. 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. On April 14, 2005, the U.S. Securities and Exchange Commission announced new rules that require companies to implement FASB No. 123R by the start of their fiscal year beginning after June 15, 2005. Among other requirements, FASB No. 123R generally requires the immediate expensing of equity-based awards granted to retirement-eligible employees. The Company adopted FASB No. 123R, as required, on January 1, 2006, using the modified prospective method. Upon adoption of FASB No. 123R on January 1, 2005, we will recognize an after-tax gain of approximately $1.6 million as the cumulative effect of a change in accounting principle, primarily attributable to the requirement to estimate forfeitures at the date of grant instead of recognizing them as incurred. We do not expect the adoption of FASB 123R to otherwise have a material effect on our consolidated financial statements.

FASB No. 123R generally requires equity-based awards granted to retirement-eligible employees to be expensed immediately. For stock-based awards granted prior to our adoption of FASB No. 123R, compensation cost for retirement eligible employees, is recognized over the service period specified in the award. We accelerate the recognition of compensation cost if and when a retirement-eligible employee leaves the Company.

53

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

The following table sets forth the pro forma net earnings that would have been reported for the years ended December 31, 2005, 2004 and 2003 if equity-based awards granted to retirement-eligible employees had been expensed immediately as required by FASB No. 123R:

	2005			2004			2003
Net earnings, as reported	$	157,443		$	131,366		$	84,051
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects		51,144			50,575			39,959
Deduct: Stock-based employee compensation expense, net of related tax effect, determined under FASB No. 123R		(76,143	)		(59,184	)		(40,030	)
Pro forma net earnings	$	132,444		$	122,757		$	83,980

In June 2005, the FASB issued FASB No. 154, “Accounting Changes and Error Corrections — a replacement of APB Opinion No. 20 and FASB Statement No. 3,” (“FASB No. 154”). FASB No. 154 changes the requirements for the accounting for and reporting of a change in accounting principle. FASB No. 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005. The Company does not expect the adoption of FASB No. 154 to have a material impact on the Company’s consolidated financial statements.

In June 2005, the FASB ratified the consensus reached by the Emerging Issues Task Force on Issue 04-5, “Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights,” (“EITF 04-5”). EITF 04-5 presumes that a general partner controls a limited partnership, and should therefore consolidate a limited partnership, unless the limited partners have the substantive ability to remove the general partner without cause based on a simple majority vote or can otherwise dissolve the limited partnership, or unless the limited partners have substantive participating rights over decision making. This guidance became effective upon ratification by the FASB on June 29, 2005 for all newly formed limited partnerships and for existing limited partnerships for which the partnership agreements have been modified. For all other limited partnerships, the guidance is effective no later than the beginning of the first reporting period in fiscal years beginning after December 15, 2005. Management is currently evaluating the effect of adoption of EITF 04-5 on the Company’s consolidated financial condition, results of operations and cash flows.

Reclassifications

Certain reclassifications have been made to the prior years’ amounts to conform to the current year’s presentation.

Use of Estimates

Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ from those estimates.

54

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

(2)   Asset Management Fees and Investment Income From Managed Funds

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

	December 31,		December 31,
	2005		2004
Assets under management:
Fixed Income(1)	$	1,042	$	602
Equities(2)		505		464
Convertibles(3)		1,656		1,380
Real Assets(4)		140		190
		3,343		2,636
Assets under management by third parties(5):
Equities, Convertibles and Fixed Income		278		652
Private Equity		639		482
		917		1,134
Total	$	4,260	$	3,770

(1)	The Company’s managed or co-managed assets under management in two Jefferies Partners Opportunity funds, Jefferies Employees Opportunity Fund, LLC, the Jackson Creek CDO, the Summit Lake CLO and the Victoria Falls CLO, but does not include third-party managed funds. The Company completed the liquidation of the Jackson Creek CDO during the second quarter of 2005. Although the Jefferies Partners Opportunity funds and the Jefferies Employees Opportunity Fund, LLC are often referred to as funds, they are registered with the Securities and Exchange Commission as broker-dealers.
(2)	The Jefferies RTS Fund and Jefferies Paragon Fund.
(3)	Managed convertible bond assets.
(4)	The Jefferies Real Asset Fund.
(5)	Third party managed funds in which the Company has a 50% or less interest in the entities that manage these assets or otherwise receives a portion of the management or incentive fees. The Company began to manage the assets of the Asymmetric Convertible Fund beginning October of 2005.

55

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

The following summarizes revenues from asset management fees and investment income from managed funds relating to funds managed by the Company and funds managed by third parties for the years ended December 31, 2005, 2004 and 2003 (in thousands of dollars):

	2005		2004		2003
Asset management fees:
Fixed Income(1)	$	19,556	$	10,999	$	9,438
Equities(2)		15,415		14,494		7,665
Convertibles(3)		7,516		9,124		165
Real Assets(4)		8,456		3,591		—
		50,943		38,208		17,268
Investment income from managed funds		31,109		42,976		15,501
Total	$	82,052	$	81,184	$	32,769

(1)	The Company’s managed or co-managed assets under management in two Jefferies Partners Opportunity funds, Jefferies Employees Opportunity Fund, LLC, the Jackson Creek CDO, the Summit Lake CLO and the Victoria Falls CLO and certain third-party managed funds. The Company completed the liquidation of the Jackson Creek CDO during the second quarter of 2005. Although the Jefferies Partners Opportunity funds and the Jefferies Employees Opportunity Fund, LLC are often referred to as funds, they are registered with the Securities and Exchange Commission as broker-dealers.
(2)	The Jefferies RTS Fund and Jefferies Paragon Fund.
(3)	Convertible bond assets managed by the Company, and Asymmetric Convertible Fund, a third party managed fund. The Company began to manage the assets of the Asymmetric Convertible Fund beginning October of 2005.
(4)	The Jefferies Real Asset Fund.

The following tables detail the Company’s average investment in managed funds, investment income from managed funds, investment income from managed funds — minority interest portion and net investment income from managed funds relating to funds managed by the Company and funds managed by third parties for the years ended December 31, 2005 and 2004 (in millions of dollars):

     Year Ended December 31, 2005

					Investment		Net
			Investment		Income from		Investment
			Income from		Managed Funds —		Income from
	Average		Managed		Minority Interest		Managed
	Investment(5)		Funds(5)		Portion		Funds
Fixed Income(1)	$	139.3	$	18.9	$	7.2	$	11.7
Equities(2)		63.2		10.1		0.3		9.8
Convertibles(3)		11.2		0.7		—		0.7
Real Assets(4)		10.4		1.4		—		1.4
Total	$	224.1	$	31.1	$	7.5	$	23.6

56

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

     Year Ended December 31, 2004

						Investment		Net
			Investment			Income from		Investment
			Income from			Managed Funds —		Income from
	Average		Managed			Minority Interest		Managed
	Investment(5)		Funds(5)			Portion		Funds
Fixed Income(1)	$	105.2	$	29.1		$	5.4	$	23.7
Equities(2)		36.8		14.1			4.6		9.5
Convertibles(3)		12.0		(0.7	)		—		(0.7	)
Real Assets(4)		9.3		0.5			—		0.5
Total	$	163.3	$	43.0		$	10.0	$	33.0

(1)	The Company’s managed or co-managed assets under management in two Jefferies Partners Opportunity funds, Jefferies Employees Opportunity Fund, LLC, the Jackson Creek CDO and certain third-party managed funds. Although the Jefferies Partners Opportunity funds and the Jefferies Employees Opportunity Fund, LLC are often referred to as funds, they are registered with the Securities and Exchange Commission as broker-dealers.
(2)	The Jefferies RTS Fund and Jefferies Paragon Fund.
(3)	Convertible bond assets managed by the Company, and Asymmetric Convertible Fund, a third party managed fund. The Company began to manage the assets of the Asymmetric Convertible Fund beginning October of 2005.
(4)	The Jefferies Real Asset Fund.
(5)	The Company has excluded the portion of average investment in managed funds that represent an economic hedge against certain employee deferred compensation obligations and the associated investment income.

Included in investments in managed funds as of December 31, 2005 and 2004 is $68,169,000 and $52,585,000, respectively, relating to the Company’s interest in the unconsolidated high yield funds that the Company manages. Included in investment income from managed funds for the years ended December 31, 2005, 2004 and 2003 is $10,547,000, $8,566,000 and $7,049,000, respectively, relating to the associated income from the Company’s interest in those high yield funds.

(3)   Cash, Cash Equivalents, and Short-Term Investments

The Company generally invests its excess cash in money market funds and other short-term investments. Cash equivalents are part of the cash management activities of the Company and have original maturities of 90 days or less.

57

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

The following are financial instruments that are cash and cash equivalents or are deemed by management to be generally readily convertible into cash, marginable, or accessible for liquidity purposes within a relatively short period of time as of December 31, 2005 and 2004 (in thousands of dollars):

	December 31,		December 31,
	2005		2004
Cash and cash equivalents:
Cash in banks	$	85,191	$	105,814
Money market investments		170,742		178,297
Total cash and cash equivalents		255,933		284,111
Cash and securities segregated(1)		629,360		553,720
Short-term bond funds		7,037		6,861
Auction rate preferreds(2)		28,756		50,365
Mortgage-backed securities(2)		13,458		27,511
Asset-backed securities(2)		33,159		21,093
	$	967,703	$	943,661

(1)	In accordance with Rule 15c3-3 of the Securities Exchange Act of 1934, Jefferies, as a broker-dealer carrying client accounts, is subject to requirements related to maintaining cash or qualified securities in a segregated reserve account for the exclusive benefit of its clients. In addition, deposits with clearing and depository organizations are included in this caption.
(2)	Items are included in securities owned or securities pledged to creditors (see note 5 of Notes to Consolidated Financial Statements). Items are financial instruments utilized in the Company’s overall cash management activities and are readily convertible to cash, marginable or accessible for liquidity purposes.

(4)   Receivable from, and Payable to, Customers

The following is a summary of the major categories of receivables from customers as of December 31, 2005 and 2004 (in thousands of dollars):

	2005		2004
Customers (net of allowance for uncollectible accounts of $620 in 2005 and $294 in 2004)	$	449,916	$	356,045
Officers and directors		7,923		15,797
	$	457,839	$	371,842

Receivable from officers and directors represents standard margin loan balances arising from their individual security transactions. These transactions are subject to the same regulations as customer transactions.

Interest is paid on free credit balances in accounts of customers who have indicated that the funds will be used for investment at a future date. The rate of interest paid on free credit balances varies between the thirteen-week treasury bill rate and 1% below that rate, depending upon the size of the customers’ free credit balances.

58

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

(5)   Securities Owned, Securities Pledged to Creditors and Securities Sold, Not Yet Purchased

The following is a summary of the market value of major categories of securities owned and securities sold, not yet purchased, as of December 31, 2005 and 2004 (in thousands of dollars):

	2005				2004
			Securities				Securities
			Sold,				Sold,
	Securities		Not Yet		Securities		Not Yet
	Owned		Purchased		Owned		Purchased
Corporate equity securities	$	291,724	$	224,235	$	217,478	$	503,536
High yield securities		107,560		34,853		92,364		20,340
Corporate debt securities		756,931		589,967		189,684		480,882
U.S. Government and agency obligations		402,316		370,863		26,954		96,747
Auction rate preferreds		28,756		—		50,365		—
Mortgage-backed securities		—		—		27,511		—
Asset backed securities		—		—		21,093		—
Other		500		665		1,075		624
Options		24,995		39,982		22,775		18,044
	$	1,612,782	$	1,260,565	$	649,299	$	1,120,173

The following is a summary of the market value of major categories of securities pledged to creditors as of December 31, 2005 and 2004 (in thousands of dollars):

	2005		2004
Corporate debt securities	$	16,882	$	429,278
U.S. Government and agency obligations		—		42,820
Mortgage-backed securities		13,458		—
Asset backed securities		33,159		—
High yield securities		15,423		25,929
Corporate equity securities		99,764		99,407
	$	178,686	$	597,434

(6)   Premises and Equipment

The following is a summary of premises and equipment as of December 31, 2005 and 2004 (in thousands of dollars):

	2005		2004
Furniture, fixtures and equipment	$	125,708	$	108,530
Leasehold improvements		63,627		54,899
Total		189,335		163,429
Less accumulated depreciation and amortization		119,514		105,680
	$	69,821	$	57,749

59

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

Depreciation and amortization expense amounted to $14,705,000, $13,776,000 and $14,745,000 for the years ended December 31, 2005, 2004 and 2003, respectively.

(7)   Bank Loans

Bank loans represent short-term borrowings that are payable on demand and generally bear interest at the brokers’ call loan rate. At December 31, 2005 there were no unsecured bank loans outstanding. At December 31, 2004 there were $70,000,000 in unsecured bank loans outstanding with an average interest rate of 2.94%

(8)   Long-Term Debt

The following summarizes long-term debt outstanding at December 31, 2005 and 2004 (in thousands of dollars):

	2005		2004
71/2% Senior Notes, due 2007, less unamortized discount of $46 and $74 in 2005 and 2004, respectively, effective rate of 8%	$	99,954	$	99,926
73/4% Senior Notes, due 2012, less unamortized discount of $5,383 and $6,025 in 2005 and 2004, respectively, effective rate of 8%		331,781		341,184
51/2% Senior Notes, due 2016, less unamortized discount of $1,862 and $2,043 in 2005 and 2004, effective rate of 5.6%		348,138		347,957
	$	779,873	$	789,067

In 2002 the Company entered into a fair value hedge with no ineffectiveness using interest rate swaps in order to convert $200.0 million aggregate principal amount of unsecured 73/4% senior notes due March 15, 2012 into floating rates based upon LIBOR. The effective interest rate on the $200.0 million aggregate principal amount of unsecured 73/4% senior notes, after giving effect to the swaps, is 6.65%. The fair value of the mark to market of the swaps was positive $12.2 million as of December 31, 2005, which was recorded as an increase in the book value of the debt and an increase in derivative assets classified as part of other assets.

(9)   Income Taxes

Total income taxes for the years ended December 31, 2005, 2004 and 2003 were allocated as follows (in thousands of dollars):

	2005			2004			2003
Earnings	$	104,089		$	83,955		$	52,851
Stockholders’ equity, for compensation expense for tax purposes in excess of amounts recognized for financial reporting purposes		(26,918	)		(15,814	)		(3,980	)
	$	77,171		$	68,141		$	48,871

60

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

Income taxes (benefits) for the years ended December 31, 2005, 2004 and 2003 consist of the following (in thousands of dollars):

	2005			2004			2003
Current:
Federal	$	95,341		$	85,884		$	53,541
State and city		24,771			22,288			13,472
Foreign		7,452			7,315			3,408
		127,564			115,487			70,421
Deferred:
Federal		(14,251	)		(23,651	)		(11,897	)
State and city		(6,344	)		(7,881	)		(5,673	)
Foreign		(2,880	)		—			—
		(23,475	)		(31,532	)		(17,570	)
	$	104,089		$	83,955		$	52,851

Income taxes differed from the amounts computed by applying the Federal income tax rate of 35% for 2005, 2004 and 2003 as a result of the following (in thousands of dollars):

	2005						2004						2003
	Amount			%			Amount			%			Amount			%
Computed expected income taxes	$	93,944			35.0	%	$	79,446			35.0	%	$	50,587			35.0	%
Increase (decrease) in income taxes resulting from:
State and city income taxes, net of Federal income tax benefit		11,977			4.5			9,365			4.1			5,069			3.5
Limited deductibility of meals and entertainment		1,634			0.6			886			0.4			1,436			1.0
Minority interest, not subject to tax		(2,887	)		(1.1	)		(4,099	)		(1.8	)		(2,945	)		(2.0	)
Foreign income		(1,086	)		(0.4	)		244			0.1			(398	)		(0.3	)
Other, net		507			0.2			(1,887	)		(0.8	)		(898	)		(0.6	)
Total income taxes	$	104,089			38.8	%	$	83,955			37.0	%	$	52,851			36.6	%

61

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

The cumulative tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at December 31, 2005 and 2004 are presented below (in thousands of dollars):

	2005		2004
Deferred tax assets:
Long-term compensation	$	164,668	$	112,243
Accounts receivable		3,472		3,631
State income taxes		3,623		3,678
Premises and equipment		—		1,331
Pension		4,390		4,922
Investments		—		414
Sub-total		176,153		126,219
Valuation allowance		—		—
Total deferred tax assets	$	176,153	$	126,219
Deferred tax liabilities:
Premises and equipment		3,573		—
Goodwill amortization		7,373		—
Investments		12,703		—
Other, net		2,810		—
Total deferred tax liabilities	$	26,459	$	—
Net deferred tax asset, included in other assets	$	149,694	$	126,219

There was no valuation allowance for deferred tax assets as of December 31, 2005, 2004 and 2003.

Management believes it is more likely than not that the Company will realize the deferred tax asset through future earnings.

The current tax liability as of December 31, 2005 and 2004 was $29,324,000 and $14,171,000, respectively.

Withholding and U.S. taxes have not been provided on approximately $29 million of unremitted earnings of certain non-U.S. subsidiaries because the Company has currently reinvested these earnings permanently in such operations. Such earnings would become taxable upon the sale or liquidation of these non-U.S. subsidiaries or upon the remittance of dividends, however, management does not believe the related tax on such taxable amounts would be material.

(10)   Benefit Plans

Pension Plan

The Company has a defined benefit pension plan which covers certain employees of the Company and its subsidiaries. The plan is subject to the provisions of the Employee Retirement Income Security Act of 1974. Benefits are based on years of service and the employee’s career average pay. The Company’s funding policy is to contribute to the plan at least the minimum amount that can be deducted for Federal income tax purposes. Differences in each year, if any, between expected and actual returns in excess of a 10% corridor (as defined in FASB No. 87, Employers’ Accounting for Pensions) are amortized in net periodic pension calculations. Effective

62

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

December 31, 2005, benefits under the pension plan have been frozen. Accordingly, there will be no further benefit accruals for future service after December 31, 2005.

The following tables set forth the plan’s funded status and amounts recognized in the Company’s accompanying consolidated statements of financial condition and consolidated statements of earnings (in thousands of dollars):

	December 31,
	2005			2004
Accumulated benefit obligation	$	43,287		$	40,565
Projected benefit obligation for service rendered to date	$	43,287		$	45,688
Plan assets, at fair market value		33,062			29,197
Excess of the projected benefit obligation over plan assets	$	10,225		$	16,491
Unamortized prior service cost		—			(252	)
Prepaid/(accrued) benefit cost		289			674
Unrecognized net loss		(10,514	)		(16,913	)
Adjustment to recognize minimum liability		10,514			12,042
Intangible asset		—			(252	)
Pension liability included in other liabilities	$	10,514		$	11,790

	Year Ended December 31,
	2005			2004			2003
Net pension cost included the following components:
Service cost — benefits earned during the period	$	2,077		$	1,984		$	1,447
Interest cost on projected benefit obligation		2,551			2,457			2,206
Expected return on plan assets		(2,239	)		(1,846	)		(1,448	)
Net amortization		1,008			1,181			913
Net periodic pension cost	$	3,397		$	3,776		$	3,118

	Year Ended December 31,
	2005			2004
Fair value of assets, beginning of year	$	29,197		$	23,665
Employer contributions		3,275			4,000
Benefit payments made		(1,682	)		(939	)
Administrative expenses paid		(261	)		(228	)
Total investment return		2,533			2,699
Fair value of assets, end of year	$	33,062		$	29,197

63

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

	Year Ended December 31,
	2005			2004
Projected benefit obligation, beginning of year	$	45,688		$	40,691
Service cost		2,077			1,984
Interest cost		2,551			2,457
Actuarial gains and losses		(6	)		1,722
Curtailments		(5,080	)		—
Administrative expenses paid		(261	)		(228	)
Benefits paid		(1,682	)		(939	)
Projected benefit obligation, end of year	$	43,287		$	45,688

The plan assets consist of approximately 60% equities and 40% fixed income securities in 2005 and 2004. The target allocation of plan assets for 2006 is approximately 60% equities and 40% fixed income securities.

The weighted average discount rate and the rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were 5.55% and 4.00%, respectively, in 2005, 5.75% and 4.00%, respectively, in 2004, and 6.00% and 4.00%, respectively, in 2003. The expected long-term rate of return on assets was 7.5% in 2005, 2004 and 2003.

The expected long-term rate of return assumption is based on an analysis of historical experience of the portfolio and the summation of prospective returns for each asset class in proportion to the fund’s current asset allocation. The target asset allocation was determined based on the risk tolerance characteristics of the plan and, at times, may be adjusted to achieve the plan’s investment objective and to minimize any concentration of investment risk.

Effective December 31,2005, benefits under the pension plan have been frozen. There will be no further benefit accruals after December 31, 2005.

The Company presently anticipates contributing between $500,000 and $1 million to its pension plan during 2006.

Expected benefit payments through December 31, 2014 are as follows (in thousands of dollars):

2005	$	2,562
2006		1,546
2007		1,696
2008		2,256
2009		3,121
2010 through 2014		11,515

Incentive Plan

The Company also has an Incentive Compensation Plan (“Incentive Plan”) which allows awards in the form of incentive stock options (within the meaning of Section 422 of the Internal Revenue Code), nonqualified stock options, stock appreciation rights, restricted stock, unrestricted stock, performance awards, dividend equivalents or other stock based awards. The plan imposes a limit on the number of shares of common stock of the Company that may be subject to awards. An award relating to shares may be granted if the aggregate number of shares subject to then-outstanding awards plus the number of shares subject to the award being granted do not exceed 30% of the

64

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

number of shares issued and outstanding immediately prior to the grant. Under the Incentive Plan, the exercise price of each option is generally not less than the market price of the Company’s stock on the date of grant and the option’s maximum term is ten years.

Restricted Stock/Restricted Stock Units.  The Incentive Plan allows for grants of restricted stock awards, whereby employees are granted restricted shares of common stock subject to forfeiture until the restrictions lapse or terminate. With certain exceptions, the employee must remain with the Company for a period of years after the date of grant to receive the full number of shares granted.

The Incentive Plan also allows for grants of restricted stock units. Restricted stock units give a participant the right to receive shares at the end of a specified deferral period. Restricted stock units may be subject to forfeiture conditions, until the restrictions lapse or terminate. One advantage of restricted stock units, as compared to restricted stock, is that the period during which the award is deferred as to settlement can be extended past the date the award becomes non-forfeitable, allowing a participant to hold an interest tied to common stock on a tax deferred basis. Prior to settlement, restricted stock units carry no voting or dividend rights associated with the stock ownership, but dividend equivalents are paid or accrued.

During 2005, 2004 and 2003, employees were awarded an aggregate of 6,037,000, 3,327,000, and 3,838,000 restricted stock and restricted stock units, respectively, with a corresponding market value of $221,330,000, $106,670,000, and $87,263,000, respectively. There were two significant series of grants of restricted stock and restricted stock units during 2005. The first series of grants occurred in the first quarter of 2005 and mostly related to 2004 employee compensation totaling 2,514,502 shares and $91.5 million. The second series of grants occurred in fourth quarter of 2005 and related to 2005 employee compensation totaling 3,054,745 shares and $116.0 million. A portion of the market value of the restricted stock related to current service is expensed in the applicable year and that portion relating to future service is amortized over its vesting period, generally three to five years.

The following table details the issuances of restricted stock and restricted stock units:

	Year Ended December 31,
	2005			2004			2003
	(Shares in 000s)
Restricted stock
Balance, beginning of year		5,271			5,811			6,015
Grants		1,298			1,763			3,838
Forfeited		(310	)		(298	)		(151	)
RSU conversion		(1,556	)		(455	)		(2,660	)
Vested		(1,024	)		(1,550	)		(1,231	)
Balance, end of year		3,679			5,271			5,811
Restricted stock units (RSU)
Balance, beginning of year		6,029			3,433			—
Grants, includes dividends		4,739			1,564			—
Restricted stock conversion		1,556			455			2,660
Deferral expiration		(268	)		—			—
Forfeited		(59	)		—			—
Deferral of option gains		334			577			773
Balance, end of year		12,331			6,029			3,433

65

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

The compensation cost associated with restricted stock and restricted stock units includes the amortization of the current year and prior years’ grants and amounted to $79,762,000, $71,730,000, and $57,408,000 in 2005, 2004, and 2003, respectively. The conversion of restricted stock into restricted stock units did not impact compensation expenses because such conversation is a result of employee deferral elections under Section 409A of the Internal Revenue Code.

Director Plan

The Company also has a Directors’ Stock Compensation Plan (“Directors’ Plan”) which provided for an annual grant to each non-employee director of $80,000 of restricted stock or deferred shares. These grants are made automatically on the date directors are elected or reelected at the Company’s annual meeting. These grants vest three years after the date of grant and are expensed over the vesting period. Beginning January of 2006, the amount of the award was increased to $100,000 of restricted stock or deferred shares.

Additionally, the Directors’ Plan permits each non-employee director to elect to be paid annual retainer fees, meeting fees and fees for service as chairman of a Board committee in the form of cash, deferred cash or deferred shares. If deferred cash is elected, interest is credited to such deferred cash at the prime interest rate in effect at the date each annual meeting of stockholders. If deferred shares are elected, dividend equivalents equal to dividends declared and paid on the common stock of the Company are credited to a Director’s account and reinvested as additional deferred shares.

A total of 1,000,000 shares of the Company’s common stock is reserved under the Directors’ Plan, of which 89,290 have been granted as of December 31, 2005.

Employee Stock Purchase Plan

The Company also has an Employee Stock Purchase Plan (“ESPP”) which qualifies under Section 423 of the U.S. Internal Revenue Code. All regular full-time employees and employees who work part-time over 20 hours per week are eligible for the ESPP. Employee contributions are voluntary and are made via payroll deduction. The employee contributions are used to purchase the Company’s common stock. The stock purchase price is based on the lower of 85 percent of the stock price at the beginning or end of the period. The stock price used is the Volume Weighted Average Price (“VWAP”) for the particular day.

In addition, the Company has a Supplemental Stock Purchase Plan (“SSPP”) which is a non-qualified plan that is similar to the Company’s ESPP.

In the past, the Company’s stock purchase plan matched employee contributions at a rate of 15% (more, if profits exceeded targets set by the Company’s Board of Directors). The Company recognized compensation cost related to its matching in the period the employee purchased the stock.

The compensation cost related to these plans was $1,800,000, $1,900,000 and $1,573,000 in 2005, 2004 and 2003, respectively.

Deferred Compensation Plan

The Company also has a Deferred Compensation Plan which was established in 2001. In 2005, 2004 and 2003, employees with annual compensation of $200,000 or more were eligible to defer compensation and to invest at a 10% discount in deferred shares of the Company’s stock (“DCP deferred shares”), stock options (prior to 2004) and other alternatives on a pre-tax basis through the plan. The compensation deferred by our employees is expensed in the period earned. In addition, the compensation cost related to the discount on the DCP deferred shares provided by the plan was $1,329,000, $1,734,000 and $5,548,000 in 2005, 2004 and 2003, respectively. A total of

66

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

8,000,000 shares of the Company’s common stock are reserved under the Deferred Compensation Plan. As of December 31, 2005, there were 3,678,227 DCP deferred shares outstanding under the Plan. The following table details the issuances of DCP deferred shares:

	Year Ended December 31,
	2005			2004			2003
	(Shares in 000s)
DCP deferred shares
Balance, beginning of year		3,405			2,878			2,121
Credits		276			539			757
Withdrawals		(3	)		(12	)		—
Balance, end of year		3,678			3,405			2,878

Employee Stock Ownership Plan

The Company has an Employee Stock Ownership Plan (“ESOP”) which was established in 1988. In 1999, the Company re-established annual contributions to the ESOP. The compensation cost related to this plan was $0, $6,663,000, and $200,000 in 2005, 2004 and 2003, respectively.

Profit Sharing Plan

The Company has a profit sharing plan, covering substantially all employees, which includes a salary reduction feature designed to qualify under Section 401(k) of the Internal Revenue Code. The compensation cost related to this plan was $3,230,000, $2,666,000 and $2,055,000 in 2005, 2004 and 2003, respectively.

Options Issued Under All Plans

The fair value of all option grants for all the Company’s plans are estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for all fixed option grants in 2004 and 2003, respectively: dividend yield of 0.9%, and 0.5%; expected volatility of 32.6%, and 33.4%; risk-free interest rates of 3.0%, and 3.7%; and expected lives of 4.8 years, and 5.6 years. There were no option grants in 2005.

A summary of the status of Company stock options in all its stock-based plans as of December 31, 2005, 2004 and 2003 and changes during the years then ended is presented below:

	2005					2004					2003
				Weighted					Weighted					Weighted
				Average					Average					Average
				Exercise					Exercise					Exercise
	Shares			Price		Shares			Price		Shares			Price
Outstanding at beginning of year		4,890,837		$	17.75		6,617,795		$	16.16		7,892,582		$	14.91
Granted		—			—		9,233			35.32		136,777			22.38
Exercised		(2,494,011	)		16.45		(1,682,882	)		11.65		(1,300,640	)		9.64
Forfeited		(130,562	)		11.98		(53,309	)		16.23		(110,924	)		11.52
Outstanding at end of year		2,266,264		$	19.50		4,890,837		$	17.75		6,617,795		$	16.16
Options exercisable at year-end		2,266,264		$	19.50		4,145,414		$	16.80		4,273,192		$	14.30
Weighted-average fair value of options granted during the year				$	—				$	10.50				$	7.62

67

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

The following table summarizes information about stock options outstanding at December 31, 2005:

	Options Outstanding						Options Exercisable
	Number		Weighted				Number
	Outstanding		Average		Weighted		Exercisable		Weighted
	at		Remaining		Average		at		Average
	December 31,		Contractual		Exercise		December 31,		Exercise
Range of Exercise Prices	2005		Life (Years)		Price		2005		Price
$ 3.10 to 9.99		95,686		1.2	$	4.60		95,686	$	4.60
$10.00 to 19.99		873,292		0.9		16.14		873,292		16.14
$20.00 to 29.99		1,274,727		1.5		22.67		1,274,727		22.67
$30.00 to 35.32		22,559		3.0		33.90		22,559		33.90
$ 3.10 to 35.32		2,266,264		1.3	$	19.50		2,266,264	$	19.50

(11)   Minority Interest

Minority interest primarily represents the minority interest holders’ proportionate share of the equity of JEOF. At December 31, 2005, Jefferies Group, Inc. owned approximately 36% of JEOF.

(12)   Earnings per Share

The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations for the years 2005, 2004 and 2003 (in thousands, except per share amounts):

	Year Ended December 31,
	2005		2004		2003
Earnings:	$	157,443	$	131,366	$	84,051
Shares:
Average shares used in basic computation		61,823		57,453		53,090
Stock options		1,373		1,966		1,903
Restricted stock/restricted stock units		4,588		4,489		4,273
Average shares used in diluted computation		67,784		63,908		59,266
Earnings per share:
Basic	$	2.55	$	2.29	$	1.58
Diluted	$	2.32	$	2.06	$	1.42

The Company had no anti-dilutive securities for purposes of the annual and quarterly earnings per share computations in 2005, 2004 and 2003.

68

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

(13)   Leases

As lessee, the Company leases certain premises and equipment under noncancelable agreements expiring at various dates through 2022. Future minimum lease payments for all noncancelable operating leases at December 31, 2005 are as follows (in thousands of dollars):

	Gross		Sub-leases		Net
2006	$	37,283	$	4,543	$	32,740
2007		35,798		3,003		32,795
2008		34,308		2,188		32,120
2009		28,539		688		27,851
2010		25,676		434		25,242
Thereafter		87,227		—		87,227

Rental expense amounted to $34,959,000, $28,311,000 and $22,908,000, in 2005, 2004 and 2003, respectively.

(14)   Derivative Financial Instruments

Off-Balance Sheet Risk

The Company has contractual commitments arising in the ordinary course of business for securities loaned or purchased under agreements to sell, securities sold but not yet purchased, repurchase agreements, future purchases and sales of foreign currencies, securities transactions on a when-issued basis, options contracts, futures index contracts, commodities futures contracts and underwriting. Each of these financial instruments and activities contains varying degrees of off-balance sheet risk whereby the market 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 the Company’s consolidated financial statements.

Jefferies Financial Products, LLC.

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

Generally, the swap and option contract tenors range from 1 month to 2 years, and in some transactions both parties may settle the changes in the mark-to-market value of the transaction on a monthly basis. Where appropriate, JFP utilizes various credit enhancements, including guarantees, collateral and margin agreements to mitigate the credit exposure relating to these swaps and options. JFP establishes credit limits based on, among other things, the creditworthiness of the counterparties, the transaction’s size and tenor, and estimated potential exposure. In

69

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

addition, swap and option transactions are generally documented under International Swaps and Derivatives Association Master Agreements. JFP believes that such agreements provide for legally enforceable set-off and close-out netting of exposures to specific counterparties. Under such agreements, in connection with an early termination of a transaction, JFP is permitted to set-off its receivables from a counterparty against its payables to the same counterparty arising out of all included transactions. As a result, the fair value represents the net sum of estimated positive fair values after the application of such netting. JFP has determined that the fair value of its swaps and options approximated $(0.6) million and $(28.8) million, respectively at December 31, 2005 and $17.3 million and $(6.5) million, respectively at December 31, 2004.

The following table sets forth the fair value of JFP’s outstanding OTC positions and exchange-traded futures and options by remaining contractual maturity as of December 31, 2005:

	0 - 12			1 - 5			5 - 10
	Months			Years			Years			Total
	(In millions)
Swaps	$	(0.6	)	$	—		$	—		$	(0.6	)
Options		—			(27.3	)		(1.5	)		(28.8	)
FX forwards		—			(0.1	)		—			(0.1	)
Exchange-traded futures and options		95.8			(0.1	)		—			95.7
Total	$	95.2		$	(27.5	)	$	(1.5	)	$	66.2

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

At December 31, 2005 and December 31, 2004, the counterparty credit quality with respect to the fair value of commodities and foreign exchange futures, options and swap portfolios were as follows:

	Fair Value
	December 31,			December 31,
	2005			2004
	(In millions)
Counterparty credit quality:
A or higher	$	(29.5	)	$	17.3
Exchange-traded futures and options(1)		95.7			(6.0	)
Total	$	66.2		$	11.3

(1)  Exchange-traded commodities and foreign exchange futures and options are not deemed to have significant credit exposures as the exchanges guarantee that every contract will be properly settled on a daily basis.

70

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

At September 30, 2005 and December 31, 2004 the counterparty breakdown by industry with respect to the fair value of JFP’s commodities and foreign exchange futures, options and swap portfolio was as follows:

	Fair Value
	December 31,			December 31,
	2005			2004
	(In millions)
Foundations, trust and endowments	$	(0.1	)	$	—
Financial services		(45.1	)		—
Collective investment vehicles (including pension plans, mutual funds and other institutional counterparties)		15.7			17.3
Exchanges(1)		95.7			(6.0	)
Total	$	66.2		$	11.3

(1)  Exchange-traded commodities and foreign exchange futures and options are not deemed to have significant credit exposures as the exchanges guarantee that every contract will be properly settled on a daily basis.

Derivative Financial Instruments

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

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

We record trading derivative contracts at fair value with realized and unrealized gains and losses recognized in principal transactions in the Consolidated Statement of Earnings on a trade date basis.

The Company has also entered into a fair value hedge with no ineffectiveness using interest rate swaps in order to convert $200.0 million aggregate principal amount of unsecured 73/4% senior notes due March 15, 2012 into floating rates based upon LIBOR. The effective interest rate on the $200.0 million aggregate principal amount of unsecured 73/4% senior notes, after giving effect to the swaps, is 6.65%. The fair value of the mark to market of the swaps was positive $12.2 million as of December 31, 2005, which was recorded as an increase in the book value of the debt and an increase in derivative assets classified as part of other assets.

71

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

The following table presents the fair value of derivatives at December 31, 2005 and December 31, 2004. The fair value of assets/liabilities related to derivative contracts at December 31, 2005 and December 31, 2004 represent the Company’s receivable/payable for derivative financial instruments before consideration of securities collateral.

	December 31,					December 31,
	2005					2004
	Assets		Liabilities			Assets		Liabilities
	(In thousands)
Futures contracts	$	189,800	$	(96,513	)	$	338	$	(10,239	)
Commodity related swaps		38,125		(38,780	)		20,497		(3,531	)
Option contracts		24,995		(39,982	)		22,775		(18,044	)
Foreign exchange forward contracts		—		(23	)		—		(27	)
Interest rate swaps		12,164		—			22,209		—

(15)   Other Comprehensive Gain (Loss)

The following summarizes other comprehensive gain and accumulated other comprehensive gain at December 31, 2005 and for the year then ended (in thousands of dollars):

	Before-Tax			Income Tax			Net-of-Tax
	Amount			or Benefit			Amount
Currency translation adjustments	$	(8,386	)	$	—		$	(8,386	)
Minimum pension liability adjustment		1,276			(533	)		743
Other comprehensive (loss)	$	(7,110	)	$	(533	)	$	(7,643	)

				Minimum			Accumulated
	Currency			Pension			Other
	Translation			Liability			Comprehensive
	Adjustments			Adjustment			Income (Loss)
Beginning balance	$	9,348		$	(6,868	)	$	2,480
Change in 2005		(8,386	)		743			(7,643	)
Ending balance	$	962		$	(6,125	)	$	(5,163	)

The following summarizes other comprehensive gain and accumulated other comprehensive gain at December 31, 2004 and for the year then ended (in thousands of dollars):

	Before-Tax		Income Tax		Net-of-Tax
	Amount		or Benefit		Amount
Currency translation adjustments	$	4,017	$	—	$	4,017
Minimum pension liability adjustment		445		151		596
Other comprehensive gain	$	4,462	$	151	$	4,613

72

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

			Minimum			Accumulated
	Currency		Pension			Other
	Translation		Liability			Comprehensive
	Adjustments		Adjustment			Income (Loss)
Beginning balance	$	5,331	$	(7,464	)	$	(2,133	)
Change in 2004		4,017		596			4,613
Ending balance	$	9,348	$	(6,868	)	$	2,480

The following summarizes other comprehensive gain and accumulated other comprehensive loss at December 31, 2003 and for the year then ended (in thousands of dollars):

	Before-Tax			Income Tax		Net-of-Tax
	Amount			or Benefit		Amount
Currency translation adjustments	$	3,436		$	—	$	3,436
Minimum pension liability adjustment		(2,855	)		1,160		(1,695	)
Other comprehensive gain	$	581		$	1,160	$	1,741

			Minimum			Accumulated
	Currency		Pension			Other
	Translation		Liability			Comprehensive
	Adjustments		Adjustment			(Loss)
Beginning balance	$	1,895	$	(5,769	)	$	(3,874	)
Change in 2003		3,436		(1,695	)		1,741
Ending balance	$	5,331	$	(7,464	)	$	(2,133	)

(16)   Net Capital Requirements

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

As of December 31, 2005, Jefferies’ and Jefferies Execution’s net capital and excess net capital were as follows (in thousands of dollars):

	Net Capital		Excess Net Capital
Jefferies	$	259,213	$	245,083
Jefferies Execution		14,212		13,962

73

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

(17)   Commitments and Guarantees

The following table summarizes other commitments and guarantees at December 31, 2005:

			Expected Maturity Date
							2008		2010		2012
	Notional/Maximum						and		and		and
	Payout		2006		2007		2009		2011		Later
					(Dollars in millions)
Standby letters of credit	$	172.6	$	172.6		—		—		—		—
Undrawn bank credit	$	24.0	$	24.0		—		—		—		—
Equity Commitments	$	160.5		—		—		—		—	$	160.5
Derivative contracts	$	56.0	$	54.9	$	.2	$	.9		—		—

Standby Letters of Credit.  In the normal course of business, the Company had letters of credit outstanding aggregating $172.6 million at December 31, 2005, mostly to satisfy various collateral requirements in lieu of depositing cash or securities. These letters of credit have a current carrying amount of $0. As of December 31, 2005, there were no draw downs on these letters of credit.

Undrawn Bank Credit.  As of December 31, 2005, the Company had outstanding guarantees of $24.0 million relating to undrawn bank credit obligations of two associated investment funds in which the Company has an interest. Also, the Company has guaranteed obligations of Jefferies International Limited (“JIL”) to various banks which provide clearing and credit services to JIL and to counterparties of JIL.

Equity Commitments.  On October 7, 2004, the Company entered into an agreement with Babson Capital and MassMutual to form Jefferies Babson Finance LLC, a joint venture entity created for the purpose of offering senior loans to middle market and growth companies. Jefferies Babson Finance LLC will be capitalized over time with $250 million in equity commitments, provided equally by Jefferies Group, Inc. and Babson Capital’s parent, MassMutual, and will be leveraged. Loans are expected to be originated primarily through the investment banking efforts of Jefferies & Company, Inc. with Babson Capital providing primary credit analytics and portfolio management services. As of December 31, 2005, the Company funded $12.0 million of its aggregate commitment leaving $113.0 million unfunded.

During 2005, the Company committed to invest an aggregate of $36.9 million in Jefferies Capital Partners IV L.P. and its related parallel funds. As of December 31, 2005, the Company funded approximately $2.3 million of its aggregate commitment leaving $34.6 million unfunded.

As of December 31, 2005, the Company had other equity commitments to invest up to $12.9 million in various other investments

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

High Yield Loan Commitments.  From time to time the Company makes commitments to extend credit to investment-banking clients in loan syndication and acquisition-finance transactions. These commitments and any related drawdowns of these facilities typically have fixed maturity dates and are contingent on certain

74

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

representations, warranties and contractual conditions applicable to the borrower. The Company defines high yield (non-investment grade) as debt securities or loan commitments to companies rated BB+ or lower or equivalent ratings by recognized credit rating agencies, as well as non-rated securities or loans that, in management’s opinion, are non-investment grade. The Company did not have commitments outstanding to non-investment grade borrowers as of December 31, 2005.

Derivative contracts.  In accordance with FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”), we disclose certain derivative contracts meeting the FIN 45 definition of a guarantee. Such derivative contracts include written equity and commodity put options. Derivative contracts are not considered guarantees if such contracts are cash settled and we have no basis to determine whether it is probable the derivative counterparty held the related underlying instrument at the inception of the contract. Accordingly, if these conditions are met, we have not included such derivatives in our guarantee disclosures. At December 31, 2005, the maximum payout value of derivative contracts deemed to meet the FIN 45 definition of a guarantee was approximately $56 million. For purposes of determining maximum payout, notional values are used; however, we believe the fair value of these contracts is a more relevant measure of these obligations because we believe the notional amounts greatly overstate our expected payout. At December 31, 2005 the fair value of such derivative contracts approximated $2 million. In addition, all amounts included above are before consideration of hedging transactions. We substantially mitigate our risk on these contracts through hedges, such as other derivative contracts and/or cash instruments. We manage risk associated with derivative guarantees consistent with our risk management policies.

Other Guarantees.  In the normal course of business the Company provides guarantees to securities clearinghouses and exchanges. These guarantees generally are required under the standard membership agreements, such that members are required to guarantee the performance of other members. To mitigate these performance risks, the exchanges and clearinghouses often require members to post collateral. The Company’s obligations under such guarantees could exceed the collateral amounts posted; however, the potential for the Company to be required to make payments under such guarantees is deemed remote. The Company has guaranteed certain of the obligations of an employee parallel fund to Jefferies Capital Partners IV L.P., including a guarantee of up to an aggregate of approximately $30 million in bank loans committed to such employee fund.

(18)   Segment Reporting

We currently have one reportable business segment, Capital Markets. The Capital Markets reportable segment includes our traditional securities brokerage and investment banking activities. Our operating segments have been aggregated where they have similar economic characteristics and are similar in each of the following areas: (i) the nature of the services they provide, (ii) their methods of distribution, (iii) the types of clients they serve and (iv) the regulatory environments in which they operate. In addition, we choose to voluntarily disclose the Asset Management segment even though it is currently an “immaterial non-reportable” segment as defined by FASB 131, Disclosures about Segments of an Enterprise and Related Information. The Asset Management segment is primarily comprised of revenue and expenses related to our non-integrated asset management businesses including the Jackson Creek CDO, Victoria Falls CLO, Summit Lake CLO, Jefferies RTS Fund, Jefferies Paragon Fund and the Jefferies Real Asset Fund.

Our segment information is prepared using the following methodologies:

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

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

75

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

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

The Company’s net revenues, expenses, income (loss) before income taxes and total assets by segment are summarized below (amounts in millions):

	Capital		Asset
	Markets		Management		Total
Twelve months ended December 31, 2005
Net revenues	$	1,163.1	$	41.6	$	1,204.7
Expenses		910.1		26.2		936.3
Income before taxes	$	253.0	$	15.4	$	268.4
Segment assets	$	12,764.2	$	16.7	$	12,780.9
Twelve months ended December 31, 2004
Net revenues	$	1,019.3	$	38.9	$	1,058.2
Expenses		811.9		19.3		831.2
Income before taxes	$	207.4	$	19.6	$	227.0
Segment assets	$	13,813.4	$	11.2	$	13,824.6
Twelve months ended December 31, 2003
Net revenues	$	825.4	$	4.2	$	829.6
Expenses		682.4		2.7		685.1
Income before taxes	$	143.0	$	1.5	$	144.5
Segment assets	$	10,992.3	$	0.0	$	10,992.3

(19)   Goodwill

The following is a summary of goodwill as of December 31, 2005 (in thousands of dollars):

	2004		2005		2005		Acquisition
Acquisition	Balance		Activity		Balance		Date
Broadview International LLC	$	48,827	$	5,998	$	54,825		Dec. 2003
Randall & Dewey		—		48,383		48,383		Jan. 2005
Helfant Group, Inc.		26,062		—		26,062		Sept. 2001
Quarterdeck Investment Partners, LLC		25,170		5,785		30,955		Dec. 2002
Bonds Direct Securities LLC		20,943		—		20,943		Sept. 2004
The Europe Company		11,123		—		11,123		Aug. 2000
Helix Associates		—		25,307		25,307		May 2005
Other		2,811		198		3,009		Dec. 2003
	$	134,936	$	85,671	$	220,607

The Company acquired Helix Associates for approximately $9.5 million in stock and $27.0 million in cash. The acquisition was accounted for as a purchase and preliminarily resulted in approximately $25.3 million in goodwill. There is also a five-year contingency for additional consideration, based on future revenues.

76

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

The Company acquired certain assets of Randall & Dewey for approximately $17.5 million in stock and $27.2 million in cash. The acquisition was accounted for as a purchase and preliminarily resulted in approximately $41.5 million in goodwill. There is also a five-year contingency for additional consideration, based on future revenues. During 2005, there was a $6.9 million accrual for additional consideration under the five-year contingency.

The acquisitions of Helix Associates, Randall & Dewey, Bonds Direct, Broadview International LLC and Quarterdeck Investment Partners, LLC all contained a five-year contingency for additional consideration to the selling shareholders, based on future revenues. This additional consideration is paid in cash annually. There is no contractual dollar limit to the potential of additional consideration. Subsequent to December 31, 2005, the Bonds Direct contingency for additional consideration was terminated pursuant to the terms of the acquisition agreement.

The 2005 activity for Quarterdeck Investment Partners, LLC and Broadview International LLC primarily represents additional contingent consideration.

None of the acquisitions listed above were considered material business combinations based on the small percentage they represented of the Company’s total assets, equity, revenues and net earnings.

(20)   Variable Interest Entities (“VIEs”)

Under the provisions of FASB Interpretation 46R (“FIN 46R”) the Company determined that the Jefferies Employees Opportunity Fund (“JEOF”) meets the definition of a VIE. The Company with our employees (related parties) are the primary beneficiary of JEOF, one of the three high yield funds that the Company manages. Therefore, JEOF starting in the third quarter of 2003 is consolidated into the Company and is no longer treated as an investment.

The Company also owns significant variable interests in Summit Lake CLO, and Victoria Falls CLO for which we are not the primary beneficiary and therefore do not consolidate these entities. In aggregate, these variable interest entities have assets approximating $606 million. The Company’s exposure to loss is limited to its capital contributions. The carrying value of the Company’s investment in Summit Lake CLO and Victoria Falls CLO is $11.8 million at December 31, 2005.

(21)   Related Party Disclosures

High Yield Funds

In January 2000, the Company created three broker-dealer entities that employ a trading and investment strategy substantially similar to that historically employed by its Jefferies High Yield department. Although the Company refers to these three broker-dealer entities as funds, they are registered with the Commission as broker-dealers. Two of these funds, the Jefferies Partners Opportunity Fund and the Jefferies Opportunity Fund II, are principally capitalized with equity contributions from institutional and high net worth investors. The third fund, Jefferies Employees Opportunity Fund (and collectively with the two Jefferies Partners Opportunity Funds, referred to as the “High Yield Funds”), is principally capitalized with equity investments from our employees and is therefore consolidated into our consolidated financial statements. The Company’s senior management (including its Chief Executive Officer and Chief Financial Officer) and certain of its employees have direct investments in these funds on terms identical to other fund participants. The Company has a 17% aggregate interest in the funds, senior management has a 3% interest and all employees (exclusive of senior management) have a 6% interest. The High Yield division and each of the funds share gains or losses on trading and investment activities of the High Yield division on the basis of a pre-established sharing arrangement related to the amount of capital each has committed. The sharing arrangement is modified from time to time to reflect changes in the respective amounts of committed capital. As of December 31, 2005, on a combined basis, the High Yield division had in excess of $945 million of

77

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

combined pari passu capital available (including unfunded commitments and availability under the fund revolving credit facility) to deploy and execute the division’s investment and trading strategy. The High Yield Funds are managed by Richard Handler, the Company’s Chief Executive Officer.

Jefferies Capital Partners

In July 2005, the Company entered into a Share and Membership Interest Purchase Agreement (“Purchase Agreement”) with Brian P. Friedman (one of our directors and Chairman of the Executive Committee of the Board of Directors of Jefferies & Company, Inc.), 2055 Partners L.P., James L. Luikart, and the manager and general partner of Jefferies Capital Partners IV L.P. Jefferies Capital Partners IV L.P., together with its related parallel funds (“Fund IV”), is a private equity fund managed by a team led by Messrs. Friedman and Luikart. The Company agreed to purchase a 49% interest in the manager of Fund IV and an amount, not less than 20% and not more than the percentage allocated to Mr. Friedman, of the carried interest attributed to Fund IV. In addition, the Company will have the right, subject to certain conditions, to receive similar interests from future private equity funds overseen by Mr. Friedman. The Company agreed to issue an aggregate of between 400,000 to 650,000 shares of common stock to Messrs. Friedman and Luikart. The actual number of shares of common stock to be issued is subject to the receipt by Fund IV of threshold levels of committed capital at the final closing of the fund, and is further subject to clawback provisions based upon the size of a subsequent fund as well as certain other conditions.

During 2005, the Company committed to invest an aggregate of $36.9 million in Fund IV. As of December 31, 2005, the Company’s remaining commitment was approximately $34.6 million.

The Company has guaranteed the obligations of two other private equity funds managed by entities controlled by Mr. Friedman. These obligations may arise under a $20 million credit facility and a $4 million credit facility provided by a third party to these funds. The Company has also guaranteed certain of the obligations of an employee parallel fund to Fund IV, including a guarantee of up to an aggregate of approximately $30 million in bank loans committed to such employee fund.

(22)   Subsequent Events (Unaudited)

Debt Issuance — 30 Year Senior Debentures

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

Massachusetts Mutual Life Insurance Company

In February 2006, Massachusetts Mutual Life Insurance Company (“MassMutual”) purchased in a private placement $125 million of the Company’s Series A convertible preferred stock. The principal terms of the Series A Preferred include a 3.25% annual, cumulative cash dividend with a conversion price of $62 per share. The preferred stock is callable after 10 years and will mature in 2036.

In February 2006, the Company and MassMutual also agreed to double their equity commitments to Jefferies Babson Finance LLC, the joint venture the two firms formed in October 2004. With an incremental $125 million from each partner, the new total committed equity capitalization of the joint venture finance company is $500 million.

The incremental capital will allow Jefferies Babson Finance to continue to grow its business of offering senior loans to middle market and growth companies, originated primarily through the Company’s investment banking efforts. Babson Capital Management LLC, a MassMutual affiliate, will continue to provide primary credit analytics and portfolio management services. The Company will continue to account for its 50% economic and voting

78

JEFFERIES GROUP, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)
December 31, 2005 and 2004

interest in Jefferies Babson Finance on the equity method of accounting. In addition, origination and syndication fees earned by the Company’s investment banking effort will be recorded as a component of investment banking revenue.

(23)   Selected Quarterly Financial Data (Unaudited)

The following is a summary of unaudited quarterly statements of earnings for the years ended December 31, 2005 and 2004 (in thousands of dollars, except per share amounts):

	March		June		September		December		Year
2005
Revenues	$	343,893	$	344,163	$	378,084	$	431,733	$	1,497,873
Earnings before income taxes and minority interest		62,173		60,310		67,537		78,387		268,407
Net earnings		36,672		35,437		38,595		46,739		157,443
Net earnings per share:
Basic	$	0.61	$	0.58	$	0.62	$	0.74	$	2.55
Diluted	$	0.56	$	0.53	$	0.57	$	0.68	$	2.32
2004
Revenues	$	303,094	$	277,170	$	293,102	$	325,273	$	1,198,639
Earnings before income taxes and minority interest		61,219		54,676		54,950		56,144		226,989
Net earnings		31,909		31,786		32,275		35,396		131,366
Net earnings per share:
Basic	$	0.57	$	0.55	$	0.56	$	0.61	$	2.29
Diluted	$	0.51	$	0.50	$	0.51	$	0.55	$	2.06

79

Item 9.   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

None

Item 9A.   Controls and Procedures.

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2005. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of December 31, 2005 are functioning effectively to provide reasonable assurance that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding disclosure. A controls system cannot provide absolute assurance, however, that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

No change in our internal control over financial reporting occurred during the fourth quarter of 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Management’s annual report on internal control over financial reporting and the report of KPMG LLP are contained in Part II, Item 8 of this report.

Our Chief Executive Officer and Chief Financial Officer filed with the SEC as exhibits to our Form 10-K for the year ended December 31, 2004 and are filing as exhibits to this report, the certifications required by Section 302 of the Sarbanes-Oxley Act of 2002 and Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.

Item 9B.   Other Information.

None

PART III

Item 10.   Directors and Executive Officers of the Registrant.

Information with respect to this item will be contained in the Proxy Statement for the 2006 Annual Meeting of Stockholders, which is incorporated herein by reference.

Item 11.   Executive Compensation.

Information with respect to this item will be contained in the Proxy Statement for the 2006 Annual Meeting of Stockholders, which is incorporated herein by reference.

Item 12.   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

Information with respect to this item will be contained in the Proxy Statement for the 2006 Annual Meeting of Stockholders, which is incorporated herein by reference.

Item 13.   Certain Relationships and Related Transactions.

Information with respect to this item will be contained in the Proxy Statement for the 2006 Annual Meeting of Stockholders, which is incorporated herein by reference.

Item 14.   Principal Accounting Fees and Services.

Information with respect to this item will be contained in the Proxy Statement for the 2006 Annual Meeting of Stockholders, which is incorporated herein by reference.

80

PART IV

Item 15.   Exhibits and Financial Statement Schedules.

	Pages
(a)1.  Financial Statements
Included in Part II of this report:
Report of Independent Registered Public Accounting Firm		39
Consolidated Statements of Financial Condition		41
Consolidated Statements of Earnings		42
Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income		43
Consolidated Statements of Cash Flows		44
Notes to Consolidated Financial Statements		46

(a)2.  Financial Statement Schedules

All Schedules are omitted because they are not applicable or because the required information is shown in the consolidated financial statements or notes thereto.

(a)3.  Exhibits

2	Share and Membership Interest Purchase Agreement dated as of July 18, 2005, by and among Brian P. Friedman, James L. Luikart, 2055 Partners L.P., Jefferies Capital Partners IV LLC, JCP IV LLC, and Jefferies Group, Inc. is incorporated by reference to Exhibit 2 of Registrants Form 8-K filed on July 21, 2005.
3.1	Registrant’s Amended and Restated Certificate of Incorporation is incorporated by reference to Exhibit 3 of Registrant’s Form 8-K filed on May 26, 2004.
3.2	Registrant’s Certificate of Designations of 3.25% Series A Cumulative Convertible Preferred Stock is incorporated by reference to Exhibit 3.1 of Registrant’s Form 8-K filed on February 21, 2006.
3.3	Registrant’s By-Laws are incorporated by reference to Exhibit 3.2 of Registrant’s Form 10-K filed on March 28, 2003.
4	Instruments defining the rights of holders of long-term debt securities of the Registrant and its subsidiaries are omitted pursuant to Item 601(b) (4)(iii) of Regulation S-K. Registrant hereby agrees to furnish copies of these instruments to the Commission upon request.
10.1	Jefferies Group, Inc. Deferred Compensation Plan, as Amended and Restated as of January 1, 2003 is incorporated by reference to Exhibit 4.1 of Registrant’s Form S-8 filed on July 14, 2003.
10.2*	Amendment No. 1, dated as of December 1, 2005, to the Jefferies Group, Inc. Deferred Compensation Plan, as Amended and Restated as of January 1, 2003.
10.3	Jefferies Group, Inc. 2003 Incentive Compensation Plan is incorporated by reference to Appendix 4 of Registrant’s Proxy Statement filed on April 4, 2003.
10.4	Jefferies Group, Inc. 1999 Incentive Compensation Plan as Amended and Restated as of October 22, 2002 is incorporated by reference to Exhibit 10.3 of Registrant’s Form 10-Q filed on August 8, 2003.
10.5	Jefferies Group, Inc. Stock Option Gain and Stock Award Deferral Program effective as of January 21, 2003 is incorporated by reference to Exhibit 10.1 of Registrant’s Form 10-Q filed on May 9, 2003.
10.6	Jefferies Group, Inc. 1999 Directors’ Stock Compensation Plan is incorporated by reference to Exhibit 10.2 of Registrant’s Form 10 filed on April 20, 1999.
10.7	Form of Restricted Stock Agreement pursuant to the Jefferies Group, Inc. 2003 Incentive Compensation Plan is incorporated by reference to Exhibit 10.2 of Registrant’s Form 10-Q filed on November 8, 2004.
10.8	Form of Option Agreement pursuant to the Jefferies Group, Inc. 2003 Incentive Compensation Plan and Jefferies Group, Inc. Deferred Compensation Plan is incorporated by reference to Exhibit 10.3 of Registrant’s Form 10-Q filed on November 8, 2004.

81

10.9	Form of Restricted Stock Units Agreement pursuant to the Jefferies Group, Inc. 2003 Incentive Compensation Plan is incorporated by reference to Exhibit 10.10 of Registrant’s Form 10-K filed on March 31, 2005.
10.10	Summary of Non-Employee Director Compensation (as amended on July 14. 2003) pursuant to the Jefferies Group, Inc. 1999 Directors’ Stock Compensation Plan is incorporated by reference to Exhibit 10.9 of Registrant’s Form 10-K filed on March 31, 2005.
10.11	Summary of Non-Employee Director Compensation (as amended on January 17, 2006) pursuant to the Jefferies Group, Inc. 1999 Directors’ Stock Compensation Plan is incorporated by reference to Exhibit 10 of Registrant’s Form 8-K filed on January 18, 2006.
10.12	Summary of the Jefferies Group, Inc. 2005 CEO, President, CFO and General Counsel Total Direct Pay Program is incorporated by reference to Exhibit 99 of Registrants Form 8-K filed on January 24, 2005.
10.13	Summary of the 2005 (partial year) and 2006 Total Direct Pay Program for Brian P. Friedman is incorporated by reference to Exhibit 10 of Registrants Form 8-K filed on August 16, 2005.
10.14	Summary of the Jefferies Group, Inc. 2006 Executive Compensation Direct Pay Program is incorporated by reference to Exhibit 10 of Registrants Form 8-K filed on February 3, 2006.
10.15*	Deferred Compensation Agreement, as amended and restated as of December 29, 2005, between Jefferies & Company, Inc. and Richard B. Handler.
10.16	Amendment Agreement dated February 7, 2006 to the Limited Liability Company Agreement, dated as of October 7, 2004, by and among Jefferies Group, Inc., Massachusetts Mutual Life Insurance Company, Babson Capital Management LLC, Class C Member LLC, and Jefferies Babson Finance LLC is incorporated by reference to Exhibit 10 of Registrant’s Form 8-K filed on February 7, 2006.
10.17	Purchase Agreement dated January 19, 2006 among Jefferies Group, Inc., Citigroup Global Markets Inc., Merrill Lynch & Co., Merrill Lynch, Pierce, Fenner & Smith Incorporated, Banc of America Securities LLC, BNY Capital Markets, Inc., Keefe, Bruyette & Woods, Inc., Wachovia Capital Markets, LLC, BNP Paribas Securities Corp., HSBC Securities (USA) Inc. and SG Americas Securities, LLC is incorporated by reference to Exhibit 10.1 of Registrants Form 8-K filed on February 1, 2006.
12.1*	Computation of Ratio of Earnings to Fixed Charges.
21*	List of Subsidiaries of Registrant.
23*	Consent of KPMG LLP.
31.1*	Rule 13a-14(a)/15d-14(a) Certification by Chief Financial Officer.
31.2*	Rule 13a-14(a)/15d-14(a) Certification by Chief Executive Officer.
32*	Rule 13a-14(b)/15d-14(b) and Section 1350 of Title 18 U.S.C. Certification by the Chief Executive Officer and Chief Financial Officer.

*  Filed herewith.

Exhibits 10.1, 10.2, 10.3, 10.4, 10.5, 10.6, 10.7, 10.8, 10.9, 10.10, 10.11, 10.12, 10.13, 10.14, and 10.15 are management contracts or compensatory plans or arrangements.

82

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

JEFFERIES GROUP, INC.

By:  /s/  RICHARD B. HANDLER

Richard B. Handler

Chairman of the Board of Directors,

Chief Executive Officer

Dated:  February 28, 2006

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

Name	Title	Date
/s/  RICHARD B. HANDLER Richard B. Handler	Chairman of the Board of Directors, Chief Executive Officer	February 28, 2006
/s/  JOSEPH A. SCHENK Joseph A. Schenk	Executive Vice President and Chief Financial Officer	February 28, 2006
/s/  BRIAN P. FRIEDMAN Brian P. Friedman	Director	February 28, 2006
/s/  W. PATRICK CAMPBELL W. Patrick Campbell	Director	February 28, 2006
/s/  RICHARD G. DOOLEY Richard G. Dooley	Director	February 28, 2006
/s/  ROBERT E. JOYAL Robert E. Joyal	Director	February 28, 2006
/s/  FRANK J. MACCHIAROLA Frank J. Macchiarola	Director	February 28, 2006

83

EX-10.2

EXHIBIT 10.2

AMENDMENT NO. 1
Dated as of December 1, 2005

TO THE

JEFFERIES GROUP, INC.

DEFERRED COMPENSATION PLAN
As Amended and Restated as of January 1, 2003

     Pursuant to Section 8.5 of the Jefferies Group, Inc. Deferred Compensation Plan (the “DCP”), the Compensation Committee of the Board of Directors has authorized and directed that the DCP be amended to provide that, solely with respect to amounts deferred in 2001 that would be distributed as a lump sum in January 2006 and, in the case of executive officers, amounts deferred in 2001 that would be distributed in installments (together, “2001 Deferrals”), the terms of the DCP applicable to such 2001 Deferrals shall conform to 409A requirements (i.e., requirements that would permit non-grandfathered deferrals to avoid 409A tax penalties).

     These amendments to the DCP as approved shall be effective December 1, 2005, and the DCP Administrator is hereby authorized to provide to participants with 2001 Deferrals an opportunity during 2005 to elect new distribution dates for such 2001 Deferrals (which may include distributions during 2005) in accordance with 409A transition rules, and all actions of the DCP Administrator in furtherance of this are ratified and approved.

     Appropriate officers of the Company are authorized to operate the DCP in conformity with the DCP as amended hereby and, regarding deferrals other than the 2001 Deferrals, in conformity with applicable 409A grandfathering rules for pre-2005 deferrals and with applicable 409A requirements for deferrals in 2005 and later years, and to prepare such amendments to the DCP as they may deem necessary or appropriate to conform the DCP to the provisions of 409A, and such officers are directed to submit the amended Plan to the Compensation Committee of the Board of Directors for ratification before the end of 2006 (the scheduled end of the transition period under the 409A transition rules).

     The appropriate officers of the Company are further authorized to take such other steps as any of them may deem necessary or appropriate to implement these amendments to the DCP.

EX-10.15

EXHIBIT 10.15

JEFFERIES & COMPANY, INC.

DEFERRED COMPENSATION AGREEMENT
As Amended and Restated as of December 29, 2005

     WHEREAS, Richard B. Handler (“Executive”) previously has entered into agreements with Jefferies & Company, Inc. (the “Company”) under which he deferred certain cash compensation, which deferred compensation has been notionally invested in a variety of investment vehicles at the direction of Executive (the “Deferral Agreement”); and

     WHEREAS, Executive and the Company desire to amend and restate the terms of the Deferral Agreement governing such deferred compensation in order to cause such deferred compensation to be subject to Section 409A of the Internal Revenue Code (the “Code”), to conform the terms of the deferred compensation to the requirements of Section 409A, to specify distribution dates for such deferred compensation as permitted under Proposed Treasury Regulation (“PTR”) § 1.409A, Preamble § XI.C. and IRS Notice 2005-1, Q/A 19(c), and to amend certain other terms of the Deferral Agreement as permitted under Section 409A, PTR § 1.409A and IRS Notice 2005-1, and with the intention to confirm the other terms of the Deferral Agreement.

     NOW, THEREFORE, for good and valuable consideration the receipt and adequacy of which the parties hereby acknowledge, and intending to be legally bound, Executive and the Company hereby agree as follows (the “Agreement”):

     1. Scope of Agreement. This Agreement amends and restates the Deferral Agreement of the parties with respect to the deferral of cash amounts payable by the Company to Executive, as referenced in Section 1 of the “Election to Defer Receipt of Incentive Compensation” currently in effect. The parties hereto agree that the deferred amounts subject to this Agreement as of September 30, 2005, and the notional investments of such deferred amounts at that date, are reflected in the “Statement of Account” dated as of September 30, 2005, and that the Agreement does not apply to any other deferral accounts or deferred amounts. This Agreement makes no change in the amounts originally deferred and credited to Executive’s Deferral Account maintained hereunder (the “Deferral Account”), in the notional investments by which the value of Executive’s Deferral Account currently is measured or in the amounts previously credited or debited to such Deferral Account in connection with those notional investments. This Agreement does not apply to deferrals under the Jefferies Group, Inc. Deferred Compensation Plan and deferrals governed by the Jefferies Group, Inc. Stock Option Gain and Stock Award Deferral Program.

     2. Notional Investments.

     (a) Notional Investment Vehicles. The Company has previously and will hereafter make available a reasonable variety of investment vehicles in which the balance of Executive’s Deferral Account may be deemed invested on a notional basis, for the purpose of determining gains and losses in the Deferral Account. Executive is permitted to request specific investment vehicles, which the Company will make available on a notional basis if the Company reasonably determines that (i) the Company can adequately hedge its notional deferred compensation obligation to Executive, (ii) the Executive has and will have a cash or cash equivalent balance in his Deferral Account available and sufficient to provide for the notional investment, including

any future commitments or capital calls that are mandatory terms of the investment, and (iii) the Company otherwise has no legal or practical impediment to the Company making such notional investment available and to the Company itself making the identical actual investment (if it should choose to do so). The Company’s determination regarding whether any particular notional investment vehicles shall be available or remain available is based on considerations as to the Company’s financial and business interests and legal compliance, and does not constitute a judgment as to the suitability of the notional investment for the Executive.

     (b) Reallocation of Deferral Account Balances. Executive will be permitted to reallocate funds from an existing notional investment to another available notional investment if the existing notional investment is one that, if an actual investment had been made therein, such investment could be liquidated for an ascertainable amount in an active market or through a right of redemption, unless the Company determines not to permit reallocation because of a legal or practical impediment affecting the Company. The foregoing notwithstanding, many of the notional investments that have been and may hereafter be made available are illiquid in nature, and therefore no election may be made by Executive to reallocate any Deferral Account balance out of such an illiquid notional investment in the absence of an independent event that would result in liquidity for the related actual investment.

     (c) Deferral Account Statements. The Company will periodically furnish a “Statement of Account” showing the notional investment vehicles in which cash balances in the Deferral Account are then deemed invested, a current value for each notional investment (to the extent then reasonably available), aggregate Deferral Account value, and other relevant information.

     (d) Interest on Cash Balances. Interest on cash balances in the Deferral Account shall be calculated and credited, from and after December 1, 2005, as though such balances were invested in the Money Market Fund that is available in the same period for notional investments of cash in the Jefferies Group, Inc. Deferred Compensation Plan.

     3. Risks to Executive. Executive acknowledges and agrees that, as a result of his deferrals of compensation hereunder, Executive is subject to risks and limitations on his rights relating to such deferrals, including the following:

     (a) Risk as Unsecured Creditor of Company. Executive is an unsecured creditor of Company, with the rights as such enforceable against the Company. No assets of the Company or its parent or subsidiaries or affiliates secure the Company’s obligations to Executive hereunder, and Executive has no claim against any specific assets. Thus, even if the Company acquires or holds assets that match Executive’s notional investments, Executive will have no claims or rights with respect to those particular assets. Other creditors of the Company or its subsidiaries may have or in the future be granted rights senior to those of Executive.

     (b) Undiversified Risk. To the extent that Executive holds other investments in the Company or its parent (Jefferies Group, Inc.) or subsidiaries or affiliates or depends on the Company or its parent or subsidiaries or affiliates for payment of other compensation (including other deferred compensation, health, welfare retirement and other benefits, and equity-based compensation), the risks of deferral hereunder may be more significant to Executive because they represent an undiversified risk.

     (c) Investment Risk of Notional Investments. The amount distributable from the Deferral Account will equal the value of the Deferral Account (or distributable portion thereof) at

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the time of distribution. Over time, the Deferral Account value will vary based on the changes in value and investment returns of the notional investments in which the Deferral Account balance is deemed invested. The Company and its parent and subsidiaries and affiliates have made no guarantee as to the value of the Deferral Account. The amount distributable from the Deferral Account may be less than the amounts originally deferred. Executive has been and will be permitted to freely choose the amount and timing of the deemed investment of his Deferral Account balance in the notional investments vehicles made available hereunder, subject to Section 2 above. The Company, its parent, subsidiaries and affiliates, and its and their directors, officers, shareholders, employees and agents, have not provided to Executive any financial, investment or other advice, and will not provide such advice to Executive, with respect to the deferral of compensation hereunder or any decision to make any particular notional investment. Executive bears the full risk that any or all such investments may decline in value or fail to appreciate at a rate deemed satisfactory by Executive. Executive is solely responsible for determining the suitability of such investments. The Company recommends that Executive consult with his own investment advisors regarding financial or investment decisions relating to the Deferral Account.

     (d) Other Risks. The Company, its parent, subsidiaries and affiliates, and its and their directors, officers, shareholders, employees and agents, have not provided to Executive any financial planning, estate-planning, tax, legal or other advice, and will not provide such advice to Executive, with respect to the deferral of compensation hereunder. Executive bears these risks fully with respect to deferrals of compensation hereunder.

     4. Distributions. The Deferral Account will be distributed in accordance with this Section 4, subject to Executive’s right to file a different distribution election under Section 4(e) on or before December 31, 2006. References to the balance in the Deferral Account refer to the balance at the time of a given distribution:

     (a) Distributions Elected by Executive. As of the effective date of this amended and restated Agreement, Executive has elected, and the Company agrees to distribute, the Deferral Account as follows, subject to earlier distribution as provided in Section 4(b), (c) and (d) below:

(i)	100% of the Deferral Account balance will be distributed at the date six months after termination of Executive’s employment with the Company and its parent and subsidiaries for any reason other than death in a transaction constituting a “separation from service” within the meaning of PTR § 1.409A-1(h) (or a successor regulation thereto) (“Termination”); and
(ii)	0% of the Deferral Account balance will be distributed in ___[up to ten] installments, such installments to be paid on the first business day of each January following Termination except that the first installment will be on the later of the first business day of January following Termination or the date six months after Termination.

     (b) Change in Control. In the event of a Change in Control, as defined below, the Company may determine to terminate this Agreement (and the deferral plan governed by this Agreement) and to make a distribution in full of the Deferral Account. Such determination may be made only by the Board of Directors of Jefferies Group, Inc. in accordance with PTR § 1.409A-3(h)(2)(viii)(B) (and any successor regulation thereto) and prior to the consummation of the transaction that constitutes a Change in Control. The distribution shall be made within the time specified in PTR § 1.409A-3(h)(2)(viii)(B) (and any successor regulation thereto). For

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purposes of this Agreement, a “Change in Control” shall mean a change in the ownership or effective control of Jefferies Group, Inc. (or its successor corporation), or in the ownership of a substantial portion of the assets of Jefferies Group, Inc. (or its successor corporation), within the meaning of Code Section 409A(a)(2)(A)(v) and regulations thereunder (including PTR § 1.409A-3(a)(5) & § 1.409A-3(g)(5) and any successor regulation thereto).

     (c) Death. In the event of the death of Executive, the Company will pay the balance of the Deferral Account to the beneficiary or beneficiaries designated by Executive or, if Executive has made no such designation or no beneficiary survives, to Executive’s estate. In either case, such payment will be made in a single sum at the date three months following the date of Executive’s death but only if, and not earlier than, such time as (i) the Company shall have received documentation reasonably satisfactory to the Company establishing the right of the payee to receive the distribution hereunder, and (ii), if an installment distribution was due within the period between death and such payment, such distribution shall be duly made at the specified date. Any designation of a beneficiary other than Executive’s spouse must be consented to by the spouse.

     (d) Withdrawal Upon Unforeseeable Emergency. Executive and, after Executive’s death, any beneficiary shall have the right to withdraw the balance in the Deferral Account in the event of an unforeseeable emergency, but only if all of the conditions of Code Section 409A(a)(2)(B) are satisfied. A withdrawal is deemed a distribution for purposes of this Agreement.

     (e) Change in Distribution Date Elected in 2005. Executive may, prior to December 31, 2006, elect distribution dates different from those specified in this Section 4 by delivering to the Company a written and signed document setting forth a new election of distribution dates, provided that (i) any change in distribution dates will be permitted only to the extent permitted under, and in accordance with, PTR § 1.409A, Preamble § XI.C & Notice 2005-1, Q/A 19(c); (ii) any such election must elect distribution dates that in all cases comply with Code Section 409A and regulations thereunder; and (iii) no distribution may be elected for a distribution date prior to Termination except if and to the extent that the distribution will not result in a loss of tax deductibility for the distributed amount under Code Section 162(m), in the reasonable opinion of the Company, so that all distributed amounts hereunder remain fully tax deductible by the Company and its parent.

     (f) Redeferral of Deferral Account. After 2006, at least 12 months prior to the earliest distribution under Section 4(a), Executive, while still an employee of the Company or its parent or a subsidiary, may elect to defer the amounts credited to the Deferral Account for an additional period of at least five years, but only if all of the conditions of Code Section 409A(a)(4)(C) are satisfied. An election to extend the Deferral Period shall be made in the manner prescribed by the Company.

     (g) Form of Payment. The Company will pay any distribution in cash, except that the Company may elect to distribute assets that match a notional investment of Executive to settle the portion of Executive’s Deferral Account deemed invested in such notional investment vehicle at the date of distribution.

     5. Indemnification. Executive agrees to indemnify, defend and hold harmless, to the fullest extent permitted by law, the Company, its parent, subsidiaries and affiliates, and its and their respective directors, officers, shareholders, employees and agents from and against any and all claims, liability, damages, costs (including, but not limited to, attorneys’ fees), and other

4

causes of action arising from Executive’s deferral of compensation governed by this Agreement, any negative consequence to Executive (including unsatisfactory performance or returns from investments), any breach by Executive of this Agreement, or any action or failure to act by Executive relating to the Deferral Account.

     6. Other Provisions.

     (a) Deferred Compensation Provisions Applicable. The following provisions of the Jefferies Group, Inc. Deferred Compensation Plan, as in effect at the date of this Agreement, shall apply to this Agreement:

• Section 8.1 (Unsecured Claims)

• Section 8.2 (Anti-alienation and Assignment)

• Section 8.3 (No Rights to Continued Employment)

• Section 8.4 (Administration)

• Section 8.6 (Governing Law)

For purposes of this Agreement, references in the Deferred Compensation Plan to the “Plan” shall be deemed to mean this Agreement, and defined terms used in the Deferred Compensation Plan provisions incorporated in this Agreement have meanings as defined elsewhere in the Deferred Compensation Plan.

     (b) Tax Withholding. The Company and its parent and subsidiaries will have the right to withhold from any amount payable hereunder and any other right to payment to Executive any withholding taxes resulting from or attributable to a distribution from the Deferral Account, and any other taxes relating to the Deferral Account.

     (c) Changes in Deferral Account Value and Distributions Not Compensation for Purposes of Other Plans. Amounts credited to Executive’s Deferral Account as investment returns and amounts distributed in settlement of such Deferral Account shall not be deemed to be compensation to Executive for purposes of calculating the amount of Executive’s benefits or contributions under a pension plan or retirement plan (qualified under Section 401(a) of the Internal Revenue Code) or any non-qualified supplemental retirement plan, the amount of life insurance payable under any life insurance plan, the amount of any disability benefit payments payable under any disability plan, or the amount of any severance payment or other payment or benefit under an employment agreement or compensation program or arrangement except to the extent specifically provided in such plan, employment agreement, program or arrangement (expressly referring to deferred compensation under this Agreement).

     (d) Compliance with Code Section 409A. All terms of this Agreement, the deferrals governed by this Agreement, and the Deferral Account are subject to Code Section 409A. Therefore, the elections and terms set forth or incorporated in this Agreement notwithstanding, if, under Code Section 409A or any other provision of the Code or regulations thereunder, as presently in effect or hereafter amended or promulgated (including Proposed Treasury Regulations), any elections or rights of Executive with respect to the Deferral Account or the deferrals hereunder would result in Executive’s constructive receipt of income (for income tax purposes) relating to the Deferral Account or a tax penalty prior to the actual distribution of the Deferral Account by the Company, such elections or rights shall be automatically modified and limited to the extent necessary such that Executive will not be deemed to be in constructive receipt of such income or subject to a tax penalty prior to the actual distribution. The Company

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shall have no authority to accelerate any distribution hereunder except to the extent permitted under Code Section 409A and regulations thereunder.

Dated this 29^th day of December, 2005.

JEFFERIES & COMPANY, INC.
By:	/s/ Joseph A. Schenk
	Title: Executive Vice President
Executive’s Signature:
/s/ Richard B. Handler
Richard B. Handler

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EX-12.1

EXHIBIT 12.1

JEFFERIES GROUP, INC. AND SUBSIDIARIES
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
(Amounts in thousands, except for per share amounts)

	Year Ended December 31,
	2005		2004		2003		2002		2001
Fixed Charges:
Interest expense on long-term indebtedness	$	47,669	$	40,256	$	23,987	$	23,419	$	12,035
Interest portion of rent expense		11,653		9,437		7,636		6,037		5,105
Total fixed charges	$	59,322	$	49,693	$	31,623	$	29,456	$	17,140
Earnings:
Earnings before income taxes and minority interest	$	268,407	$	226,989	$	144,533	$	103,692	$	102,652
Total fixed charges		59,322		49,693		31,623		29,456		17,140
Total earnings	$	327,729	$	276,682	$	176,156	$	133,148	$	119,792
Ratio of Earnings to Fixed Charges (1)		5.5		5.6		5.6		4.5		7.0

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

EX-21

Exhibit 21

Subsidiaries of Jefferies Group, Inc.

(excludes certain subsidiaries pursuant to Item 601 of Regulation S-K)

Name	Place of Formation / Incorporation
Jefferies & Company, Inc.	Delaware
Jefferies Advisers, Inc.	Delaware
Jefferies Asset Management, LLC	Delaware
Jefferies Asset Management (Zurich)	Switzerland
Jefferies Asset Management Japan Limited	England & Wales
Jefferies Capital Management, Inc.	Delaware
Jefferies Execution Services, Inc.	California
Jefferies Financial Products, LLC	Delaware
Jefferies International Limited	England & Wales
Jefferies Investment Advisers, LLC	Delaware
Jefferies International (Holdings) Limited	England & Wales
Jefferies Investment Management Limited	England & Wales
Jefferies (Japan) Limited	England & Wales
Jefferies Pacific Limited	Hong Kong
Jefferies (Switzerland) Limited	Switzerland

EX-23

EXHIBIT 23

Independent Registered Public Accounting Firm’s Consent

The Board of Directors and Stockholders
JEFFERIES GROUP, INC.:

We consent to incorporation by reference in the Registration Statements No. 333-84079 dated July 29, 1999, and No. 333-107014 dated July 14, 2003, on Form S-8, No. 333-74723 on Form S-4, No. 333-81354 dated January 24, 2002, and No. 333-107032 dated July 15, 2003 and August 22, 2003, on Form S-3, No. 333-130325 dated December 14, 2005 on Form S-3ASR, and No. 001-14947 dated April 20, 1999 on Form 10 of Jefferies Group, Inc. of our reports dated February 28, 2006, relating to the consolidated statements of financial condition of Jefferies Group, Inc. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of earnings, changes in stockholders’ equity and comprehensive income and cash flows for each of the years in the three-year period ended December 31, 2005, management’s assessment of the effectiveness of internal control over financial reporting as of December 31, 2005 and the effectiveness of internal control over financial reporting as of December 31, 2005, which reports appear in the December 31, 2005 annual report on Form 10-K of Jefferies Group, Inc.

/s/ KPMG LLP

New York, New York
February 28, 2006

EX-31.1

Exhibit 31.1

RULE 13a-14(a)/15d-14(a)
CERTIFICATION BY CHIEF FINANCIAL OFFICER

I, Joseph A. Schenk, certify that:

1. I have reviewed this annual report on Form 10-K of Jefferies Group, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

By: /s/   Joseph A. Schenk

Joseph A. Schenk

Chief Financial Officer

Date: February 28, 2006

EX-31.2

Exhibit 31.2

RULE 13a-14(a)/15d-14(a)
CERTIFICATION BY CHIEF EXECUTIVE OFFICER

I, Richard B. Handler, certify that:

1. I have reviewed this annual report on Form 10-K of Jefferies Group, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

By: /s/  Richard B. Handler

Richard B. Handler

Chief Executive Officer

Date: February 28, 2006

EX-32

Exhibit 32

Rule 13a-14(b)/15d-14(b) and Section 1350 of Title 18 U.S.C.
CERTIFICATION BY THE CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER

I, Richard B. Handler, Chief Executive Officer, and I, Joseph A. Schenk, Chief Financial Officer, of Jefferies Group, Inc, a Delaware corporation (the “Company”), each hereby certifies, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge:

(1) The Company’s periodic report on Form 10-K for the year ended December 31, 2005 (the “Form 10-K”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Form 10-K fairly presents, in all material respects, the financial condition and results of operations of the Company.

* * *

CHIEF EXECUTIVE OFFICER


/s/  Richard B. Handler
Richard B. Handler


Date: February 28, 2006 CHIEF FINANCIAL OFFICER


/s/  Joseph A. Schenk
Joseph A. Schenk


Date: February 28, 2006

A signed original of this written statement required by Section 906 has been provided to Jefferies Group, Inc. and will be retained by Jefferies Group, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.