10-K 1 d438142d10k.htm FORM 10-K FORM 10-K
Table of Contents

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-K

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

For the fiscal year ended November 30, 2012

OR

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

For the transition period from                      to                     

Commission File Number: 1-14947

JEFFERIES GROUP, INC.

(Exact name of registrant as specified in its charter)

 

Delaware   95-4719745

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

520 Madison Avenue,

New York, New York

  10022
(Address of principal executive offices)   (Zip Code )

Registrant’s telephone number, including area code:

(212) 284-2550

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  x        No  ¨

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  ¨        No  x

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x         No  ¨

Indicate by check mark 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.    ¨

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

 

Large accelerated filer  x   Accelerated filer  ¨    Non-accelerated filer  ¨   Smaller Reporting company  ¨

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

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. $1,864,244,506 as of May 31, 2012.

Indicate the number of shares outstanding of the registrant’s class of common stock, as of the latest practicable date. 203,799,188 shares as of the close of business on January 9, 2013.

 

 

 

 


Table of Contents

JEFFERIES GROUP, INC.

2012 FORM 10-K ANNUAL REPORT

TABLE OF CONTENTS

 

  PART I   

Item 1.

  Business    1

Item 1A.

  Risk Factors    7

Item 1B.

  Unresolved Staff Comments    14

Item 2.

  Properties    14

Item 3.

  Legal Proceedings    14

Item 4.

  Mine Safety Disclosures    15
  PART II   

Item 5.

  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities    16

Item 6.

  Selected Financial Data    19

Item 7.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations    21

Item 7A.

  Quantitative and Qualitative Disclosures About Market Risk    73

Item 8.

  Financial Statements and Supplementary Data    74

Item 9.

  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure   

164

Item 9A.

  Controls and Procedures   

164

Item 9B.

  Other Information   

164

  PART III   

Item 10.

  Directors, Executive Officers and Corporate Governance   

165

Item 11.

  Executive Compensation   

168

Item 12.

  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters   

192

Item 13.

  Certain Relationships and Related Transactions, and Director Independence   

195

Item 14.

  Principal Accountant Fees and Services   

198

  PART IV   

Item 15.

  Exhibits and Financial Statement Schedules   

199


Table of Contents

JEFFERIES GROUP, INC. AND SUBSIDIARIES

PART I

 

Item 1. Business.

Introduction

Jefferies Group, Inc. and its subsidiaries operate as a global full service, integrated securities and investment banking firm. Our principal operating subsidiary, Jefferies & Company, Inc. (“Jefferies”), was founded in the U.S. in 1962 and our first international operating subsidiary, Jefferies International Limited, was established in the U.K. in 1986. On November 12, 2012, we agreed to merge with Leucadia National Corporation (“Leucadia”), a diversified holding company. The transaction is expected to close during the first quarter of 2013 and is subject to customary closing conditions, including approval to effect the merger by both Leucadia’s shareholders and our shareholders. Upon the merger, we will continue to operate in our current form and our Chairman and Chief Executive Officer and Chairman of the Executive Committee will remain in their current roles with respect to Jefferies Group, Inc. while assuming the roles of Chief Executive Officer and President, respectively, at Leucadia.

Since 2000, we have grown considerably and become increasingly diversified, increasing our market share and the breadth of our business. Our growth has been achieved through the ongoing addition of talented personnel in targeted areas, as well as the acquisition of complementary businesses. As of November 30, 2012, we had 3,804 employees in the U.S., Europe, the Middle East and Asia. Our global headquarters and executive offices are located at 520 Madison Avenue, New York, New York 10022. We also have regional headquarters offices in London and Hong Kong. Our primary telephone number is (212) 284-2550 and our Internet address is jefferies.com.

The following documents and reports are available on our public website:

 

   

Code of Ethics;

 

   

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

 

   

Board of Directors Corporate Governance Guidelines;

 

   

Charter of the Audit Committee of the Board of Directors;

 

   

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

 

   

Charter of the Compensation Committee of the Board of Directors;

 

   

Annual and interim reports on Form 10-K;

 

   

Quarterly reports on Form 10-Q;

 

   

Current reports on Form 8-K;

 

   

Beneficial ownership reports on Forms 3, 4 and 5; and

 

   

Any amendments to the above-mentioned documents and reports.

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

 

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JEFFERIES GROUP, INC. AND SUBSIDIARIES — (Continued)

 

Business Segments

We currently operate in two business segments, Capital Markets and Asset Management. Our Capital Markets reportable segment, which represents principally our entire business, consists of our securities and commodities trading activities (including the results of our indirectly partially owned subsidiary, Jefferies High Yield Trading, LLC), and our investment banking activities. The Capital Markets reportable segment provides the sales, trading and/or origination and execution effort for various equity, fixed income, commodities, foreign exchange and advisory products and services. The Asset Management segment includes asset management activities and related services.

Financial information regarding our reportable business segments as of November 30, 2012, November 30, 2011 and November 30, 2010 is set forth in Note 23, Segment Reporting, in our consolidated financial statements and is incorporated herein by reference.

Our Businesses

Capital Markets

Our Capital Markets segment includes our Equities, Fixed Income and Investment Banking businesses. We primarily serve institutional investors, corporations and government entities.

Equities

Equities Research, Sales & Trading

We operate a full-service, client-focused equities research, sales and trading business across global securities markets. We earn commissions or spread revenue by executing transactions for clients across these markets in equity and equity-related products, including common stock, American depository receipts, global depository receipts, exchange-traded funds, exchange-traded equity options, convertible products and closed-end funds. Our primary competitors are U.S. and non-U.S. bank holding companies. We act as agent or principal (including as a market-maker) when executing client transactions via traditional “high-touch” and electronic “low-touch” channels. In order to facilitate client transactions, we may act as principal to provide liquidity which requires the commitment of our capital and maintenance of dealer inventory.

Our equity research, sales and trading efforts are organized across three geographical regions: the Americas; Europe, the Middle East, and Africa (EMEA); and Asia Pacific. Our main product lines within the regions are cash equities, electronic trading, derivatives and convertibles. Our clients are primarily institutional market participants such as mutual funds, hedge funds, investment advisors, pension and profit sharing plans, and insurance companies. Through our global research team and sales force, we maintain relationships with our clients, distribute investment research, trading ideas, market information and analyses across a range of industries and receive and execute client orders. Our research covers over 1,560 individual companies around the world.

Equity Finance

Our Equity Finance business provides financing, securities lending and other prime brokerage services.

We offer prime brokerage services in the U.S. that provide hedge funds, money managers and registered investment advisors with execution, financing, clearing, reporting and administrative services. We finance our

 

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clients’ securities positions through margin loans that are collateralized by securities, cash or other acceptable liquid collateral. We earn an interest spread equal to the difference between the amount we pay for funds and the amount we receive from our clients. We also operate a matched book in equity and corporate bond securities, whereby we borrow and lend securities versus cash or liquid collateral and earn a net interest spread.

Customer assets (securities and funds) held by us are segregated in accordance with regulatorily mandated customer protection rules. We do not comingle customer and firm principal assets or rely on customer free credit balances to finance firm principal positions. We offer selected prime brokerage clients with the option of custodying their assets at an unaffiliated U.S. broker-dealer that is a subsidiary of a bank holding company. Under this arrangement, we provide our clients directly all customary prime brokerage services other than custody.

Wealth Management

We provide tailored wealth management services designed to meet the needs of high net worth individuals, their families and their businesses, private equity and venture funds and small institutions. Our advisors provide access to all of our institutional execution capabilities and deliver other financial services. Our open architecture platform affords clients with access to products and services from both our firm and from a variety of other major financial services institutions.

Fixed Income

Our Fixed Income business consists of fixed income sales and trading, as well as commodities, listed futures, foreign exchange and over-the-counter derivative trading activities.

Fixed Income Sales and Trading

Our fixed income effort encompasses the sales and trading of investment grade and high yield corporate bonds, U.S. and European government and agency securities, municipal bonds, mortgage- and asset-backed securities, whole loans, leveraged loans, high yield and distressed securities and emerging markets debt. Jefferies is designated as a Primary Dealer by the Federal Reserve Bank of New York, and Jefferies International Limited, our U.K. regulated broker-dealer, is designated in similar capacities for numerous government bond issuers in Europe, and trades a broad spectrum of other European government bonds. Additionally, through the use of repurchase agreements, we act as an intermediary between borrowers and lenders of short-term funds and provide funding for various inventory positions.

Within the U.S., our high yield activities are primarily conducted through Jefferies High Yield Trading, LLC, which is a registered broker-dealer and a wholly owned subsidiary of Jefferies High Yield Holdings, LLC (“JHYH”). We own voting and nonvoting interests in JHYH and have entered into management, clearing, and other services agreements with JHYH. We and Leucadia National Corporation each have the right to nominate two of a total of four directors to JHYH’s board of directors. Two funds managed by us, Jefferies Special Opportunities Fund (“JSOP”) and Jefferies Employees Special Opportunities Fund (“JESOP”), are also investors in JHYH.

Our strategists and economists provide ongoing commentary and analysis of the global fixed income markets. In addition, our fixed income research professionals, including research and desk analysts, provide investment ideas and analysis across a variety of fixed income products.

 

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Futures, Foreign Exchange and Commodities

Our global commodities business, Jefferies Bache, provides 24-hour global coverage, with direct access to major commodity and financial futures exchanges including the CME, CBOT, NYMEX, ICE, NYSE Euronext, LME and Eurex and provides 24-hour global coverage, execution, clearing and market making in futures, options and derivatives on industrial metals including aluminum, copper, nickel, zinc, tin and lead. Products provided to clients include LME and CME futures and over-the-counter metals swaps and options.

We provide a full-service trading desk in all precious metals, cash, futures and exchange-for-physicals markets, and are a market maker providing execution and clearing services as well as market analysis. Jefferies Bache also provides prime brokerage services and is an authorized coin distributor of the U.S. Mint.

In addition, Jefferies Bache is a market-maker providing operational support in foreign exchange spot, forwards, swaps and options across major currencies and emerging markets globally.

Investment Banking

We offer our clients a full range of financial advisory services, as well as equity, debt and equity-linked capital raising services.

Over 800 investment banking professionals operate in the Americas, Europe and Asia, and are organized into industry, product and geographic coverage groups. Sector coverage groups include Aerospace and Defense, Business Services, CleanTech, Consumer and Retail, Energy, Financial Institutions, Financial Sponsors, Gaming, General Industrials, Healthcare, Maritime, Media, Mining and Metals, Public Finance, Real Estate, Technology and Telecommunications.

Equity Capital Markets

We originate and sell direct placements, private equity, private placements, initial public offerings and follow-on offerings of equity and equity-linked convertible securities.

Debt Capital Markets

We offer a range of debt financing for companies, governmental entities and financial sponsors. We focus on structuring and distributing public and private debt in leveraged finance transactions, including investment grade and high yield corporate debt, leveraged buyouts, acquisitions, growth capital financings, mortgage-related and asset-backed securities, municipal securities, public finance, recapitalizations and Chapter 11 exit financings.

Advisory Services

We offer companies mergers and acquisitions, recapitalization and restructuring and other financial advisory services. We advise buyers and sellers on sales, divestitures, acquisitions, mergers, tender offers, joint ventures, strategic alliances and takeover defenses. We facilitate and finance acquisitions and recapitalizations on both buyside and sellside mandates. Our service to our clients includes leveraging our industry knowledge, extensive relationships, and capital markets and restructuring expertise.

We offer advisory services in connection with exchange offers, consent solicitations, capital raising, and distressed mergers and acquisitions. We provide advice and support in the structuring, valuation and placement of securities issued in recapitalizations and restructurings. We represent issuers, bondholders and creditors, as well as buyers and sellers of assets.

 

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Asset Management

We provide investment management services to private investment funds, separate accounts (such as for pension funds, insurance companies and other institutional investors) and mutual funds. Our primary asset management programs are commodity asset management strategies, strategic investment programs and convertible bond strategies.

Our commodity asset management strategies are provided through CoreCommodity Management, LLC (formerly known as Jefferies Asset Management, LLC), which is registered as an investment advisor with the SEC and as a commodity trading advisor with the Commodity Futures Trading Commission and is a member of the National Futures Association.

Our strategic investment programs, including our Structured Alpha Program, are provided through the Strategic Investments Division of Jefferies Investment Advisers, LLC, which is registered as an investment adviser with the SEC. These programs are systematic, multi-strategy, multi-asset class programs with the objective of generating a steady stream of absolute returns irrespective of the direction of major market indices or phase of the economic cycle. These strategies are provided through both long-short equity private funds and separately managed accounts.

Our convertible bond strategies are provided through Jefferies (Switzerland) Limited, which is licensed by the Swiss Financial Market Supervisory Authority. These strategies are long only investment solutions in global convertible bonds offered to pension funds, insurance companies and private banking clients.

Competition

All aspects of our business are intensely competitive. We compete primarily with bank holding companies, but also with firms listed in the AMEX Securities Broker/Dealer Index, other brokers and dealers, and boutique investment banking firms. Large bank holding companies have substantially greater capital and resources than we do. We believe that the principal factors affecting our competitive standing include the quality, experience and skills of our professionals, the depth of our relationships, the breadth of our service offerings and our tenacity and commitment to serve our clients.

Regulation

Regulation In the United States.    The financial services industry in which we operate is subject to extensive regulation. In the U.S., the Securities and Exchange Commission (“SEC”) is the federal agency responsible for the administration of federal securities laws, and the Commodity Futures Trading Commission (“CFTC”) is the federal agency responsible for the administration of commodity futures laws. In addition, self-regulatory organizations, principally Financial Industry Regulatory Authority (“FINRA”), are actively involved in the regulation of broker-dealers. The SEC and self-regulatory organizations conduct periodic examinations of broker-dealers. Securities firms are also subject to regulation by state securities commissions and attorneys general in those states in which they do business.

Broker-dealers are subject to regulations that cover all aspects of the securities business, including sales and trading methods, trade practices among broker-dealers, use and safekeeping of customers’ funds and securities, capital structure of securities firms, anti-money laundering efforts, recordkeeping and the conduct of directors, officers and employees. Registered advisors are subject to regulations including marketing, transactions with affiliates, disclosure to clients, and recordkeeping; and advisors that are also registered as commodity trading advisors or commodity pool operators are also subject to regulation by the CFTC and the National Futures

 

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Association (“NFA”). Additional legislation, changes in rules promulgated by the SEC and self-regulatory organizations, or changes in the interpretation or enforcement of existing laws and rules may directly affect the operations and profitability of broker-dealers. Futures commission merchants (“FCMs”) that engage in commodities and futures transactions, are subject to regulation by the CFTC and the NFA. The SEC, self-regulatory organizations, state securities commissions, state attorneys general, the CFTC and the NFA may conduct administrative proceedings or initiate civil litigation that can result in censure, fine, suspension, expulsion of a firm, its officers or employees, or revocation of a firm’s licenses.

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) was enacted in the United States. Implementation of the Dodd-Frank Act is to be accomplished through extensive rulemaking by the SEC and other governmental agencies. The Dodd-Frank Act also mandates the preparation of studies on a wide range of issues. These studies could lead to additional regulatory changes. For additional information see Item 1A. Risk Factors – “Recent legislation and new and pending regulation may significantly affect our business.”

Net Capital Requirements.    U.S. registered broker-dealers are subject to the SEC’s Uniform Net Capital Rule (the “Net Capital Rule”), which specifies minimum net capital requirements. Jefferies Group is not a registered broker-dealer and is therefore not subject to the Net Capital Rule; however, its United States broker-dealer subsidiaries are registered and are subject to the Net Capital Rule, which provides that a broker-dealer shall not permit its aggregate indebtedness to exceed 15 times its net capital (the “basic method”) or, alternatively, that it not permit its net capital to be less than the greater of 2% of its aggregate debit balances (primarily receivables from customers and broker-dealers) or $250,000 ($1.5 million for prime brokers) computed in accordance with such Net Capital Rule (the “alternative method”). Jefferies, Jefferies Execution Services, Inc. (“Jefferies Execution”) and Jefferies High Yield Trading, LLC (“JHYT”) use the alternative method of calculation. (See Net Capital within Item 7. Management’s Discussion and Analysis and Note 22, Net Capital Requirements in this Annual Report on Form 10-K for additional discussion of net capital calculations.)

Compliance with the Net Capital Rule could limit operations of our broker-dealers, 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, Jefferies Execution, or JHYT to us. U.S. registered FCMs are subject to the CFTC’s “minimum financial requirements for futures commission merchants and introducing brokers.” Jefferies Group is not a registered FCM nor a registered Introducing Broker, and is therefore not subject to the minimum financial requirements; however, Jefferies Bache, LLC, a United States FCM subsidiary, is registered and subject to the minimum financial requirements. Under the minimum financial requirements, an FCM must maintain adjusted net capital equal to or in excess of the greater of (A) $1,000,000 or (B) the FCM’s risk-based capital requirements totaling (1) eight percent of the total risk margin requirement for positions carried by the FCM in customer accounts, plus (2) eight percent of the total risk margin requirement for positions carried by the FCM in noncustomer accounts. An FCM’s ability to make capital and certain other distributions is subject to the rules and regulations of various exchanges, clearing organizations and other regulatory agencies which may have capital requirements that are greater than the CFTC’s. Further, Jefferies is a registered Introducing Broker. Under the minimum financial requirements, an Introducing Broker must maintain adjusted net capital equal to or in excess of the greater of (A) $45,000 or (B) since Jefferies is also a registered broker-dealer, the amount of net capital required by the SEC’s Net Capital Rule. An Introducing Broker’s ability to make capital and certain other distributions is subject to the rules and regulations of various exchanges, clearing organizations and other regulatory agencies which may have capital requirements that are greater than the CFTC’s.

Regulation Outside the United States.    We are an active participant in the international fixed income and equity markets, engage in commodity futures brokerage and provide investment banking services throughout the world, but primarily in Europe and Asia. As is true in the U.S., our subsidiaries are subject to comprehensive regulations promulgated and enforced by, among other regulatory bodies, the U.K. Financial Services Authority,

 

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the Hong Kong Securities and Futures Commission and the Monetary Authority of Singapore. Every country in which we do business imposes upon us laws, rules and regulations similar to those in the U.S., including with respect to some form of capital adequacy rules, customer protection rules, anti-money laundering and anti-bribery rules, compliance with other applicable trading and investment banking regulations and similar regulatory reform packages in response to the credit and liquidity crisis of 2007 and 2008. For additional information see Item 1A. Risk Factors — “Extensive international regulation of our business limits our activities, and, if we violate these regulations, we may be subject to significant penalties.”

 

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 specific factors mentioned in this report, we may also be affected by other factors that affect businesses generally such as global or regional changes in economic or business conditions, acts of war, terrorism and natural disasters.

Recent legislation and new and pending regulation may significantly affect our business.

Recent market and economic conditions have led to legislation and regulation affecting the financial services industry. These legislative and regulatory initiatives will affect not only us, but also our competitors and certain of our clients. These changes could eventually have an effect on our revenue and profitability, limit our ability to pursue certain business opportunities, impact the value of assets that we hold, require us to change certain business practices, impose additional costs on us, and otherwise adversely affect our business. Accordingly, we cannot provide assurance that new legislation and regulation will not eventually have an adverse effect on our business, results of operations, cash flows and financial condition.

The Dodd-Frank Act was signed into law on July 21, 2010. Title VII of the Dodd-Frank Act and the rules and regulations adopted and to be adopted by the SEC and CFTC introduce a comprehensive regulatory regime for swaps and security-based swaps (both of which are defined terms). We are required to register two of our subsidiaries as swap dealers with the CFTC by January 30, 2013 and may register one or more subsidiaries as security-based swap dealers with the SEC. The new laws and regulations will subject certain swaps and security-based swaps to clearing and exchange trading requirements, and will subject swap dealers and security-based swap dealers to significant new burdens, including (i) capital and margin requirements, (ii) reporting, recordkeeping and internal business conduct requirements, (iii) external business conduct requirements in dealings with swap counterparties (which are particularly onerous when the counterparty is a special entity such as a federal, state, or municipal entity, an ERISA plan, a government employee benefit plan or an endowment), and (iv) large trader position reporting and certain position limit requirements. The final rules under Title VII, including those rules that have already been adopted, for both cleared and uncleared swap transactions will impose increased capital and margin requirements on our registered entities and require additional operational and compliance costs and resources that will likely affect our business.

Section 619 of the Dodd-Frank Act (Volcker Rule) and section 716 of the Dodd-Frank Act (swaps push-out rule) limit proprietary trading of certain securities and swaps by banking entities such as banks, bank holding companies and similar institutions. Although we are not a banking entity and are not otherwise subject to these rules, some of our clients and many of our counterparties are affiliated with bank holding companies and will be subject to these restrictions. These sections of the Dodd-Frank Act and the regulations that are adopted to implement them could negatively affect the swaps and securities markets by reducing their depth and liquidity

 

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and thereby affect pricing in these markets. Other negative effects could result from an expansive extraterritorial application of the Dodd-Frank Act in general or the Volcker Rule in particular and/or insufficient international coordination with respect to adoption of rules for derivatives in other jurisdictions. We will not know the exact impact that these changes in the markets will have on our business until after the final rules are implemented.

The Dodd-Frank Act, in addressing systemic risks to the financial system, charges the Federal Reserve with drafting enhanced regulatory requirements for systemically important bank holding companies and certain other nonbank financial companies designated as systemically important by the Financial Stability Oversight Council. The enhanced requirements proposed by the Federal Reserve include capital requirements, liquidity requirements, limits on credit exposure concentrations and risk management requirements. We do not believe that we will be deemed to be a systemically important nonbank financial company under the new legislation and therefore will not be directly impacted. However, there will be an indirect impact to us as the new regulations will most likely effect our competitors, counterparties and certain of our clients.

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

The financial services industry is subject to extensive laws, rules and regulations in every country in which we operate. Firms that engage in securities and derivatives trading, commodity futures brokerage, wealth and asset management and investment banking must comply with the laws, rules and regulations imposed by the governing country, state, regulatory bodies and self-regulatory bodies with governing authority over such activities. Such laws, rules and regulations cover all aspects of the financial services business, including, but not limited to, sales and trading methods, trade practices, use and safekeeping of customers’ funds and securities, capital structure, anti-money laundering and anti-bribery and corruption efforts, recordkeeping and the conduct of directors, officers and employees.

Each of our regulators supervises our business activities to monitor compliance with such laws, rules and regulations in the relevant jurisdiction. In addition, if there are instances in which our regulators question our compliance with laws, rules, and regulations, they may investigate the facts and circumstances to determine whether we have complied. At any moment in time, we may be subject to one or more such investigation or similar reviews. At this time, all such investigations, and similar reviews are insignificant in scope and immaterial to us. However, there can be no assurance that, in the future, the operations of our businesses will not violate such laws, rules, and regulations and that related investigations and similar reviews could result in adverse regulatory requirements, regulatory enforcement actions and/or fines.

Additional legislation, changes in rules, changes in the interpretation or enforcement of existing laws and rules, or the entering into businesses that subject us to new rules and regulations may directly affect our business, results of operations and financial condition.

In the UK, our primary regulator, the UK Financial Services Authority (“FSA”), has adopted a “twin peaks” model with a clear internal separation of conduct of business and prudential regulation. This move mirrors the UK government’s intention to transfer prudential supervision of the more systemically important institutions from the FSA to the Prudential Regulation Authority (“PRA”), a subsidiary of The Bank of England, and for the FSA (to be renamed the Financial Conduct Authority (“FCA”)) to focus on consumer protection and market regulation as well as prudential supervision of all other regulated financial institutions. It is currently expected that this transfer will take place in April 2013. The Financial Services Bill, which will formally establish the PRA and FCA, is currently making its way through Parliament. Our regulated UK subsidiaries, Jefferies International Limited, Jefferies Investment Management Limited and Jefferies Bache Limited, are maintaining a close dialogue with the FSA as it implements these changes.

 

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We continue to monitor the impact that the Basel Accords will have on us. The latest update issued by the Basel Committee on Banking Supervision in December 2010, known as Basel III, has recommended strengthening capital and liquidity rules. In response, the European Commission is in the process of implementing amendments to its Capital Requirements Directive known as CRD IV. Changes under CRD IV are expected to start to come into effect in late 2013 or early 2014 and we continue to monitor the potential impact on our UK subsidiaries.

The European Market Infrastructure Regulation (“EMIR”) came into force in August 2012 and will be effective in the UK in early 2013. In common with the Dodd-Frank Act in the US, these rules are intended, amongt other things, to reduce counterparty risk by requiring that all standardized over-the-counter derivatives are cleared through a central counterparty. We are reviewing EMIR and the related technical standards published by the European Securities and Markets Authority to assess the impact on us.

We are also reviewing the draft texts of the amendments to the Markets in Financial Instruments Directive and the Markets in Financial Instruments Regulation to assess the impact both pieces of legislation are likely to have on our business when they come into force in 2013 or 2014. Amongt other things, the legislation will require certain over-the-counter derivatives to be traded on exchanges and other electronic trading platforms.

We could be adversely affected if our merger with Leucadia National Corporation is not consummated.

On November 11, 2012, we and certain merger-related subsidiaries agreed to a series of merger transactions whereby we would become a wholly owned subsidiary of Leucadia. These transactions, which are expected to close during the first quarter of 2013, are subject to customary closing conditions, including approval by both Leucadia’s and our shareholders. As part of the transactions, we will be converted from a corporation to a limited liability company organized under the laws of the State of Delaware. Leucadia will not assume or guarantee any of Jefferies’ outstanding debt securities, but Jefferies’ 3.875% Convertible Senior Debentures due 2029 will become convertible into common shares of Leucadia following the merger transactions. If not redeemed, Jefferies’ 3.25% Series A Convertible Cumulative Preferred Stock will be exchanged for a comparable series of convertible preferred shares of Leucadia. Jefferies will retain a credit rating separate from Leucadia’s.

In addition to approval by both Leucadia and our shareholders, the closing of the transactions is subject to a number of other conditions that make the completion and timing of the completion of the transactions uncertain. If the transactions are not completed on a timely basis, or at all, our businesses may be adversely affected and, without realizing any of the benefits of having completed the transactions, we will be subject to a number of risks, including the following:

 

   

We will be required to pay our costs relating to the transactions, such as legal, accounting, financial advisory and printing fees, whether or not the transactions are completed.

 

   

We may be required to pay a termination fee plus out-of-pocket fees and expenses incurred by Leucadia.

 

   

Time and resources committed by our management and employees to matters relating to the transactions could otherwise have been devoted to pursuing other beneficial opportunities.

 

   

The market price of our common stock could decline to the extent that the current market price reflects a market assumption that the transactions will be completed.

 

   

If the merger agreement is terminated and our board of directors seeks another business combination, our stockholders cannot be certain that we will be able to find a party willing to enter into a merger agreement on terms equivalent to or more attractive than the terms that Leucadia has agreed to in connection with the transactions.

 

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JEFFERIES GROUP, INC. AND SUBSIDIARIES — (Continued)

 

Our merger with Leucadia National Corporation could be affected by certain litigation.

Seven putative class action lawsuits have been filed in New York and Delaware concerning the merger transactions whereby Jefferies Group, Inc. would become a wholly owned subsidiary of Leucadia. The class actions, filed on behalf of our shareholders, name as defendants Jefferies Group, Inc., the members of our board of directors, Leucadia and, in certain of the actions, certain merger-related subsidiaries. The actions allege that the directors breached their fiduciary duties in connection with the merger transactions by engaging in a flawed process and agreeing to sell Jefferies Group, Inc., for inadequate consideration pursuant to an agreement that contains improper deal protection terms. The actions allege that Jefferies Group, Inc. and Leucadia aided and abetted the directors’ breach of fiduciary duties and seek, among other things, an injunction barring the proposed transactions. We are unable to predict the outcome of this litigation, including whether it will affect the closing of the merger with Leucadia National Corporation.

Changing conditions in financial markets and the economy could result in decreased revenues, losses or other adverse consequences.

As a global securities and investment banking firm, global or regional changes in the financial markets or economic conditions 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 reduce the number and size of transactions in which we provide underwriting, financial advisory and other services. Our investment banking revenues, in the form of financial advisory and underwriting or placement fees, are directly related to the number and size of the transactions in which we participate and could therefore be adversely affected by unfavorable financial or economic conditions.

 

   

Adverse changes in the market could lead to losses from principal transactions on our inventory positions.

 

   

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 on our own capital invested in managed funds. Even in the absence of a market downturn, below-market investment performance by our funds and portfolio managers could reduce asset management revenues and assets under management and result in reputational damage that might make it more difficult to attract new investors.

 

   

Limitations on the availability of credit, such as occurred during 2008, can affect our ability to borrow on a secured or unsecured basis, which may adversely affect our liquidity and results of operations.

 

   

New or increased taxes on compensation payments such as bonuses or on balance sheet items may adversely affect our profits.

 

   

Should one of our competitors fail, our securities prices and our revenue could be negatively impacted based upon negative market sentiment causing customers to cease doing business with us and our lenders to cease loaning us money, which could adversely affect our business, funding and liquidity.

Unfounded allegations about us could result in extreme price volatility and price declines in our securities and loss of revenue, clients, and employees.

In November 2011, we became the subject of unfounded allegations and false rumors, including among others those relating to our exposure to European sovereign debt. Despite the fact that we were able to dispel

 

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such rumors, both our stock and bond prices were significantly impacted. Our common stock suffered a 20% sell-off in minutes and, consequently, its trading was temporarily suspended, and our debt-securities prices suffered not only extreme volatility but also record high yields. In addition, our operations were impacted as some clients either ceased doing business or temporarily slowed down the level of business they do, thereby decreasing our revenue stream. Although we were able to reverse the negative impact of such unfounded allegations and false rumors, there is no assurance that we will be able to do so successfully in the future and our potential failure to do so could have a material adverse effect on our business, financial condition and liquidity.

The downgrade of the U.S. credit rating and Europe’s debt crisis could have a material adverse effect on our business, financial condition and liquidity.

Standard & Poor’s lowered its long term sovereign credit rating on the United States of America from AAA to AA+ on August 5, 2011. A further downgrade or a downgrade by other rating agencies, including a Nationally Recognized Statistical Rating Organization, could have a material adverse impact on financial markets and economic conditions in the United States and worldwide. Any such adverse impact could have a material adverse effect on our business, financial condition and liquidity.

In addition, during 2011 and 2012, the possibility that certain European Union (“EU”) member states could have defaulted on their debt obligations negatively impacted economic conditions and global markets. The continued uncertainty over the outcome of international and the European Union’s financial support programs and the possibility that EU member states may experience similar financial troubles could disrupt global markets. The negative impact on economic conditions and global markets could also have a material adverse effect on our business, financial condition and liquidity.

A credit-rating agency downgrade could significantly impact our business.

Maintaining an investment grade credit rating is important to our business and financial condition. On October 16, 2012 Moody’s announced that it downgraded our credit rating from Baa2 to Baa3. We intend to access the capital markets and issue debt securities from time to time; and a decrease in our credit rating would not only increase our borrowing costs, but could also decrease demand for our debt securities and make a successful financing more difficult. In addition, in connection with certain over-the-counter derivative contract arrangements and certain other trading arrangements, we may be required to provide additional collateral to counterparties, exchanges and clearing organizations in the event of a credit rating downgrade. Such a downgrade could also negatively impact our stock and bond prices. There can be no assurance that our credit ratings will not be further downgraded by Moody’s or downgraded by other rating agencies.

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

A considerable portion of our revenues is derived from trading in which we act as principal. We may incur trading losses relating to the purchase, sale or short sale of fixed income, high yield, international, convertible, and equity securities and futures and commodities for our own account. In any period, we may experience losses on our inventory positions as a result of price fluctuations, 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, securities of issuers engaged in a specific industry, or securities from issuers located in a particular country or region. In general, because our inventory is marked to market on a daily basis, any adverse 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.

 

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Increased competition may adversely affect our revenues, profitability and staffing.

All aspects of our business are intensely competitive. We compete directly with a number of bank holding companies and commercial banks, other brokers and dealers, investment banking firms and other financial institutions. 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, bundling of products and services 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 employees we need to effectively operate our business.

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

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

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

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

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

 

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

Asset management revenue includes management and performance fees from funds and accounts managed by us, management and performance fees from related party managed funds and accounts and investment income (loss) from our investments in these funds, accounts and related party managed 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 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. Even in the absence of a market downturn, below market investment performance by our funds and portfolio managers could reduce asset management revenues and assets under management and result in reputational damage that might make it more difficult to attract new investors.

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 and introduce new products, 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 international operations subject us to numerous risks which could adversely impact our business in many ways.

Our business and operations are expanding globally. Wherever we operate, we are subject to legal, regulatory, political, economic and other inherent risks. The laws and regulations applicable to the securities and investment banking industries differ in each country. Our inability to remain in compliance with applicable laws and regulations in a particular country could have a significant and negative effect on our business and prospects in that country as well as in other countries. A political, economic or financial disruption in a country or region could adversely impact our business and increase volatility in financial markets generally.

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 codefendant 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. The expansion of our business, including increases in the number and size of investment banking transactions and our expansion into new areas impose 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 derivative transactions. These activities are transacted on a cash, margin or

 

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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 and the risk of counterparty nonperformance to the extent collateral has not been secured or the counterparty defaults before collateral or margin can be adjusted. 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. However, there can be no assurances that our risk controls will be successful.

Derivative transactions may expose us to unexpected risk and potential losses.

We are party to a number of derivative transactions that require us to deliver to the counterparty the underlying security, loan or other obligation in order to receive payment. In a number of cases, we do not hold the underlying security, loan or other obligation and may have difficulty obtaining, or be unable to obtain, the underlying security, loan or other obligation through the physical settlement of other transactions. As a result, we are subject to the risk that we may not be able to obtain the security, loan or other obligation within the required contractual time frame for delivery. This could cause us to forfeit the payments due to us under these contracts or result in settlement delays with the attendant credit and operational risk as well as increased costs to the firm.

 

Item 1B. Unresolved Staff Comments.

None

 

Item 2. Properties.

Our global executive offices and principal administrative offices are located at 520 Madison Avenue, New York, New York under an operating lease arrangement. We maintain additional offices throughout the world including, in the United States, Charlotte, Chicago, Houston, Los Angeles, San Francisco, Stamford, and Jersey City, and internationally, London, Zurich, Hong Kong, Frankfurt, Singapore, Tokyo and Mumbai. In addition, we maintain backup facilities with redundant technologies in Jersey City, New Jersey and Stamford, Connecticut. We lease all of our office space, which management believes is adequate for our business. For information concerning leasehold improvements and rental expense, see Note 2, Summary of Significant Accounting Policies and Note 21, Commitments, Contingencies and Guarantees, in our consolidated financial statements.

 

Item 3. Legal Proceedings.

Many aspects of our business involve substantial risks of legal and regulatory liability. In the normal course of business, we have been named as defendants or codefendants in lawsuits involving primarily claims for damages. We are also involved in a number of judicial and regulatory matters, including exams, investigations and similar reviews, arising out of the conduct of our business. Based on currently available information, we do not believe that any matter will have a material adverse effect on our financial condition.

Seven putative class action lawsuits have been filed in New York and Delaware concerning the merger transactions whereby Jefferies Group, Inc. would become a wholly owned subsidiary of Leucadia. The class actions, filed on behalf of our shareholders, name as defendants Jefferies Group, Inc., the members of our board

 

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of directors, Leucadia and, in certain of the actions, certain merger-related subsidiaries. The actions allege that the directors breached their fiduciary duties in connection with the merger transactions by engaging in a flawed process and agreeing to sell Jefferies Group, Inc. for inadequate consideration pursuant to an agreement that contains improper deal protection terms. The actions allege that Jefferies Group, Inc. and Leucadia aided and abetted the directors’ breach of fiduciary duties and seek, among other things, an injunction barring the proposed transactions. We are unable to predict the outcome of this litigation, including whether it will affect the closing of the merger with Leucadia.

 

Item 4. Mine Safety Disclosures.

Not applicable

 

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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  

YEAR ENDED NOVEMBER 30, 2012

     

Fourth Quarter

   $ 17.32       $ 13.50   

Third Quarter

     14.95         11.59   

Second Quarter

     19.82         12.75   

First Quarter

     17.12         11.04   

YEAR ENDED NOVEMBER 30, 2011

     

Fourth Quarter

   $ 16.40       $ 9.50   

Third Quarter

     22.11         14.33   

Second Quarter

     25.81         21.42   

First Quarter

     27.12         23.43   

There were approximately 1,560 holders of record of our Common Stock at January 15, 2013. Our transfer agent is American Stock Transfer & Trust Company, LLC and their address is 59 Maiden Lane, Plaza Level, New York, NY 10038.

The only restrictions on our present ability to pay dividends on our common stock are the dividend preference terms of our Series A convertible preferred stock, the governing provisions of the Delaware General Corporation Law and financial covenants under our $950.0 million senior secured revolving credit facility.

Dividends per Common Share (declared):

 

     1st Quarter      2nd Quarter      3rd Quarter      4th Quarter  

2012

   $ 0.075       $ 0.075       $ 0.075       $ 0.075   

2011

   $ 0.075       $ 0.075       $ 0.075       $ 0.075   

On December 6, 2012, the Board of Directors declared a quarterly dividend of $0.075 per share of common stock, payable on December 31, 2012 to stockholders of record as of December 21, 2012.

Issuer Purchases of Equity Securities

 

Period

   (a) Total
Number of
Shares
Purchased(1)
     (b) Average
Price Paid
per Share
     (c) Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs(2)
     (d) Maximum Number
of Shares that May
Yet Be Purchased
Under the Plans or
Programs
 

September 1 — September 30, 2012

     103,151         15.81                 11,500,000   

October 1 — October 31, 2012

     204,465         14.51                 11,500,000   

November 1 — November 30, 2012

     294,949         16.15                 11,500,000   
  

 

 

       

 

 

    

Total

     602,565                 
  

 

 

       

 

 

    

 

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(1) We repurchased an aggregate of 602,565 shares other than as part of a publicly announced plan or program. We repurchased these securities in connection with our stock compensation plans which allow participants to use shares to pay the exercise price of certain options exercised and to use shares to satisfy certain 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.

 

(2) On September 20, 2011, we announced the authorization by our Board of Directors of the repurchase, from time to time, of up to an aggregate of 20,000,000 shares of our Common Stock, inclusive of prior authorizations.

 

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Shareholder Return Performance Presentation

The following graph compares the yearly change in the cumulative total shareholder return on our common stock, after consideration of all relevant stock splits during the period, against the cumulative total return of the Standard & Poor 500 and Standard & Poor 500 Financials Indices for the last five years. The performance graph assumes a $100 investment in our Common Stock and each index based on the closing prices on November 30, 2007, and that all dividends have been reinvested. The performance shown in the graph represents past performance and should not be considered an indication of future performance.

 

LOGO

 

     2007      2008      2009      2010      2011      2012  

Jefferies Group, Inc.

     100         49         93         97         47         71   

S&P 500

     100         62         78         85         92         107   

S&P 500 Financials

     100         42         50         50         45         57   

 

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Item 6. Selected Financial Data.

The selected data presented below as of and for the years ended November 30, 2012 and 2011, eleven months ended November 30, 2010 and each of the years in the two year period ended December 31, 2009 and 2008 are derived from the Consolidated Financial Statements of Jefferies Group, Inc. and its subsidiaries. The data should be read in connection with the Consolidated Financial Statements including the related notes included in Item 8 of this Annual Report on Form 10-K.

 

     Year Ended November 30,      Eleven
Months Ended
November 30,
     Year Ended December 31,  
   2012      2011      2010      2009      2008  
     (In Thousands, Except Per Share Amounts)  

Earnings Statement Data

              

Revenues:

              

Commissions

   $ 485,569       $ 534,726       $ 466,246       $ 512,293       $ 611,823   

Principal transactions

     1,035,974         428,035         509,070         838,396         (80,479

Investment banking

     1,125,883         1,122,528         890,334         474,315         425,887   

Asset management fees and investment income (loss) from managed funds

     26,966         44,125         16,785         35,887         (52,929

Interest

     1,031,839         1,248,132         852,494         732,250         741,559   

Other

     164,974         152,092         62,417         38,918         28,573   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

     3,871,205         3,529,638         2,797,346         2,632,059         1,674,434   

Interest expense

     872,421         980,825         605,096         468,798         660,448   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net revenues

     2,998,784         2,548,813         2,192,250         2,163,261         1,013,986   

Interest on mandatorily redeemable preferred interests of consolidated subsidiaries

     42,883         3,622         14,916         37,248         (69,077
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net revenues, less mandatorily redeemable preferred interests

     2,955,901         2,545,191         2,177,334         2,126,013         1,083,063   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Non-interest expenses:

              

Compensation and benefits

     1,770,798         1,482,604         1,282,644         1,195,971         1,522,157   

Non-compensation expenses:

              

Floor brokerage and clearing fees

     120,145         126,313         110,835         80,969         64,834   

Technology and communications

     244,511         215,940         160,987         141,233         127,357   

Occupancy and equipment rental

     97,397         84,951         68,085         72,824         76,255   

Business development

     95,330         93,645         62,015         37,614         49,376   

Professional services

     73,427         66,305         49,080         41,125         46,948   

Other

     62,498         56,099         47,017         48,530         84,296   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total non-compensation expenses

     693,308         643,253         498,019         422,295         449,066   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total non-interest expenses

     2,464,106         2,125,857         1,780,663         1,618,266         1,971,223   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Earnings (loss) before income taxes

     491,795         419,334         396,671         507,747         (888,160

Income tax expense (benefit)

     168,646         132,966         156,404         195,928         (293,359
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net earnings (loss)

     323,149         286,368         240,267         311,819         (594,801

Net earnings (loss) to noncontrolling interests

     40,740         1,750         16,601         36,537         (53,884
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net earnings (loss) to common shareholders

   $ 282,409       $ 284,618       $ 223,666       $ 275,282       $ (540,917
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Earnings per common share:

              

Basic earnings (loss) per common share

   $ 1.23       $ 1.28       $ 1.10       $ 1.36       $ (3.30

Diluted earnings (loss) per common share

   $ 1.22       $ 1.28       $ 1.09       $ 1.35       $ (3.30

Weighted average common shares:

              

Basic

     215,989         211,056         196,393         200,446         166,163   

Diluted

     220,101         215,171         200,511         204,572         166,163   

Cash dividends per common share

   $ 0.30       $ 0.30       $ 0.30               $ 0.25   

 

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     November 30,      December 31,  
     2012      2011      2010      2009      2008  
     (In Thousands, Except Per Share Amounts)  

Selected Balance Sheet Data

              

Total assets

   $ 36,293,541       $ 34,971,422       $ 36,726,543       $ 28,121,023       $ 19,978,685   

Long-term debt

   $ 4,804,607       $ 4,608,926       $ 3,778,681       $ 2,729,117       $ 1,764,274   

Mandatorily redeemable convertible preferred stock

   $ 125,000       $ 125,000       $ 125,000       $ 125,000       $ 125,000   

Mandatorily redeemable preferred interests of consolidated subsidiaries

   $ 348,051       $ 310,534       $ 315,885       $ 318,047       $ 280,923   

Total common stockholders’ equity

   $ 3,436,015       $ 3,224,312       $ 2,477,989       $ 2,298,140       $ 2,115,583   

Shares outstanding

     203,312         197,160         171,694         165,638         163,216   

Other Data (Unaudited)

              

Common book value per share(1)

   $ 16.90       $ 16.35       $ 14.43       $ 13.87       $ 12.96   

 

(1) See “Analysis of Financial Condition and Capital Resources” in Item 7 of this Annual Report on Form 10-K for further information regarding our book value and stockholders’ equity.

 

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JEFFERIES GROUP, INC. AND SUBSIDIARIES — (Continued)

 

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 results, 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. 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 discussion of our risk management policies, procedures and methodologies contained in this report under the caption “Risk Management” included within Management’s Discussion and Analysis of Financial Condition and Results of Operations;

 

   

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

 

   

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

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

Consolidated Results of Operations

On April 19, 2010, our Board of Directors approved a change to our fiscal year end from a calendar year basis to a fiscal year ending November 30. As such, the current and most recent previous period represents the twelve months ended November 30, 2012 and 2011, respectively, and has been reported on the basis of a fiscal year beginning as of December 1. Our prior period ended November 30, 2010 consisted of the eleven month transition period beginning January 1, 2010 through November 30, 2010.

 

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The following table provides an overview of our consolidated results of operations (in thousands, except per share amounts):

 

     Year Ended
November 30,
    Eleven  Months
Ended

November 30,
 
     2012     2011     2010  

Net revenues, less mandatorily redeemable preferred interests

   $ 2,955,901      $ 2,545,191      $ 2,177,334   

Non-interest expenses

     2,464,106        2,125,857        1,780,663   

Earnings before income taxes

     491,795        419,334        396,671   

Income tax expense

     168,646        132,966        156,404   

Net earnings

     323,149        286,368        240,267   

Net earnings to noncontrolling interests

     40,740        1,750        16,601   

Net earnings to common shareholders

     282,409        284,618        223,666   

Earnings per diluted common share

   $ 1.22      $ 1.28      $ 1.09   

Effective tax rate

     34.3     31.7     39.4

On November 12, 2012, we announced a definitive merger agreement with Leucadia National Corporation (“Leucadia”) (the “Merger Agreement”) whereby Jefferies shareholders (other than Leucadia, which currently owns approximately 28.6% of Jefferies outstanding common shares) will receive 0.81 of a share of Leucadia common stock for each share of Jefferies common stock they hold. The merger, which is expected to close during the first quarter of 2013, is subject to customary closing conditions, including approval to effect the merger by both Leucadia and Jefferies shareholders. Upon the closing of the merger, Richard Handler, current Chief Executive Officer and Chairman of Jefferies, will remain in these positions and also become the Chief Executive Officer of Leucadia, as well as a Director of Leucadia. Brian Friedman, the Chairman of the Executive Committee of Jefferies, will remain in this position and will also become Leucadia’s President and one of Leucadia’s Directors. Upon the merger, Jefferies will continue to operate as a full-service global investment banking firm in its current form and will retain a credit rating separate from Leucadia. We intend to remain an SEC reporting company, regularly filing annual, quarterly and periodic financial reports.

Executive Summary

2012 v. 2011 — Net revenues, less mandatorily redeemable preferred interests, for the year ended November 30, 2012 increased $410.7 million, or 16%, to a record $2,955.9 million, as compared to the previous record of $2,545.2 million for the year ended November 30, 2011. During 2012, we structured and invested in convertible preferred stock of Knight Capital, Inc. (“Knight Capital”). Net revenues for the year ended November 30, 2012 include a mark-to-market gain of $151.9 million on our share ownership in Knight Capital and an advisory fee of $20.0 million for services in respect of the transaction. Net revenues for the year ended November 30, 2012 include within Other revenues a bargain purchase gain of $3.4 million on the acquisition of the corporate broking business of Hoare Govett from The Royal Bank of Scotland plc, a gain on debt extinguishment of $9.9 million and a gain of $23.8 million on the sale of certain mortgage servicing right assets by our Fixed Income business. Fixed income revenues for the year ended November 30, 2012 include a full twelve months of the Global Commodities Group business (also referred to as “Jefferies Bache”), compared to five months in 2011 as a result of the acquisition from Prudential Financial, Inc. (“Prudential”) on July 1, 2011. The results for fiscal 2011 include a bargain purchase gain of $52.5 million arising on the acquisition of Jefferies Bache.

Non-interest expenses of $2,464.1 million for the year ended November 30, 2012, reflect a 16% increase over the 2011 comparable period. This net increase is primarily attributable to higher compensation expense consistent with higher net revenues, the inclusion of costs from Jefferies Bache for a longer period in fiscal 2012,

 

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and higher technology and communications, occupancy and professional services costs. partially offset by lower floor brokerage and clearing fees on lower equities trading volume. Increased professional service costs are primarily associated with our announced merger with Leucadia and efforts associated with Dodd-Frank compliance. Non-interest expenses for 2012 and 2011 include donations to Hurricane Sandy relief of $4.1 million and $4.6 million to Japanese earthquake relief, respectively. Compensation costs as a percentage of Net revenues for the year ended November 30, 2012 were 59.1%, as compared to 58.2% for the year ended November 30, 2011.

2011 v. 2010 — Net revenues, less mandatorily redeemable preferred interests, for the twelve months ended November 30, 2011 increased 17% to a record $2,545.2 million as compared to $2,177.3 million for the eleven months ended November 30, 2010. The increase was primarily driven by strong investment banking results, revenues associated with Jefferies Bache acquired on July 1, 2011 as well as the additional one month of results included in 2011 versus 2010. The results for 2011 include within Other revenues a bargain purchase gain of $52.5 million arising on the acquisition of Jefferies Bache and a gain on debt extinguishment of $21.1 million. Non-interest expenses of $2,125.9 million for the twelve months ended November 30, 2011 reflect a 19% increase over the 2010 eleven month period primarily attributable to an additional one month’s costs in the fiscal year, as well as increased compensation and benefits costs, technology and communications expenses and business development expenses. Compensation costs for the twelve month period ended November 30, 2011 were 58.2% of Net revenues as compared to 58.5% for the eleven month period ended November 30, 2010. Non-interest expenses for the twelve months ended November 30, 2011 and eleven months ended November 30, 2010 include our $4.6 million charitable contribution for Japanese earthquake relief and our $6.8 million donation to various Haiti earthquake charities, respectively.

Our effective tax rate was 34.3%, 31.7% and 39.4% for the years ended November 30, 2012 and 2011 and eleven months ended November 30, 2010, respectively. The increase in our effective tax rate to 34.3% as compared to the prior fiscal year was primarily attributable to the fact that the 2011 effective tax rate was reduced by a bargain purchase gain of $52.5 million arising on the acquisition of the Global Commodities Group, which was non-taxable. The effective tax rate for 2011 of 31.7% was down from 39.4% for fiscal 2010 primarily due to the non-taxable bargain purchase gain of $52.5 million in 2011 and, to a lesser extent, a change in the mix of taxable profits by business and geographic region.

At November 30, 2012, we had 3,804 employees globally, as compared to 3,898 at November 30, 2011 and 3,084 at November 30, 2010. We added an additional 51 employees with the acquisition of Hoare Govett in February 2012 and expanded our headcount during the 2012 third quarter in our metal and energy futures business. These increases were offset by headcount reductions since the start of the fiscal year aimed at better resource allocation and improved productivity. On July 1, 2011, we added approximately 400 employees as part of Jefferies Bache.

Our business, by its nature, does not produce predictable or necessarily recurring earnings. Our results in any given period can be materially affected by conditions in global financial markets, economic conditions generally and our own activities and positions. For a further discussion of the factors that may affect our future operating results, see “Risk Factors” in Part I, Item IA of this Annual Report on Form 10-K for the year ended November 30, 2012.

Revenues by Source

The Capital Markets reportable segment includes our securities trading activities, and our investment banking and capital raising activities. The Capital Markets reportable segment provides the sales, trading and origination and execution effort for various equity, fixed income, commodities, foreign exchange and advisory services. The Capital Markets segment comprises many business units, with many interactions and much integration among them. In addition, we separately discuss our Asset Management business.

 

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JEFFERIES GROUP, INC. AND SUBSIDIARIES — (Continued)

 

For presentation purposes, the remainder of “Results of Operations” is presented on a detailed product and expense basis, rather than on a business segment basis. Net revenues presented for our equity and fixed income businesses include allocations of interest income and interest expense as we assess the profitability of these businesses inclusive of the net interest revenue or expense associated with the respective sales and trading activities, which is a function of the mix of each business’s associated assets and liabilities and the related funding costs.

The composition of our net revenues has varied over time as financial markets and the scope of our operations have changed. The composition of net revenues can also vary from period to period due to fluctuations in economic and market conditions, and our own performance. The following provides a summary of “Revenues by Source” for the years ended November 30, 2012 and 2011 and eleven months ended November 30, 2010 (amounts in thousands):

 

     Year Ended November 30,     Eleven Months Ended
November 30,
 
     2012     2011     2010  
     Amount     % of Net
Revenues
    Amount      % of Net
Revenues
    Amount      % of Net
Revenues
 

Equities

   $ 642,360        21   $ 593,589         23   $ 556,772         25

Fixed income

     1,190,400        40        714,956         28        728,359         33   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total sales and trading

     1,832,760        61        1,308,545         51        1,285,131         58   

Other

     13,175               73,615         3                  

Equity

     193,797        7        187,288         7        126,363         6   

Debt

     455,790        15        384,921         15        347,471         16   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Capital markets

     649,587        22        572,209         22        473,834         22   

Advisory

     476,296        16        550,319         22        416,500         19   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total investment banking

     1,125,883        38        1,122,528         44        890,334         41   

Asset management fees and investment income from managed funds:

              

Asset management fees

     38,130        1        33,425         1        16,519         1   

Investment (loss)/income from managed funds

     (11,164            10,700                266           
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

     26,966        1        44,125         1        16,785         1   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Net revenues

     2,998,784        100     2,548,813         100     2,192,250         100

Interest on mandatorily redeemable preferred interests of consolidated subsidiaries

     42,883          3,622           14,916      
  

 

 

     

 

 

      

 

 

    

Net revenues, less mandatorily redeemable preferred interests

   $ 2,955,901        $  2,545,191         $ 2,177,334      
  

 

 

     

 

 

      

 

 

    

Net Revenues

2012 v. 2011 — Net revenues for the year ended November 30, 2012 were $2,998.8 million, an increase of $450.0 million, or 18%, as compared to $2,548.8 million for the year ended November 30, 2011. Our 2012 results include twelve months of results of Jefferies Bache, compared to five months in 2011, having been acquired from Prudential in July 2011. Our 2012 results also include Principal transaction revenues of $151.9 million from our investment in Knight Capital. Secondary trading volume was lower contributing to a decline in Equities revenue for 2012 (excluding mark-to-market gains from our ownership of Knight Capital) compared to

 

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the 2011 year. Fixed income revenue increased significantly in 2012 as compared to 2011 supported by investor demand for higher-yielding assets translating into reasonably robust trading volumes. Total investment banking revenue of $1,125.9 million for the year ended November 30, 2012 was comparable with 2011. Asset management fees increased for the year though were offset by write-downs on certain of our investments in unconsolidated funds. Net revenues for 2012 include a bargain purchase gain of $3.4 million recognized in connection with our acquisition of Hoare Govett in February 2012 and a gain on extinguishment of debt of $9.9 million related to transactions in our own debt by our broker-dealer’s market-making desk in December 2011 reported within Other revenues. This compares to a bargain purchase gain of $52.5 million recognized in connection with our Jefferies Bache acquisition and a gain on debt extinguishment of $21.1 million in 2011.

2011 v. 2010 — Net revenues, before interest on mandatorily redeemable preferred interests, for the twelve months ended November 30, 2011 were a record $2,548.8 million, an increase of 16% over the previous record of $2,192.3 million recorded during the eleven months ended November 30, 2010. The increase was primarily due to an increase of 26% in investment banking revenue to a record $1,122.5 million for fiscal 2011 and a 7% increase in equities sales and trading revenue as well as the additional one month of results included in fiscal 2011 versus fiscal 2010. These increases were partially offset by a 2% decline in fixed income revenue compared with the prior fiscal period, partially offset by added revenue from our Jefferies Bache businesses acquired during 2011. Net revenues for the twelve months ended November 30, 2011 also include within Other revenue a bargain purchase gain of $52.5 million recognized in connection with our acquisition of the Global Commodities Group and a gain on extinguishment of debt of $21.1 million related to transactions in our own debt by our broker-dealer’s market-making desk and the repurchase of $50.0 million of our senior notes due 2012.

Interest on mandatorily redeemable preferred interests of consolidated subsidiaries represents the allocation of earnings and losses from our consolidated high yield business to third party noncontrolling interest holders invested in that business through mandatorily redeemable preferred securities.

Equities Revenue

Equities revenue is comprised of equity commissions, principal transactions and net interest revenue relating to cash equities, electronic trading, equity derivatives, convertible securities, prime brokerage, securities finance and alternative investment strategies. Equities revenue also includes our share of the net earnings from our joint venture investments in Jefferies Finance, LLC (“Jefferies Finance”) and Jefferies LoanCore, LLC (“LoanCore”), which are accounted for under the equity method.

2012 v. 2011 — Total equities revenue was $642.4 million for the year ended November 30, 2012, as compared to $593.6 million for the comparable prior year. Equities revenue includes a gain of $151.9 million recognized on our investment in Knight Capital recognized within Principal transaction revenues. Exclusive of Knight Capital, equity revenues decreased 17%, compared with the year ended November 30, 2011. Equities revenue is heavily driven by the overall level of trading activity of our clients.

While U.S. equity markets posted gains during the year with the S&P index up over 13%, investor caution was evidenced through declining volumes. Average New York Stock Exchange and NASDAQ exchange volumes were down 26% and 14%, respectively, for the year ended November 30, 2012 as compared to the year ended November 30, 2011, which contributed to reduced commissions for the respective periods. Similarly, European equity revenues declined on lower overall volumes across the broader markets, compounded by fears over Eurozone uncertainty. Partially offsetting these lower revenues was an increase in our Asian equity commissions as our client base increased. While commission revenues were similarly disadvantaged by lower volumes, trading revenue from our equity derivatives business improved on a change in our strategy regarding client activity when compared to the prior year.

 

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JEFFERIES GROUP, INC. AND SUBSIDIARIES — (Continued)

 

For the year ended November 30, 2012, equity trading revenues from block trading opportunities and performance from certain strategic investments declined as compared to the comparable prior year period. Net earnings from our Jefferies Finance and LoanCore joint ventures for the year ended November 30, 2012 were higher as compared to 2011, and include a full year of LoanCore’s results.

2011 v. 2010 — Total equities revenue was $593.6 million and $556.8 million for the twelve months ended November 30, 2011 and eleven months ended November 30, 2010, respectively, an increase of $36.8 million or 7%. Equity market conditions during the first half of 2011 were mainly characterized by lower stock market volumes and a reduction in equity market volatility as compared with uneven equity prices and higher stock market volumes for the six months ended May 31, 2010. While volumes picked up significantly in August 2011 with increased volatility, investors’ concern over the U.S. economy, the Standard & Poor’s downgrade of the U.S. long-term credit rating and the continued sovereign debt crisis within the European region caused investors to be reluctant to take risk and transact in the remaining months of 2011. Further, client transaction flows were reduced notably in November 2011 due to the attention focused on our firm following the bankruptcy of MF Global Holdings, Ltd.

Declines in client stock volumes negatively impacted our U.S. cash equities trading revenue, while revenue from U.S. derivatives grew slightly. International equities revenue benefited from the development of our Asia cash equities business, expansion of our Europe sales force and improved international electronic product capabilities. Prime brokerage and securities finance revenues benefited from new clients and higher balances, as well as transaction volumes with existing clients. A gain was also recognized related to our ownership of LME shares consistent with recent sales of shares of the exchange. These increases in equities revenue were partially offset by reduced net revenues from our equity joint ventures as increased interest expense was incurred in supporting these ventures. In November 2010, the Company entered into an agreement to sell certain correspondent broker accounts and assign the related clearing arrangements. The purchase price was dependent on the number and amount of client accounts that convert to the purchaser’s platform. During fiscal 2011, proceeds amounted to $11.0 million were received, of which revenues of $9.1 million was recognized and included within Other revenues on the Consolidated Statement of Earnings. Equities revenue for the eleven months ended November 30, 2010 does not include any significant gain from transaction and revenue from our correspondent clearing business.

Fixed Income Revenue

Fixed income revenue includes commissions, principal transactions and net interest revenue from investment grade corporate bonds, mortgage- and asset-backed securities, government and agency securities, municipal bonds, emerging markets debt, high yield and distressed securities, bank loans, foreign exchange and commodities trading activities.

2012 v. 2011 — Fixed income revenue was $1,190.4 million for the year ended November 30, 2012, a $475.4 million or 66% increase compared to revenue of $715.0 million for the year ended November 30, 2011. Fixed income revenue for the year ended November 30, 2012 includes a full twelve months of revenue from Jefferies Bache as compared to five months in 2011 following the acquisition from Prudential in July 2011.

With the start of the European sovereign debt crisis in the second quarter of 2011 and slowing economic growth, U.S. and European market conditions in 2011 were significantly more severe than those of 2012, as evidenced by the widening of credit spreads and thinning liquidity. In contrast, in 2012, despite occasional investor concerns surrounding the European sovereign debt crisis and global economic growth, a Greek default was avoided, and coordinated austerity measures taken by European governments and the European Central Bank proved successful in allaying fears of a Eurozone breakup and disbanding of the Euro currency. In the U.S., Treasuries benefited from their perception of safety and a third round of quantitative easing by the U.S. Federal

 

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Reserve and investors continued to seek higher yields in a low interest rate environment. Narrowing credit spreads and improved credit and emerging market conditions contributed to strong performances and customer flow across a broad number of fixed income products.

Revenues from our leveraged finance sales and trading business for the year ended November 30, 2012 were significantly improved from 2011 as credit spreads tightened considerably as compared to the challenging market conditions during 2011 upon the European sovereign debt crisis. Investor confidence returned in 2012 attracted to the yield on leveraged credit products. Additionally, certain of our high yield positions generated significant gains. Similarly, mortgage revenues were significantly improved during 2012 as compared 2011, as the markets rallied on tighter interest and mortgage index spreads. Municipal trading activities also benefited from spreads tightening over the period as well as investors seeking higher yields in a low interest rate environment. Additionally, revenues from our investment grade corporates business were up significantly in 2012 as compared to 2011 on improved credit market conditions, tightening spreads and stronger trading volumes. Revenue increases across a large portion of our fixed income businesses for 2012 versus the 2011 year were partially offset by a decline in revenue for the period in our Eurorates business, which had captured significant revenue in 2011 on the extreme volatility in the European markets upon the start of the European crisis.

Jefferies Bache commodities futures and foreign exchange revenues increased significantly compared to the year ended November 30, 2011, partially as a result of the inclusion of twelve months of results in 2012 compared to five months in 2011. Despite increased revenues, counterparty activity, though improved, remained somewhat reduced from historical levels. In addition, in 2012 Jefferies Bache recognized gains on its investment in shares of the London Metal Exchange and benefited from new client activity with the global metals desk introduced in the latter part of 2012.

Fixed Income revenues for the year ended November 30, 2012 also include a gain on the sale of mortgage servicing rights assets. This is compared to results for 2011, which include losses on certain U.S. dollar denominated interest rate swap futures contracts (fully closed out in August 2011) cleared through International Derivative Clearing Group.

2011 v. 2010 — The first half of the 2011 fiscal year was characterized by reasonable customer flow, tighter bid-offer spreads, ample liquidity and rising commodity prices. Beginning in the third quarter of 2011, concerns about European sovereign debt risk, the deteriorating global economy, the uncertainty created by the U.S. deficit negotiations and continuing high unemployment in the U.S. led to challenging trading conditions. Market volatility in certain fixed income sectors suppressed customer activity. Trading conditions were particularly difficult in August 2011. While the fixed income markets improved slightly in the fourth quarter of 2011, our customer volumes were negatively impacted during November 2011 due to external stresses concentrated on our business following the bankruptcy of MF Global Holdings Ltd. Customer volumes have since returned to more normal levels.

Fixed income revenue was $715.0 million for the twelve months ended November 30, 2011, a decrease of 2%, compared to $728.4 million for the eleven months ended November 30, 2010. The decrease in fixed income revenue for fiscal 2011 as compared to 2010 is primarily attributed to declines in corporate, mortgage-backed security, high yield and emerging market revenues. The drop in prices in the second half of 2011 led to significant mark downs in high yield and corporate bonds and mortgage-backed securities. In addition, a flight to quality beginning in the third quarter of 2011 led to U.S. Treasury yields trading at the lowest levels on record, resulting in losses on short treasury positions used as inventory hedges in our corporates and mortgage-backed securities businesses. The results for 2011 also include losses on certain U.S. dollar denominated interest rate swap futures contracts (which fully closed out in August 2011) cleared through International Derivatives Clearing Group.

The decrease in fixed income revenue from these businesses was partially offset by revenue increases from our government and agency sales and trading revenues in the U.S., Europe and Asia. Fixed income revenue reflects the continued growth of our fixed income platform in Europe with strong performance from our Euro

 

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rates platform, as well as improved performance from our U.S. government and agency business due to increased customer flow from ample liquidity and, to a lesser extent, inventory appreciation as spreads tightened in the earlier part of the period. Stronger performance from our municipal trading activities benefited overall fixed income revenue as a result of recent strengthening of our trading effort and new products offered, partially offset by trading losses and widening credit spreads that impacted the municipal trading business in the latter part of 2011. Fixed income revenue for fiscal 2011 also includes revenue contributions from Jefferies Bache for a five month period as a result of the acquisition from Prudential on July 1, 2011.

During November 2011, we significantly reduced our inventory holdings in sovereign debt of Portugal, Italy, Ireland, Greece and Spain with no meaningful profit or loss impact on our trading revenues. While we sold such positions, these actions had no substantive effect on our ability to fulfill our role and obligations as a primary dealer and market maker in the debt securities of these countries and no effect on our execution relationships with our clients.

Of the net earnings recognized in Jefferies High Yield Holdings, LLC (our high yield and distressed securities and bank loan trading and investment business), approximately 65% and 66% of such income for the years ended November 30, 2012 and 2011, respectively, are allocated to the minority investors and are presented within interest on mandatorily redeemable preferred interests and net earnings to noncontrolling interests in our Consolidated Statements of Earnings.

Other Revenue

For the year ended November 30, 2012, Other revenue of $13.2 million is comprised of gains on debt extinguishment of $9.9 million in connection with the accounting treatment for certain purchases of our long-term debt by our secondary market making corporates desk in the three months ended February 2012 and a bargain purchase gain of $3.4 million arising in the accounting for the acquisition of Hoare Govett on February 1, 2012. Other revenue of $73.6 million for the year ended November 30, 2011 million represents the bargain purchase gain of $52.5 million arising on the acquisition of the Global Commodities Group and total gains on debt extinguishment of $21.1 million in connection with the accounting treatment for certain purchases of our debt by our secondary market making corporates desk and the repurchase of $50.0 million of our senior notes due 2012 in November 2011. For additional information see Note 4, Acquisitions and Note 14, Long-term Debt, respectively, in our consolidated financial statements.

Investment Banking Revenue

We provide a full range of capital markets and financial advisory services to our clients across most industry sectors primarily in the U.S. and Europe and to a lesser extent in Asia, Latin America and Canada. Capital markets revenue includes underwriting and placement revenue related to corporate debt, municipal bonds, mortgage- and asset-backed securities and equity and equity convertible financing services. Advisory revenue consists primarily of advisory and transaction fees generated in connection with merger, acquisition and restructuring transactions. The following table sets forth our investment banking revenue (in thousands):

 

     Year Ended November 30,      Eleven  Months
Ended

November 30,
     % Change  
     2012      2011      2010      2012 v. 2011     2011 v. 2010  

Equity

   $ 193,797       $ 187,288       $ 126,363         3     48

Debt

     455,790         384,921         347,471         18     11
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Capital markets

     649,587         572,209         473,834         14     21

Advisory

     476,296         550,319         416,500         -13     32
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 1,125,883       $ 1,122,528       $ 890,334         0     26
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

 

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2012 v. 2011 — Investment banking revenue was a record $1,125.9 million for the year ended November 30, 2012, as compared to revenue of $1,122.5 million for the year ended November 30, 2011, with higher debt capital market revenues offset by lower advisory revenues. Capital markets revenue increased $77.4 million, or 14%, to $649.6 million compared to 2011 with debt capital markets revenue increasing $70.9 million to $455.8 million from $384.9 million in 2011 driven by a higher number of debt capital market transactions as companies took advantage of lower borrowing costs and more favorable economic and market conditions. During 2012, we completed 482 public and private debt financings raising a total of $175 billion, as compared to 406 transactions raising a total of $99 billion in 2011. Equity capital markets revenue totaled $193.8 million for the year ended November 30, 2012, as compared to $187.3 million for 2011. During the year ended November 30, 2012, we completed 111 public equity financings raising $21 billion in capital (96 of which we acted as sole or joint bookrunner). This compares to 81 public equity financings raising $15 billion in capital (70 of which we acted as sole or joint bookrunner) during the year ended November 30, 2011.

For 2012, advisory revenue decreased $74 million, or 13%, to $476.3 million as compared with $550.3 million for the year ended November 30, 2011. During the 2012 fiscal year, we served as financial advisor on 111 merger and acquisition and 10 restructuring transactions having an aggregate transaction value of approximately $104 billion, as compared to 126 merger and acquisition transactions and 12 restructuring transactions with an aggregate transaction value of $77 billion during the prior fiscal year.

2011 v. 2010 — Investment banking revenue increased 26% to a record $1,122.5 million for the twelve months ended November 30, 2011 as compared to revenue of $890.3 million for the eleven months ended November 30, 2010, principally driven by both record advisory revenues and our increasing success in winning book runner roles in debt and equity financing. The first half of fiscal 2011 benefited from a particularly strong environment for capital markets issuance. The second half of the year exhibited significant periods of volatility due to economic uncertainty caused by economic growth, unemployment and leverage concerns in Europe and the U.S., which contributed to a dramatic reduction in capital-raising by corporate issuers. Restructuring activity also declined due to the slower pace in the number of corporate defaults.

Capital markets revenue totaled $572.2 million for the twelve months ended November 30, 2011, compared to $473.8 million for the eleven months ended November 30, 2010, reflecting the strengthening in our market share and book runner roles in capital markets underwritings, the improved market environment for debt and equity underwritings in the first half of fiscal 2011, and the contribution of our mortgage securities origination and municipal bond underwriting platforms. Revenue from our advisory business increased 32% to $550.3 million for 2011 as compared to the prior year revenue of $416.5 million. The record result for 2011 is reflective of our increasing prominence in mergers and acquisition advisory work and a greater number of completed advisory engagements, including several larger-sized transactions. Investment banking revenue, overall, also benefited in the 2011 period from the addition of professional talent and expansion of our capabilities across sectors, products and geography.

Asset Management Fees and Investment (Loss) Income from Managed Funds

Asset management revenue includes management and performance fees from funds and accounts managed by us, management and performance fees from related party managed funds and accounts and investment income (loss) from our investments in these funds, accounts and related party managed funds. The key components of asset management revenue are the level of assets under management and the performance return, whether on an absolute basis or relative to a benchmark or hurdle. These components can be affected by financial markets, profits and losses in the applicable investment portfolios and client capital activity. Further, asset management fees vary with the nature of investment management services. The terms under which clients may terminate our investment management authority, and the requisite notice period for such termination, varies depending on the nature of the investment vehicle and the liquidity of the portfolio assets.

 

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JEFFERIES GROUP, INC. AND SUBSIDIARIES — (Continued)

 

The following summarizes the results of our Asset Management segment for the year ended November 30, 2012 and 2011 and eleven months ended November 30, 2010 (in thousands):

 

     Year Ended
November 30,
     Eleven  Months
Ended

November 30,
 
     2012     2011      2010  

Asset management fees:

       

Fixed income

   $ 4,094      $ 3,725       $ 3,590   

Equities

     4,573        5,335         3,708   

Convertibles

     10,387        13,703         5,429   

Commodities

     19,076        10,662         3,792   
  

 

 

   

 

 

    

 

 

 
     38,130        33,425         16,519   

Investment (loss) income from managed funds(1)

     (11,164     10,700         266   
  

 

 

   

 

 

    

 

 

 

Total

   $ 26,966      $ 44,125       $ 16,785   
  

 

 

   

 

 

    

 

 

 

 

(1) Of the total investment (loss) income from managed funds, no amounts are attributed to noncontrolling interest holders for the years ended November 30, 2012 and 2011 and $0.2 million is attributed to noncontrolling interest holders for the eleven months ended November 30, 2010.

2012 v. 2011 — Asset management fees increased by $4.7 million to $38.1 million for the year ended November 30, 2012 as compared to the year ended November 30, 2011. The increase resulted from higher average assets under management in our commodity funds and managed accounts partially offset by lower management fees in our global convertible bond funds and managed accounts and lower unrealized performance fees in our global convertible bond and strategic investment programs as compared to 2011. Fixed income asset management fees represent ongoing consideration we receive from the sale of contracts to manage certain collateralized loan obligations (“CLOs”) to Babson Capital Management, LLC in January 2010. As sale consideration, we are entitled to a portion of the asset management fees earned under the contracts for their remaining lives.

For the year ended November 30, 2012, unrealized markdowns in private equity funds managed by a related party resulted in an investment loss of $11.2 million. This compares with a gain of $10.7 million recognized on these funds for the prior year.

2011 v. 2010 — Asset management fees increased to $33.4 million for the twelve months ended November 30, 2011 as compared to $16.5 million for the eleven months ended November 30, 2010. The increased fees resulted primarily from growth in management and performance fees in our global convertible bond fund and from customer asset inflows into our commodity managed accounts and commodity funds. To a lesser extent, the launch of certain of our strategic investment programs increased asset management fees.

Investment income from managed funds for the twelve months ended November 30, 2011 totaled $10.7 million as compared to $0.3 million for the eleven months ended November 30, 2010. The increase of $10.4 million is primarily due to asset appreciation in our investments in private equity funds managed by a related party.

 

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JEFFERIES GROUP, INC. AND SUBSIDIARIES — (Continued)

 

Assets under Management

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

 

     November 30,  
     2012      2011  

Assets under management(1):

     

Equities

   $ 75       $ 318   

Convertibles

     1,092         1,532   

Commodities

     1,002         434   
  

 

 

    

 

 

 

Total

   $ 2,169       $ 2,284   
  

 

 

    

 

 

 

 

(1) Assets under management include assets actively managed by us, including hedge funds and certain managed accounts. Assets under management do not include the assets of funds that are consolidated due to the level or nature of our investment in such funds.

Change in Assets under Management

 

     Year Ended November 30,        
(in millions)        2012             2011         %
Change
 

Balance, beginning of period

   $ 2,284      $ 1,964        16
  

 

 

   

 

 

   

Net cash flow (out) in

     (110     525     

Net market depreciation

     (5     (205  
  

 

 

   

 

 

   
     (115     320     
  

 

 

   

 

 

   

Balance, end of period

   $ 2,169      $ 2,284        -5
  

 

 

   

 

 

   

For the year ended November 30, 2012, the net decrease in assets under management of $115 million resulted from outflows from our global convertible bond and equity funds partially offset by inflows into our commodity funds. Net market depreciation of $5 million reflects the decline in value of the underlying assets of our convertible bond funds. For the year ended November 30, 2011, the net increase of $0.3 billion in assets under management to $2.3 billion resulted primarily from cash inflows into our commodity funds and strategic investment programs, net of fund outflows from our global convertible bond funds and managed accounts.

Managed Accounts

We manage certain portfolios as mandated by client arrangements whereby management fees are assessed on an agreed upon basis such as notional account value or another measure specified in the investment management agreement. Managed accounts based on these measures by predominant asset strategy were as follows (in millions):

 

(notional account value)

   November 30,  
     2012      2011  

Managed Accounts:

     

Commodities

   $ 3,321       $ 1,612   
  

 

 

    

 

 

 
   $ 3,321       $ 1,612   
  

 

 

    

 

 

 

 

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JEFFERIES GROUP, INC. AND SUBSIDIARIES — (Continued)

 

Change in Managed Accounts

 

(notional account value)    Year Ended November 30,  
(in millions)        2012              2011      

Balance, beginning of period

   $ 1,612       $ 949   

Net account additions

     1,702         629   

Net account appreciation

     7         34   
  

 

 

    

 

 

 

Balance, end of period

   $ 3,321       $ 1,612   
  

 

 

    

 

 

 

During the year ended November 30, 2012, new customer accounts and additional inflows from existing customers in our commodity managed accounts resulted in an increase in the notional value of our managed accounts.

Invested Capital in Managed Funds

The following table presents our invested capital in managed funds at November 30, 2012 and 2011 (in thousands):

 

     November 30,  
   2012      2011  

Unconsolidated funds(1)

   $ 57,763       $ 70,224   

Consolidated funds(2)

     30,561         10,076   
  

 

 

    

 

 

 

Total

   $ 88,324       $ 80,300   
  

 

 

    

 

 

 

 

(1) Our invested capital in unconsolidated funds is reported within Investments in managed funds on the Consolidated Statements of Financial Condition. The decrease in our invested capital in unconsolidated funds results primarily from a $9 million distribution from Jefferies Capital Partners IV L.P.

 

(2) Invested capital in managed funds includes funds that are actively managed by us and by third parties and related parties including hedge funds, managed accounts and other private investment funds. Due to the level or nature of our investment in such funds and accounts, certain funds and accounts are consolidated and the assets and liabilities of these funds and accounts are reflected in our consolidated financial statements primarily within Financial instruments owned. We do not recognize asset management fees for funds and accounts that we have consolidated. The increase in invested capital as of November 30, 2012 from November 30, 2011 is due to our increase in investment in the Structured Alpha program by $20.0 million.

 

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JEFFERIES GROUP, INC. AND SUBSIDIARIES — (Continued)

 

Non-interest Expenses

Non-interest expenses for the years ended November 30, 2012 and 2011 and eleven months ended November 30, 2010, were as follows (in thousands):

 

     Year Ended November 30,      Eleven Months  Ended
November 30,
 
     2012      2011      2010  

Compensation and benefits

   $ 1,770,798       $ 1,482,604       $ 1,282,644   

Non-compensation expenses:

        

Floor brokerage and clearing fees

     120,145         126,313         110,835   

Technology and communications

     244,511         215,940         160,987   

Occupancy and equipment rental

     97,397         84,951         68,085   

Business development

     95,330         93,645         62,015   

Professional services

     73,427         66,305         49,080   

Other

     62,498         56,099         47,017   
  

 

 

    

 

 

    

 

 

 

Total non-compensation expenses

   $ 693,308       $ 643,253       $ 498,019   
  

 

 

    

 

 

    

 

 

 

Total non-interest expenses

   $ 2,464,106       $ 2,125,857       $ 1,780,663   
  

 

 

    

 

 

    

 

 

 

Compensation and Benefits

Compensation and benefits expense consists of salaries, benefits, cash bonuses, commissions, annual share-based compensation awards and the amortization of certain nonannual share-based and cash compensation to employees. Annual cash- and share-based awards granted to employees as part of year end compensation generally contain provisions such that employees who terminate their employment or are terminated without cause may continue to vest in their awards, so long as those awards are not forfeited as a result of other forfeiture provisions (primarily non-compete clauses) of those awards. Accordingly, the compensation expense for a substantial portion of awards granted at year end as part of annual compensation is fully recorded in the year of the award. Included within compensation and benefits expense are share-based amortization expense for senior executive awards granted in January 2010 and September 2012, non-annual share-based and cash-based awards to other employees and certain year end awards that contain future service requirements for vesting. Such awards are being amortized over their respective future service periods and amounted to compensation expense of $288.8 million and $170.6 million for the years ended November 30, 2012 and 2011, respectively.

2012 v. 2011 — Compensation and benefits as a percentage of Net revenues was 59.1% and the ratio for the year ended November 30, 2011 was 58.2%. Compensation and benefits expense increased $288.2 million, or 19%, to $1,770.8 million for the year ended November 30, 2012, compared to $1,482.6 million for the prior fiscal year. The increase was primarily a result of higher net revenues and a full year of compensation expenses related to Jefferies Bache as compared to only five months in the year ended November 30, 2011 having completed the acquisition on July 1, 2011. In addition, compensation costs for 2012 reflect our investments to build our firm over the past few years and further investments in 2012 in our Jefferies Bache business. Employee headcount of 3,804 employees globally at November 30, 2012 decreased from 3,898 employees at November 30, 2011.

For the year ended November 30, 2012, Compensation and benefits expense includes $22.9 million relating to the acquisition of the Global Commodities Group on July 1, 2011 and Hoare Govett on February 1, 2012, comprised of the amortization of retention and stock replacement awards granted to Jefferies Bache employees as replacement awards for previous Prudential stock awards that were forfeited at acquisition and amortization of

 

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JEFFERIES GROUP, INC. AND SUBSIDIARIES — (Continued)

 

retention awards granted to Hoare Govett employees and bonus costs for employees as a result of the completion of the acquisition of Hoare Govett. When excluding these costs, together with the gain on debt extinguishment of $9.9 million relating to trading activities in our own debt, amortization of discounts recognized on our long-term debt purchased and re-issued in December 2011 and January 2012 and recognized in Interest expense of $4.8 million and the bargain purchase gain of $3.4 million on our Hoare Govett acquisition, our ratio of Compensation and benefits expense to Net revenues for the year ended November 30, 2012 was 58.4%. Compensation and benefits expense for the year ended November 30, 2012 also includes severance costs of approximately $30.6 million, approximately 1% of Net revenues, and an increase of approximately $10 million over the prior year.

2011 v. 2010 — Compensation and benefits expense totaled $1,482.6 million for the twelve months ended November 30, 2011, a ratio of compensation and benefits to net revenues of 58.2%. This is in comparison to Compensation and benefits expense of $1,282.6 million for the eleven months ended November 30, 2010, a ratio of compensation and benefits to net revenues of 58.5%. For the twelve months ended November 30, 2011, compensation and benefits expense includes costs relating to the acquisition of the Global Commodities Group, comprising severance costs for certain employees of the acquired group that were terminated subsequent to the acquisition, the amortization of stock awards granted to Jefferies Bache employees as replacement awards for previous Prudential stock awards that were forfeited as a result of the acquisition, bonus costs for employees as a result of the completion of the acquisition and the amortization of retention awards totaling $11.8 million. When excluding these expenses, together with the bargain purchase gain of $52.5 million and the gain on debt extinguishment of $21.1 million recognized in Other revenues, our ratio of compensation and benefits expense to net revenues for the twelve months ended November 30, 2011 was 59.4%.

Compensation and benefit expense increased $200.0 million, or 16%, for the twelve months ended November 30, 2011 as compared to the 2010 prior period. This increase was partially due to the additional month’s expense in the 2011 results and the increased headcount, both domestically and internationally, in connection with our business growth, which included Jefferies Bache as of July 1, 2011. The increase in compensation and benefits expense was partially offset by reduced cash awards offered to employees in lieu of stock compensation, while compensation and benefits as a percentage of net revenues remained relatively flat over the comparable periods. Employee headcount increased to 3,898 employees globally at November 30, 2011 as compared to 3,084 employees at November 30, 2010. Approximately 400 employees were added to our firm on July 1, 2011 in connection with the acquisition of the Global Commodities Group.

Non-Compensation Expenses

2012 v. 2011 — Non-compensation expenses were $693.3 million for the year ended November 30, 2012, a 8% or $50.1 million increase, as compared to expenses of $643.3 million for the year ended November 30, 2011. A portion of the overall increase relates to the inclusion of twelve months of operating costs of Jefferies Bache in the year ended November 30, 2012 compared to five months in the prior fiscal year. Non-compensation expenses as a percentage of Net revenues were 23% for the year ended November 30, 2012 as compared to 25% for the year ended November 30, 2011 on the strength of higher revenues in fiscal 2012.

Floor brokerage and clearing expense decreased 5% to $120.1 million for the year ended November 30, 2012 commensurate with lower equity trading volumes, partially offset by costs associated with the additional seven months of Jefferies Bache futures activity in 2012. Technology and communications expense increased 13%, or $28.6 million, to $244.5 million for the year ended November 30, 2012 compared to an expense of $215.9 million for the year ended November 30, 2011. Exclusive of the effect of the additional months of expenses attributable to Jefferies Bache, technology and communications expense was comparable to fiscal 2011 due to the conclusion of various projects associated with corporate support infrastructure in fiscal 2012, offsetting increased costs associated with the continued build out of our Asian businesses. Occupancy and

 

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JEFFERIES GROUP, INC. AND SUBSIDIARIES — (Continued)

 

equipment expense was $97.4 million for 2012, an increase of 15% compared to 2011, primarily due to the inclusion of a full years costs for Jefferies Bache, our office growth in Asia and Europe and additional space at our global head office in New York. Professional services expense of $73.4 million for the year ended November 30, 2012 reflects an increase of 11% over expenses of $66.3 million for the prior year, which is primarily attributable to legal and consulting fees related to the announced merger with Leucadia and efforts associated with Dodd-Frank compliance. The increase in business development of $1.7 million, or 2%, to $95.3 million for the year ended November 30, 2012, as compared to $93.6 million for the comparable period in the prior year, is primarily driven by our continued efforts to build market share, specifically our futures business. Other expenses of $62.5 million for the 2012 year increased 11%, or $6.4 million, as compared to the 2011 year as a result of inclusion of a full year’s operating costs of the Bache entities, a $2.9 million impairment charge recognized in the second quarter of 2012 on certain indefinite-lived intangible assets, donations to Hurricane Sandy relief of $4.1 million and fees associated with the announced merger with Leucadia. Other expenses for 2011 included a $4.6 million charitable donation for Japan earthquake relief.

2011 v. 2010 — Non-compensation expenses were $643.3 million for the twelve months ended November 30, 2011, a 29% increase as compared to expenses of $498.0 million for the eleven months ended November 30, 2010. In addition to the increase related to the additional month included in the 2011 twelve months results, a portion of the overall increase relates to non-compensation expenses with the addition of Jefferies Bache and corresponding integration costs of $4.9 million. Technology and communications expense increased 34% or $55.0 million to $215.9 million for the twelve months ended November 30, 2011 versus $161.0 million for the eleven months ended November 30, 2010 due to the continued expansion of our business platforms and support infrastructure, particularly in Europe and Asia. Business development costs increased 51% or $31.6 million to $93.6 million for 2011 due to continued efforts to build market share and further enhance the Jefferies brand, including due to increased global travel in connection with these efforts. Occupancy and equipment expense increased 25% or $16.9 million to $85.0 million for 2011 primarily due to office growth in Asia. Professional services expense increased 35% for 2011, or $17.2 million, to $66.3 million primarily driven by legal and consulting fees related to the acquisition of the Global Commodities Group. Other non-interest expense includes a $4.6 million charitable contribution for Japanese earthquake relief. Non-compensation expenses as a percentage of net revenues was 25% for the twelve months ended November 30, 2011 as compared to 23% for the eleven months ended November 30, 2010.

Income Taxes

For the year ended November 30, 2012, the provision for income taxes was an expense of $168.6 million, equating to an effective tax rate of 34.3%, compared with tax expense of $133.0 million and $156.4 million, equating to an effective tax rate of 31.7% and 39.4%, for the year ended November 30, 2011 and the eleven months ended November 30, 2010, respectively. The increase in the effective tax rate to 34.3% for the year ended November 30, 2012 as compared with 2011 is primarily attributable to the fact that the 2011 effective tax rate was reduced by a bargain purchase gain of $52.5 million arising on the acquisition of the Global Commodities Group from Prudential, which was non-taxable. The effective tax rate for 2011 of 31.7% was down from 39.4% for fiscal 2010 primarily due to the non-taxable gain of $52.5 million recorded in fiscal 2011 and, to a lesser extent, a change in the mix of taxable profits by business and geographic region.

Earnings per Common Share

Diluted net earnings per common share was $1.22 for the year ended November 30, 2012 on 220,101,000 shares, compared to diluted net earnings per common share of $1.28 for the year ended November 30, 2011 on 215,171,000 shares and compared to diluted net earnings per common share of $1.09 for the eleven months ended November 30, 2010 on 200,511,000 shares. See Note 19, Earnings per Share, in our consolidated financial statements for further information regarding the calculation of earnings per common share.

 

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JEFFERIES GROUP, INC. AND SUBSIDIARIES — (Continued)

 

Accounting Developments

Accounting Standards to be Adopted in Future Periods

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

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

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

Adopted Accounting Standards

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

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

 

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JEFFERIES GROUP, INC. AND SUBSIDIARIES — (Continued)

 

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

Critical Accounting Policies

The consolidated financial statements are prepared in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”), 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 may differ from estimates. These differences could be material to the financial statements.

We believe our application of U.S. GAAP and the associated estimates are reasonable. Our accounting policies and estimates are constantly reevaluated, 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.

We believe our critical accounting policies (policies that are both material to the financial condition and results of operations and require our most subjective or complex judgments) are our valuation of financial instruments, assessment of goodwill and our use of estimates related to compensation and benefits during the year.

Valuation of Financial Instruments

Financial instruments owned and Financial instruments sold, not yet purchased are recorded at fair value. The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (the exit price). Unrealized gains or losses are generally recognized in Principal transactions in our Consolidated Statements of Earnings.

The following is a summary of the fair value of major categories of financial instruments owned and financial instruments sold, not yet purchased, as of November 30, 2012 and 2011 (in thousands):

 

     November 30, 2012      November 30, 2011  
     Financial
Instruments
Owned
     Financial
Instruments
Sold,

Not Yet
Purchased
     Financial
Instruments
Owned
     Financial
Instruments
Sold,

Not Yet
Purchased
 

Corporate equity securities

   $ 1,762,775         1,539,332       $ 1,235,079       $ 1,330,096   

Corporate debt securities

     3,038,146         1,389,312         2,868,304         1,614,493   

Government, federal agency and other sovereign obligations

     5,153,750         3,666,112         7,471,563         3,209,713   

Mortgage- and asset-backed securities

     5,468,284         241,211         3,923,303         50,517   

Loans and other receivables

     678,311         207,227         376,146         151,117   

Derivatives

     298,086         229,127         525,893         249,037   

Investments

     127,023                 105,585           

Physical commodities

     144,016         183,142         172,668           
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 16,670,391       $ 7,455,463       $ 16,678,541       $ 6,604,973   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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JEFFERIES GROUP, INC. AND SUBSIDIARIES — (Continued)

 

At November 30, 2012 and 2011 derivative liabilities included within Financial instruments sold, not yet purchased were comprised primarily of exchange traded equity options, over-the-counter (“OTC”) foreign currency forwards and options, OTC commodity forwards and options, and interest rate and commodity swaps.

Fair Value Hierarchy — In determining fair value, we maximize the use of observable inputs and minimize the use of unobservable inputs by requiring that observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability based on market data obtained from independent sources. Unobservable inputs reflect our assumptions that market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. We apply a hierarchy to categorize our fair value measurements broken down into three levels based on the transparency of inputs, where Level 1 uses observable prices in active markets and Level 3 uses valuation techniques that incorporate significant unobservable inputs and broker quotes that are considered less observable. Greater use of management judgment is required in determining fair value when inputs are less observable or unobservable in the marketplace, such as when the volume or level of trading activity for a financial instrument has decreased and when certain factors suggest that observed transactions may not be reflective of orderly market transactions. Judgment must be applied in determining the appropriateness of available prices, particularly in assessing whether available data reflects current prices and/or reflects the results of recent market transactions. Prices or quotes are weighed when estimating fair value with greater reliability placed on information from transactions that are considered to be representative of orderly market transactions.

Fair value is a market based measure; therefore, when market observable inputs are not available, our judgment is applied to reflect those judgments that a market participant would use in valuing the same asset or liability. The availability of observable inputs can vary for different products. We use prices and inputs that are current as of the measurement date even in periods of market disruption or illiquidity. The valuation of financial instruments classified in Level 3 of the fair value hierarchy involves the greatest amount of management judgment. For further information on the fair value definition, Level 1, Level 2, Level 3 and related valuation techniques, see Note 2, Summary of Significant Accounting Policies and Note 6, Fair Value Disclosures, in our consolidated financial statements.

 

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JEFFERIES GROUP, INC. AND SUBSIDIARIES — (Continued)

 

Level 3 Assets and Liabilities — The following table reflects the composition of our Level 3 assets and Level 3 liabilities by asset class at November 30, 2012 and 2011 (in thousands):

 

     Financial Instruments Owned     Financial Instruments Sold,
Not Yet Purchased
 
     November 30,
2012
    November 30,
2011
    November 30,
2012
    November 30,
2011
 

Loans and other receivables

   $ 180,393      $ 97,291      $ 1,711      $ 10,157   

Residential mortgage-backed securities

     156,069        149,965                 

Investments at fair value

     83,897        78,326                 

Collateralized debt obligations

     31,255        47,988                 

Commercial mortgage-backed securities

     30,202        52,407                 

Corporate equity securities

     16,815        13,489        38          

Corporate debt securities

     3,631        48,140               74   

Derivatives

     328        124        9,516        9,409   

Other asset-backed securities

     1,114        3,284                 

Municipal securities

            6,904                 

Sovereign obligations

            140                 
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Level 3 financial instruments

     503,704        498,058        11,265        19,640   
      

 

 

   

 

 

 

Level 3 financial instruments for which the firm bears no economic exposure(1)

     (53,289     (45,901    
  

 

 

   

 

 

     

Level 3 financial instruments for which the firm bears economic exposure

     450,415        452,157       

Investments in managed funds

     57,763        70,740       
  

 

 

   

 

 

     

Level 3 assets for which the firm bears economic exposure

   $ 508,178      $ 522,897       
  

 

 

   

 

 

     

Total Level 3 assets

   $ 561,467      $ 568,798       
  

 

 

   

 

 

     

Total Level 3 financial instruments as a percentage of total financial instruments

     3     3     0.2     0.3

 

(1) Consists of Level 3 assets which are financed by nonrecourse secured financing or attributable to third party or employee noncontrolling interests in certain consolidated entities.

While our Financial instruments sold, not yet purchased, which are included within liabilities on our Consolidated Statements of Financial Condition, are accounted for at fair value, we do not account for any of our other liabilities at fair value, except for certain secured financings that arise in connection with our securitization activities included with Other liabilities of approximately $2.3 million and $3.8 million at November 30, 2012 and 2011, respectively.

The following table reflects activity with respect to our Level 3 assets and liabilities (in millions):

 

     Year Ended
November 30,
    Eleven  Months
Ended

November 30,
 
     2012     2011     2010  

Assets:

      

Transfers from Level 3 to Level 2

   $ 81.8      $ 105.5      $ 163.9   

Transfers from Level 2 to Level 3

     180.6        63.6        18.0   

Net gains (losses)

     28.8        (14.3     108.5   

Liabilities:

      

Transfers from Level 3 to Level 2

   $ 2.2      $ 0.04      $ 93.3   

Transfers from Level 2 to Level 3

                   0.04   

Net (losses) gains

     (2.5     (6.6     2.3   

 

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JEFFERIES GROUP, INC. AND SUBSIDIARIES — (Continued)

 

See Note 6, Fair Value Disclosures, in our consolidated financial statements for additional discussion on transfers of assets and liabilities among the fair value hierarchy levels.

Controls Over the Valuation Process for Financial Instruments — Our Independent Price Verification Group, independent of the trading function, plays an important role in determining that our financial instruments are appropriately valued and that fair value measurements are reliable. This is particularly important where prices or valuations that require inputs are less observable. In the event that observable inputs are not available, the control processes are designed to assure that the valuation approach utilized is appropriate and consistently applied and that the assumptions are reasonable. Where a pricing model is used to determine fair value, these control processes include reviews of the pricing model’s theoretical soundness and appropriateness by risk management personnel with relevant expertise who are independent from the trading desks. In addition, recently executed comparable transactions and other observable market data are considered for purposes of validating assumptions underlying the model.

Goodwill

At least annually, and more frequently if warranted, we assess whether goodwill has been impaired by comparing the estimated fair value of each reporting unit with its carrying value. The fair value of reporting units are based on valuations techniques that we believe market participants would use, although the valuation process requires significant judgment and often involves the use of significant estimates and assumptions. The estimates and assumptions used in determining fair value could have a significant effect on whether or not an impairment charge is recorded and the magnitude of such a charge. Adverse market or economic events could result in impairment charges in future periods. Refer to Note 12, Goodwill and Other Intangible Assets, in our consolidated financial statements for further detail on our assessment of goodwill.

Compensation and Benefits

A portion of our compensation and benefits represents discretionary bonuses, which are finalized 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, profitability, individual and business performance metrics, and our use of share-based compensation programs. We believe the most appropriate way to allocate estimated annual total compensation among interim periods is in proportion to projected net revenues earned. Consequently, during the year we accrue compensation and benefits based on annual targeted compensation ratios, taking into account the mix of our revenues and the timing of expense recognition.

For further discussion of these and other significant accounting policies, see Note 2, Summary of Significant Accounting Policies, in our consolidated financial statements.

Liquidity, Financial Condition and Capital Resources

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

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

 

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JEFFERIES GROUP, INC. AND SUBSIDIARIES — (Continued)

 

Analysis of Financial Condition

A business unit level balance sheet and cash capital analysis is prepared and reviewed with senior management on a weekly basis. As a part of this balance sheet review process, capital is allocated to all assets and gross and adjusted balance sheet limits are established. This process ensures that the allocation of capital and costs of capital are incorporated into business decisions. The goals of this process are to protect the firm’s platform, enable our businesses to remain competitive, maintain the ability to manage capital proactively and hold businesses accountable for both balance sheet and capital usage.

We actively monitor and evaluate our financial condition and the composition of our assets and liabilities. Substantially all of our Financial instruments owned and Financial instruments sold, not yet purchased are valued on a daily basis and we monitor and employ balance sheet limits for our various businesses. In connection with our government and agency fixed income business and our role as a primary dealer in these markets, a sizable portion of our securities inventory is comprised of U.S. government and agency securities and other G-7 government securities.

The following table provides detail on key balance sheet asset and liability line items (in millions):

 

     November 30,         
   2012      2011      %
Change
 

Total assets

   $ 36,293.5       $ 34,971.4         4

Cash and cash equivalents

     2,692.6         2,393.8         12

Cash and securities segregated and on deposit for regulatory purposes or deposited with clearing and depository organizations

     4,082.6         3,345.0         22

Financial instruments owned

     16,670.4         16,678.5         0

Financial instruments sold, not yet purchased

     7,455.5         6,605.0         13

Total Level 3 assets

     561.5         568.8         -1

Level 3 financial instruments for which we have economic exposure

     450.4         452.2         0

Securities borrowed

   $ 5,094.7       $ 5,169.7         -1

Securities purchased under agreements to resell

     3,357.6         2,893.0         16
  

 

 

    

 

 

    

Total securities borrowed and securities purchased under agreements to resell

   $ 8,452.3       $ 8,062.7         5
  

 

 

    

 

 

    

Securities loaned

   $ 1,934.4       $ 1,706.3         13

Securities sold under agreements to repurchase

     8,181.3         9,620.7         -15
  

 

 

    

 

 

    

Total securities loaned and securities sold under agreements to repurchase

   $ 10,115.7       $ 11,327.0         -11
  

 

 

    

 

 

    

Total assets at November 30, 2012 were relatively consistent from November 30, 2011 as management determined these balances as of these dates to be appropriate levels of risk and leverage while maintaining sufficient liquidity for the firm and balancing our clients’ trading needs. During the year ended November 30, 2012, average total assets were approximately 19% higher than total assets at November 30, 2012.

Jefferies Bache, LLC (our U.S. futures commission merchant) and Jefferies Bache Limited (our U.K. commodities and financial futures broker-dealer), receive cash or securities as margin to secure customer futures trades. As a result of the acquisition of this business and the related margin requirements for such activity, the balance of cash and securities segregated increased at November 30, 2011 from prior years and remains

 

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JEFFERIES GROUP, INC. AND SUBSIDIARIES — (Continued)

 

consistent with levels expected for this business activity. Jefferies & Company, Inc. (a U.S. broker-dealer), under SEC Rule 15c3-3, and Jefferies Bache, LLC, under CFTC Regulation 1.25, are required to maintain customer cash or qualified securities in a segregated reserve account for the exclusive benefit of our clients. We are required to conduct customer segregation calculations to ensure the appropriate amounts of funds are segregated and that no customer funds are used to finance firm activity. Similar requirements exist with respect to our U.K.-based activities conducted through Jefferies Bache Limited and Jefferies International Limited (a U.K. broker-dealer). Customer funds received are separately segregated and “locked-up” apart from our funds. If we rehypothecate customer securities, that activity is conducted only to finance customer activity. Additionally, we do not lend customer cash to counterparties to conduct securities financing activity (i.e., we do not lend customer cash to reverse in securities). Further, we have no customer loan activity in Jefferies International Limited and we do not have any European prime brokerage operations. In Jefferies Bache Limited, any funds received from a customer are placed on deposit and not used as part of our operations. We do not transfer U.S. customer assets to our U.K. entities.

Our total Financial instruments owned inventory at November 30, 2012 was $16.7 billion, consistent with inventory at November 30, 2011. Financial instruments owned at November 30, 2012 reflects increases in long inventory positions of sovereign obligations of $1.5 billion, mortgage- and asset-backed securities of $1.5 billion and corporate equity securities of $0.5 billion offset by a decrease in the holdings of U.S. government and agency securities of $4.4 billion as compared to Financial instruments owned at November 30, 2011. This is reflective of positioning to take advantage of widening credit spreads and reflective of more normal inventory levels in comparison to the significant liquidation of sovereign inventory exposures at the end of fiscal 2011. Our Financial instruments sold, not yet purchased inventory increased to $7.5 billion from $6.6 billion at November 30, 2011, primarily due to a $0.9 billion increase in sovereign obligations, increases in corporate equity and mortgage- and asset-backed securities and physical commodities, partially offset by a $0.4 billion decrease in U.S. government and agency securities. Inventory held of sovereign obligations fluctuated from an overall net long position of $4.1 million at November 30, 2011 to an overall net long position of $710.9 million at November 30, 2012, primarily driven by an increase in net long exposure to sovereign positions of Germany, Spain, France and the United Kingdom.

Our overall net inventory positions decreased by $0.9 billion to $9.2 billion as of November 30, 2012 from $10.1 billion as of November 30, 2011 with U.S. government and agency securities and other sovereign obligations accounting for $1.9 billion of the decrease offset by an increase in net mortgage-and asset backed securities inventory. We continually monitor our overall securities inventory, including the inventory turnover rate, which confirms the liquidity of our overall assets. As a Primary Dealer in the U.S. and with our similar role in several European jurisdictions, we carry inventory and make an active market for our clients in securities issued by the various governments. These inventory positions are substantially comprised of the most liquid securities in the asset class, with a significant portion in holdings of securities of G-7 countries. For further detail on our outstanding sovereign exposure to Greece, Ireland, Italy, Portugal and Spain as of November 30, 2012, refer to the Risk Management section within Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, within this Annual Report on Form 10-K.

Of our total Financial instruments owned, approximately 78% are readily and consistently financeable at haircuts of 10% or less. In addition, as a matter of our policy, a portion of these assets have internal capital assessed, which is in addition to the funding haircuts provided in the securities finance markets. Further, our Financial instruments owned consists of high yield bonds, bank loans, investments and non-agency mortgage-backed securities that are predominantly funded by long term capital. Under our cash capital policy, we model capital allocation levels that are more stringent than the haircuts used in the market for secured funding; and we maintain surplus capital at these maximum levels.

At November 30, 2012 and 2011, our Level 3 financial instruments owned for which we have economic exposure was 3% of our total financial instruments owned.

 

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JEFFERIES GROUP, INC. AND SUBSIDIARIES — (Continued)

 

Securities financing assets and liabilities include both financing for our financial instruments trading activity and matched book transactions. Matched book transactions accommodate customers, as well as obtain securities for the settlement and financing of inventory positions. The aggregate outstanding balance of our securities borrowed and securities purchased under agreements to resell increased by 5% from November 30, 2011 to November 30, 2012 primarily to facilitate our international fixed income business where short inventory increased. The outstanding balance of our securities loaned and securities sold under agreement to repurchase decreased by 11% from November 30, 2011 to November 30, 2012 due to a reduction in usage as our domestic fixed income businesses operated at levels that utilized less secured financing. Additionally, during fiscal 2012, and consistent with fiscal 2011, our utilization of repurchase agreements to finance liquid inventory was predominantly executed with central clearing corporations rather than bi-lateral repurchase agreements, which reduces the credit risk associated with these arrangements and results in decreased net outstanding balances and which partially offset the increase in matchbook secured financing activity. Our average month end balances of total reverse repos and stock borrows and total repos and stock loans during the year ended November 30, 2012, were 25% and 33% higher, respectively, than the November 30, 2012 balances. Our average month end balances of total reverse repos and stock borrows and total repos and stock loans during the year ended November 30, 2011, were 67% and 37% higher, respectively, than the November 30, 2011 balances.

The following table presents our period end balance, average balance and maximum balance at any month end within the periods presented for Securities purchased under agreements to resell and Securities sold under agreements to repurchase (in millions):

 

     Year Ended
November 30,
     Eleven Months  Ended
November 30,
 
     2012      2011      2010  

Securities Purchased Under Agreements to Resell

        

Period end

   $ 3,358       $ 2,893       $ 3,252   

Month end average

     4,890         4,780         3,769   

Maximum month end

     6,638         6,956         4,983   

Securities Sold Under Agreements to Repurchase

        

Period end

   $ 8,181       $ 9,621       $ 10,684   

Month end average

     11,380         13,024         11,464   

Maximum month end

     15,035         18,231         14,447   

Fluctuations in the balance of our repurchase agreements from period to period and intraperiod are dependent on business activity in those periods. Additionally, the fluctuations in the balances of our securities purchased under agreements to resell over the periods presented are influenced in any given period by our clients’ balances and our clients’ desires to execute collateralized financing arrangements via the repurchase market or via other financing products. Average balances and period end balances will fluctuate based on market and liquidity conditions and we consider the fluctuations intraperiod to be typical for the repurchase market.

 

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JEFFERIES GROUP, INC. AND SUBSIDIARIES — (Continued)

 

Leverage Ratios

The following table presents total assets, adjusted assets, total stockholders’ equity and tangible stockholders’ equity with the resulting leverage ratios as of November 30, 2012 and 2011 (in thousands):

 

          November 30,  
          2012     2011  

Total assets

   $ 36,293,541      $ 34,971,422   

Deduct:

  

Securities borrowed

     (5,094,679     (5,169,689
  

    Securities purchased under agreements to resell

     (3,357,602     (2,893,043

Add:

  

Financial instruments sold, not yet purchased

     7,455,463        6,604,973   
  

    Less derivative liabilities

     (229,127     (249,037
     

 

 

   

 

 

 

Subtotal

        7,226,336        6,355,936   

Deduct:

  

Cash and securities segregated and on deposit for regulatory purposes or deposited with clearing and depository organizations

     (4,082,595     (3,344,960
  

    Goodwill and intangible assets

     (380,929     (385,589
     

 

 

   

 

 

 

Adjusted assets

   $ 30,604,072      $ 29,534,077   
     

 

 

   

 

 

 

Total stockholders’ equity

   $ 3,782,753      $ 3,536,975   

Deduct:

  

Goodwill and intangible assets

     (380,929     (385,589
     

 

 

   

 

 

 

Tangible stockholders’ equity

   $ 3,401,824      $ 3,151,386   
     

 

 

   

 

 

 

Leverage ratio(1)

     9.6        9.9   
     

 

 

   

 

 

 

Adjusted leverage ratio(2)

     9.0        9.4   
     

 

 

   

 

 

 

 

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

 

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

Adjusted assets is a non-GAAP financial measure and excludes certain assets that are considered of lower risk as they are generally self-financed by customer liabilities through our securities lending activities. We view the resulting measure of adjusted leverage, also a non-GAAP financial measure, as a more relevant measure of financial risk when comparing financial services companies. The decrease in our leverage ratio and adjusted leverage ratio from November 30, 2011 to November 30, 2012 is commensurate with the increase in stockholders’ equity and management’s decision to maintain significant liquidity on hand.

Liquidity Management

The key objectives of the liquidity management framework are to support the successful execution of our business strategies while ensuring sufficient liquidity through the business cycle and during periods of financial distress. Our liquidity management policies are designed to mitigate the potential risk that we may be unable to access adequate financing to service our financial obligations without material franchise or business impact.

The principal elements of our liquidity management framework are our Contingency Funding Plan, our Cash Capital Policy and our assessment of Maximum Liquidity Outflow.

Contingency Funding Plan.    Our Contingency Funding Plan is based on a model of a potential liquidity contraction over a one year time period. This incorporates potential cash outflows during a liquidity stress event, including, but not limited to, the following: (a) repayment of all unsecured debt maturing within one year and no incremental unsecured debt issuance; (b) maturity rolloff of outstanding letters of credit with no further issuance

 

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JEFFERIES GROUP, INC. AND SUBSIDIARIES — (Continued)

 

and replacement with cash collateral; (c) higher margin requirements than currently exist on assets on securities financing activity, including repurchase agreements; (d) liquidity outflows related to possible credit downgrade; (e) lower availability of secured funding; (f) client cash withdrawals; (g) the anticipated funding of outstanding investment and loan commitments; and (h) certain accrued expenses and other liabilities and fixed costs.

Cash Capital Policy.    We maintain a cash capital model that measures long-term funding sources against requirements. Sources of cash capital include our equity, preferred stock and the noncurrent portion of long-term borrowings. Uses of cash capital include the following: (a) illiquid assets such as equipment, goodwill, net intangible assets, exchange memberships, deferred tax assets and certain investments; (b) a portion of securities inventory that is not expected to be financed on a secured basis in a credit stressed environment (i.e., margin requirements) and (c) drawdowns of unfunded commitments. To ensure that we do not need to liquidate inventory in the event of a funding crisis, we seek to maintain surplus cash capital, which is reflected in the leverage ratios we maintain. Our total capital of $8.7 billion as of November 30, 2012 exceeded our cash capital requirements.

Maximum Liquidity Outflow.    Our businesses are diverse, and our liquidity needs are determined by many factors, including market movements, collateral requirements and client commitments, all of which can change dramatically in a difficult funding environment. During a liquidity crisis, credit-sensitive funding, including unsecured debt and some types of secured financing agreements, may be unavailable, and the terms (e.g., interest rates, collateral provisions and tenor) or availability of other types of secured financing may change. As a result of our policy to ensure we have sufficient funds to cover what we estimate may be needed in a liquidity crisis, we hold more unencumbered securities and have greater long-term debt balances than our businesses would otherwise require. As part of this estimation process, we calculate a Maximum Liquidity Outflow that could be experienced in a liquidity crisis. Maximum Liquidity Outflow is based on a scenario that includes both a market-wide stress and a firm-specific stress, characterized by some or all of the following elements:

 

   

Global recession, default by a medium-sized sovereign, low consumer and corporate confidence, and general financial instability.

 

   

Severely challenged market environment with material declines in equity markets and widening of credit spreads.

 

   

Damaging follow-on impacts to financial institutions leading to the failure of a large bank.

 

   

A firm-specific crisis potentially triggered by material losses, reputational damage, litigation, executive departure, and/or a ratings downgrade.

The following are the critical modeling parameters of the Maximum Liquidity Outflow:

 

   

Liquidity needs over a 30-day scenario.

 

   

A two-notch downgrade of our long-term senior unsecured credit ratings.

 

   

No support from government funding facilities.

 

   

A combination of contractual outflows, such as upcoming maturities of unsecured debt, and contingent outflows (e.g., actions though not contractually required, we may deem necessary in a crisis). We assume that most contingent outflows will occur within the initial days and weeks of a crisis.

 

   

No diversification benefit across liquidity risks. We assume that liquidity risks are additive.

 

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JEFFERIES GROUP, INC. AND SUBSIDIARIES — (Continued)

 

The calculation of our Maximum Liquidity Outflow under the above stresses and modeling parameters considers the following potential contractual and contingent cash and collateral outflows:

 

   

All upcoming maturities of unsecured long-term debt, commercial paper, promissory notes and other unsecured funding products assuming we will be unable to issue new unsecured debt or rollover any maturing debt.

 

   

Repurchases of our outstanding long-term debt in the ordinary course of business as a market maker.

 

   

A portion of upcoming contractual maturities of secured funding trades due to either the inability to refinance or the ability to refinance only at wider haircuts (i.e., on terms which require us to post additional collateral). Our assumptions reflect, among other factors, the quality of the underlying collateral and counterparty concentration.

 

   

Collateral postings to counterparties due to adverse changes in the value of our OTC derivatives and other outflows due to trade terminations, collateral substitutions, collateral disputes, collateral calls or termination payments required by a two-notch downgrade in our credit ratings.

 

   

Variation margin postings required due to adverse changes in the value of our outstanding exchange-traded derivatives and any increase in initial margin and guarantee fund requirements by derivative clearing houses.

 

   

Liquidity outflows associated with our prime brokerage business, including withdrawals of customer credit balances, and a reduction in customer short positions.

 

   

Liquidity outflows to clearing banks to ensure timely settlements of cash and securities transactions.

 

   

Draws on our unfunded commitments considering, among other things, the type of commitment and counterparty.

 

   

Other upcoming large cash outflows, such as tax payments.

Based on the sources and uses of liquidity calculated under the Maximum Liquidity Outflow scenarios we determine, based on a calculated surplus or deficit, additional long-term funding that may be needed versus funding through the repurchase financing market and consider any adjustments that may be necessary to our inventory balances and cash holdings. At November 30, 2012, we have sufficient excess liquidity to meet all contingent cash outflows detailed in the Maximum Liquidity Outflow. We regularly refine our model to reflect changes in market or economic conditions and the firm’s business mix.

 

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JEFFERIES GROUP, INC. AND SUBSIDIARIES — (Continued)

 

Sources of 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):

 

     November 30,
2012
     Average balance
Quarter ended
November 30, 2012 (1)
     November 30,
2011
 

Cash and cash equivalents:

        

Cash in banks

   $ 1,038,664       $ 643,462       $ 846,990   

Money market investments

     1,653,931         1,137,032         1,546,807   
  

 

 

    

 

 

    

 

 

 

Total cash and cash equivalents

     2,692,595         1,780,494         2,393,797   
  

 

 

    

 

 

    

 

 

 

Other sources of liquidity:

        

Securities purchased under agreements to resell(2)

     900,000         1,032,289         233,887   

U.K. liquidity pool(2)

     407,378         327,763         303,416   

Other(3)

     423,735         485,958         509,491   
  

 

 

    

 

 

    

 

 

 

Total other sources

     1,731,113         1,846,010         1,046,794   
  

 

 

    

 

 

    

 

 

 

Total cash and cash equivalents and other liquidity sources

   $ 4,423,708       $ 3,626,504       $ 3,440,591   
  

 

 

    

 

 

    

 

 

 

 

(1) Average balances are calculated based on weekly balances.

 

(2) The liquidity pool, segregated by our U.K. broker-dealer, as required by FSA regulation, consists of high quality debt securities issued by a government or central bank of a state within the European Economic Area (“EEA”), Canada, Australia, Japan, Switzerland or the USA; reserves in the form of sight deposits with a central bank of an EEA state, Canada, Australia, Japan, Switzerland or the USA; and securities issued by a designated multilateral development bank and reverse repurchase agreements with underlying collateral comprised of these securities.

 

(3) Other includes unencumbered inventory representing an estimate of the amount of additional secured financing that could be reasonably expected to be obtained from our financial instruments owned that are currently not pledged after considering reasonable financing haircuts and additional funds available under the committed senior secured revolving credit facility available for working capital needs of Jefferies Bache.

 

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JEFFERIES GROUP, INC. AND SUBSIDIARIES — (Continued)

 

In addition to the cash balances and liquidity pool presented above, the majority of financial instruments (both long and short) in our trading accounts are actively traded and readily marketable. We have the ability to readily obtain repurchase financing for 78% of our inventory at haircuts of 10% or less, which reflects the marketability of our inventory. We continually assess the liquidity of our inventory based on the level at which we could obtain financing in the market place for a given asset. Assets are considered to be liquid if financing can be obtained in the repurchase market or the securities lending market at collateral haircut levels of 10% or less. The following summarizes our financial instruments by asset class that we consider to be of a liquid nature and the amount of such assets that have not been pledged as collateral at November 30, 2012 and 2011 (in thousands):

 

     November 30, 2012      November 30, 2011  
     Liquid Financial
Instruments
     Unencumbered
Liquid Financial
Instruments(2)
     Liquid Financial
Instruments
     Unencumbered
Liquid Financial
Instruments(2)
 

Corporate equity securities

   $ 1,745,960       $ 426,401       $ 1,105,271       $ 297,408   

Corporate debt securities

     2,292,823         61,303         2,193,821         48,503   

U.S. Government, agency and municipal securities

     2,114,768         57,681         6,109,749         19,003   

Other sovereign obligations

     2,681,457         269,475         1,166,577         336,453   

Agency mortgage- and asset-backed securities(1)

     4,052,289                 3,249,366           

Physical commodities

     144,016                 172,668         88,307   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 13,031,313       $ 814,860       $ 13,997,452       $ 789,674   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Consists solely of agency mortgage-backed securities issued by Freddie Mac, Fannie Mae and Ginnie Mae. These securities include pass-through securities, securities backed by adjustable rate mortgages (“ARMs”), collateralized mortgage obligations, commercial mortgage-backed securities and interest- and principal-only securities.

 

(2) Unencumbered liquid balances represent assets that can be sold or used as collateral for a loan, but have not been.

Average liquid financial instruments for the three months ended November 30, 2012 and 2011 were approximately $16.9 billion and $18.6 billion, respectively.

In addition to being able to be readily financed at modest haircut levels, we estimate that each of the individual securities within each asset class could be sold into the market and converted into cash within three business days under normal market conditions, assuming that the entire portfolio of a given asset class was not simultaneously liquidated. There are no restrictions on the unencumbered liquid securities, nor have they been pledged as collateral.

Sources of Funding and Capital Resources

Our assets are funded by equity capital, senior debt, convertible debt, mandatorily redeemable convertible preferred stock, mandatorily redeemable preferred interests, securities loaned, securities sold under agreements to repurchase, customer free credit balances, bank loans and other payables.

Secured Financing

We rely principally on secured and readily available funding to finance our inventory of financial instruments. Our ability to support increases in total assets is largely a function of our ability to obtain short term secured funding, primarily through securities financing transactions. We finance a portion of our long inventory

 

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and cover some of our short inventory by pledging and borrowing securities in the form of repurchase or reverse repurchase agreements (collectively “repos”), respectively. Approximately 89% of our repurchase financing activities use collateral that is considered eligible collateral by central clearing corporations. Central clearing corporations are situated between participating members who borrow cash and lend securities (or vice versa); accordingly repo participants contract with the central clearing corporation and not one another individually. Therefore, counterparty credit risk is borne by the central clearing corporation which mitigates the risk through initial margin demands and variation margin calls from repo participants. The comparatively large proportion of our total repo activity that is eligible for central clearing reflects the high quality and liquid composition of the inventory we carry in our trading books. The tenor of our repurchase and reverse repurchase agreements generally exceeds the expected holding period of the assets we are financing.

During fiscal 2011, and despite the increasingly uncertain economic situation in Europe and elsewhere, we continued to gain access to additional liquidity providers and increased funding availability both in terms of asset classes being financed and the term of the financing being offered. Near the end of the 2011 third quarter, given the instability and possible credit tightening of European banks, we began to execute more of our financing of European Sovereign inventory using central clearinghouse financing arrangements rather than via bi-lateral arrangements repo agreements. For those asset classes not eligible for central clearinghouse financing, we successfully increased the term of the bi-lateral financings. The remaining 11% of our outstanding repo balances is currently contracted bi-laterally, of which a significant portion is on a term basis. The following table provides detail on the composition of our outstanding repurchase agreements at November 30, 2012 (in millions):

 

     Repo Profile by Instrument Type  

Contract Type

   Total Contract
Amount
     Clearing Organization
Eligible
     % of Total     Non-Eligible      % of Total  

Treasury

   $ 8,117       $ 8,117         100   $         0

Sovereign

     2,101         2,101         100             0

Agency Debt

     1,078         1,078         100             0

Agency MBS

     6,837         5,949         87     887         13

Non-Agency MBS/ABS

     682                 0     682         100

Corporate Debt

     648         125         19     523         81

Municipal

     96                 0     96         100

Other

     1                 0     1         100
  

 

 

    

 

 

      

 

 

    
   $ 19,560       $ 17,370         89   $ 2,189         11
  

 

 

    

 

 

      

 

 

    

In addition to the above financing arrangements, in November 2012, we entered into a structured issuance program whereby we issue structured repurchase agreement notes backed by eligible collateral under a master repurchase agreement, which provides an additional financing source for our inventory. At November 30, 2012, the outstanding amount of the notes issued under the program was $60 million with a maturity date in November 2014 bearing interest at a spread over one month LIBOR. As the financing program is considered other secured financing, the balance of the financing is classified within Accrued expenses and other liabilities on the consolidated statement of financial condition. For additional discussion on the arrangement, refer to Note 10, Variable Interest Entities, in our consolidated financial statements.

Our ability to finance our inventory via central clearinghouses and bi-lateral arrangements is augmented by our $514.8 million of uncommitted secured and unsecured bank lines, comprised of $475.0 million of bank lines and $39.8 million of letters of credit. Of the $475.0 million uncommitted bank lines, $375.0 million is secured. As of November 30, 2012, short-term borrowings under the uncommitted bank lines totaled $150.0 million, of which $100.0 million is secured. Secured amounts are collateralized by a combination of customer and firm securities. Interest under the bank lines is generally at a spread over the federal funds rate. Letters of credit are

 

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used in the normal course of business mostly to satisfy various collateral requirements in favor of exchanges in lieu of depositing cash or securities. Average daily bank loans for the years ended November 30, 2012 and 2011 were $66.4 million and $12.0 million, respectively.

Total Capital

We had total long-term capital of $8.7 billion and $8.2 billion resulting in a long-term debt to equity capital ratio of 1.30:1 and 1.33:1 at November 30, 2012 and 2011, respectively. Our total capital base as of November 30, 2012 and 2011 was as follows (in thousands):

 

     November 30,  
     2012      2011  

Long-Term Debt(1)

   $ 4,454,600       $ 4,254,000   

Mandatorily Redeemable Convertible Preferred Stock

     125,000         125,000   

Mandatorily Redeemable Preferred Interest of Consolidated Subsidiaries

     348,051         310,534   

Total Stockholders’ Equity

     3,782,753         3,536,975   
  

 

 

    

 

 

 

Total Capital

   $ 8,710,404       $ 8,226,509   
  

 

 

    

 

 

 

 

(1) Long-term debt for purposes of evaluating long-term capital at November 30, 2012 and 2011 excludes $350.0 million and $100.0 million, respectively, of our outstanding borrowings under our long-term revolving Credit Facility and excludes $254.9 million of our 7.75% Senior Notes as of November 30, 2011 as the notes matured in less than one year from November 30, 2011 balance sheet date.

On November 12, 2012, we agreed to merge with Leucadia and the transaction is expected to close during the first quarter of 2013. As a result of the merger provisions, our outstanding mandatorily redeemable convertible preferred stock will either be redeemed or exchanged for a newly created series of preferred shares of Leucadia upon the merger consummation.

Subsequent to November 30, 2012, we issued $1.0 billion in new senior unsecured long-term debt, including 5.125% Senior Notes, due 2023 and 6.5% Senior Notes, due 2043. The 5.125% Senior Notes were issued with a par amount of $600.0 million and we received proceeds of $595.6 million. The 6.5% Senior Notes were issued with a par amount of $400.0 million and we received proceeds of $391.7 million.

At November 30, 2012, Stockholders’ equity includes noncontrolling interests in our high yield joint venture of $338 million, which we intend to redeem during the first quarter of 2013. We do not anticipate that this redemption will have a significant impact on our liquidity as we have sufficient cash on hand to affect the redemption and believe we have sufficient access to the capital markets for potential long-term funding to maintain an adequate total capital base. Further, while the redemptions would have the impact of reducing stockholders’ equity, it is also contemplated that the terms of the mandatorily redeemable preferred interests of consolidated subsidiaries, which are scheduled to terminate in April 2013, will be amended and ultimately be contributed as equity of Jefferies Group, Inc.

Long-Term Debt

On July 13, 2012, under our Euro Medium Term Note Program we issued senior unsecured notes with a principal amount of €4.0 million which bear interest at 2.25% per annum and mature on July 13, 2022. Proceeds net of original issue discount amounted to €2.8 million. In addition, on April 19, 2012, we issued an additional $200.0 million aggregate principal amount of our 6.875% Senior Notes due April 15, 2021. Proceeds before underwriting discount and expenses amounted to $197.7 million. The total aggregate principal amount issued under this series of notes including the add-on is $750.0 million.

 

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In connection with our announcement of the $422 million acquisition of Prudential Bache’s Global Commodities Group, in April 2011, we raised $500 million of additional common equity and $800 million in unsecured senior notes with a maturity of seven years. On August 26, 2011, we entered into a committed senior secured revolving credit facility (“Credit Facility”) with a group of commercial banks in Dollars, Euros and Sterling, in aggregate totaling $950.0 million, of which $250.0 million can be borrowed unsecured. At November 30, 2012 and 2011, we had borrowings outstanding under the Credit Facility amounting to $350.0 million and $100.0 million, respectively. These long-term capital raises and the Credit Facility exceed the needs of Jefferies Bache and provide us with additional liquidity.

Borrowers under the Credit Facility are Jefferies Bache Financial Services, Inc., Jefferies Bache, LLC and Jefferies Bache Limited. The Credit Facility terminates on August 26, 2014. Interest is based on the Federal funds rate or, in the case of Euro and Sterling borrowings, the Euro Interbank Offered Rate and the London Interbank Offered Rate, respectively. The Credit Facility is guaranteed by Jefferies Group, Inc. and contains financial covenants that, among other things, imposes restrictions on future indebtedness of our subsidiaries, requires Jefferies Group, Inc. to maintain specified level of tangible net worth and liquidity amounts, and requires certain of our subsidiaries to maintain specified levels of regulated capital. On a monthly basis we provide a certificate to the Administrative Agent of the Credit Facility as to the maintenance of various financial covenant ratios at all times during the preceding month. At November 30, 2012 and 2011, the minimum tangible net worth requirement was $2,200.0 million and $2,058.8 million, respectively and the minimum liquidity requirement was $400.8 million and $411.0 million, respectively for which we were in compliance. Throughout the period, no instances of noncompliance with the Credit Facility occurred and we expect to remain in compliance both in the near term and long term given our current liquidity, anticipated additional funding requirements given our business plan and profitability expectations. While our subsidiaries are restricted under the Credit Facility from incurring additional indebtedness beyond trade payable and derivative liabilities in the normal course of business, we do not believe that these restrictions will have a negative impact on our liquidity.

Our U.S. broker-dealer, from time to time, makes a market in our long-term debt securities (i.e., purchases and sells our long-term debt securities). During November and December 2011, there was extreme volatility in the price of our debt and a significant amount of secondary trading volume through our market-making desk. Given the volume of activity and significant price volatility, purchases and sales of our debt were treated as debt extinguishment and debt reissuance, respectively. We recognized a $9.9 million gain on debt extinguishment which is reported in Other revenues for the year ended November 30, 2012. The balance of Long-term debt has been reduced by $37.1 million as a result of the repurchase and subsequent reissuance of our debt below par during November and December 2011, which is being amortized over the remaining life of the debt using the effective yield method.

As of November 30, 2012, our long-term debt has an average maturity exceeding 8 years, excluding the Credit Facility. We have no other scheduled debt maturities until the $250.0 million 5.875% Senior Notes mature in 2014.

Our long-term debt ratings are as follows as of November 30, 2012:

 

     Rating    Outlook

Moody’s Investors Service

   Baa3    Stable

Standard and Poor’s

   BBB    Negative

Fitch Ratings

   BBB    Negative

On October 16, 2012, Moody’s Investor Services, Inc. (“Moody’s”), downgraded our senior unsecured debt rating one notch to Baa3 and assigned us a Stable outlook, thus concluding their credit review that commenced on September 10, 2012. Following the announcement on November 11, 2012 that Jefferies Group, Inc. had

 

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entered into a merger agreement with Leucadia, Moody’s affirmed the Baa3 debt rating. Standard and Poor’s affirmed the BBB rating and Negative outlook but commented that it anticipates revising the outlook to Stable if the merger with Leucadia is concluded as currently proposed. Fitch Ratings placed our credit rating on Ratings Watch Negative with a possible one-notch downgrade to BBB- following completion of the proposed merger with Leucadia in the first quarter of 2013. The above mentioned rating actions have not had any material adverse impact on our cost of funds or our ability to fund our operations.

We rely upon our cash holdings and external sources to finance a significant portion of our day to day operations. Access to these external sources, as well as the cost of that financing, is dependent upon various factors, including our debt ratings. Our current debt ratings are dependent upon many factors, including industry dynamics, operating and economic environment, 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. Deteriorations in any of these factors could impact our credit ratings. While certain aspects of a credit rating downgrade are quantifiable pursuant to contractual provisions, the impact on our business and trading results in future periods is inherently uncertain and depends on a number of factors, including the magnitude of the downgrade, the behavior of individual clients and future mitigating action taken by us.

In connection with certain over-the-counter derivative contract arrangements and certain other trading arrangements, we may be required to provide additional collateral to counterparties, exchanges and clearing organizations in the event of a credit rating downgrade. At November 30, 2012, the amount of additional collateral that could be called by counterparties, exchanges and clearing organizations under the terms of such agreements in the event of a downgrade of our long-term credit rating below investment grade by a single rating agency was $50.3 million and $102.0 million could be called in the event of a downgrade of our long-term credit rating below investment grade by a second rating agency. The impact of additional collateral requirements are considered in our Contingency Funding Plan and calculation of Maximum Liquidity Outflow, as described above.

Mandatorily Redeemable Preferred Interests of Consolidated Subsidiaries

Mandatorily redeemable preferred interests of $348.1 million and $310.5 million at November 30, 2012 and 2011, respectively, represent interests held in JHYH, which are entitled to a pro rata share of the profits and losses of JHYH. The term of these interests are scheduled to terminate in April 2013, with an option to extend up to three additional one-year periods. Under the proposed merger, it is contemplated that the interests will be amended and contributed as an increase to the stockholders’ equity of Jefferies Group, Inc.

 

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Contractual Obligations and Commitments

The tables below provide information about our commitments related to debt obligations, investments and derivative contracts as of November 30, 2012. The table presents principal cash flows with expected maturity dates (in millions):

 

     Expected Maturity Date         
     2013      2014      2015
and
2016
     2017
and
2018
     2019
and
Later
     Total  

Debt obligations:

                 

Unsecured long-term debt (contractual principal payments net of unamortized discounts and premiums)

   $       $ 249.6       $ 848.6       $ 771.4       $ 2,585.0       $ 4,454.6   

Senior secured revolving credit facility

             350.0                                 350.0   

Interest payment obligations on senior notes

     272.7         265.7         481.9         398.4         887.6         2,306.3   

Mandatorily redeemable convertible preferred stock

     125.0                                         125.0   

Mandatorily redeemable preferred interests of consolidated subsidiaries(1)

     348.1                                         348.1   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     745.8         865.3         1,330.5         1,169.8         3,472.6         7,584.0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Commitments and guarantees:

                 

Equity commitments

     0.4         4.1         1.2                 633.0         638.7   

Loan commitments

     129.8         387.6         111.3         16.4         2.3         647.4   

Mortgage-related commitments

     1,056.4         465.8         577.8                         2,100.0   

Forward starting reverse repos and repos

     342.7                                         342.7   

Derivative contracts:

                 

Derivative contracts — non credit related

     52,712.3         45,703.9         1.3                         98,417.5   

Derivative contracts — credit related

                             67.5                 67.5   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     54,241.6         46,561.4         691.6         83.9         635.3         102,213.8   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 54,987.4       $ 47,426.7       $ 2,022.1       $ 1,253.7       $ 4,107.9       $ 109,797.8   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) These mandatorily redeemable financial instruments represent interests held in JHYH and are scheduled to terminate in April 2013, with an option to extend up to three additional one-year periods. Refer also to discussion in Note 16, Noncontrolling Interest and Mandatorily Redeemable Preferred Interests of Consolidated Subsidiaries, in our consolidated financial statements.

 

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As lessee, we lease certain premises and equipment under noncancelable agreements expiring at various dates through 2023 which are operating leases. Future minimum lease payments for all noncancelable operating leases at November 30, 2012 are as follows for the fiscal years through 2023 (in thousands):

 

     Gross      Subleases      Net  

2013

   $ 65,602       $ 5,440       $ 60,162   

2014

     58,341         5,013         53,328   

2015

     33,090         2,344         30,746   

2016

     30,050         2,221         27,829   

2017

     28,566         300         28,266   

Thereafter

     88,216                 88,216   
  

 

 

    

 

 

    

 

 

 
   $ 303,865       $ 15,318       $ 288,547   
  

 

 

    

 

 

    

 

 

 

During 2012, we entered into a master sale and leaseback agreement under which we sold and have leased back existing and additional new equipment supplied by the lessor. The transaction resulted in a gain of $2.0 million, which is being amortized into earnings in proportion to and is reflected net against the leased equipment. The lease may be terminated on September 30, 2017 for a termination cost of the present value of the remaining lease payments plus a residual value. If not terminated early, the lease term is approximately five years from the start of the supply of new and additional equipment, which commences on various dates in 2013 and 2014. Minimum future lease payments are as follows (in thousands):

 

Fiscal Year

  

2013

   $ 3,887   

2014

     3,887   

2015

     3,887   

2016

     3,887   

2017

     3,887   

Thereafter

     1,750   
  

 

 

 

Net minimum lease payments

     21,185   

Less amount representing interest

     2,219   
  

 

 

 

Present value of net minimum lease payments

   $ 18,966   
  

 

 

 

Certain of our derivative contracts meet the definition of a guarantee and are therefore included in the above table. For additional information on commitments, see Note 21, Commitments, Contingencies and Guarantees, in our consolidated financial statements.

In the normal course of business we engage in other off balance sheet arrangements, including derivative contracts. Neither derivatives’ notional amounts nor underlying instrument values are reflected as assets or liabilities in our Consolidated Statements of Financial Condition. Rather, the fair value of derivative contracts are reported in the Consolidated Statements of Financial Condition as Financial instruments owned — derivative contracts or Financial instruments sold, not yet purchased — derivative contracts as applicable. Derivative contracts are reflected net of cash paid or received pursuant to credit support agreements and are reported on a net by counterparty basis when a legal right of offset exists under an enforceable master netting agreement. For additional information about our accounting policies and our derivative activities see Note 2, Summary of Significant Accounting Policies, Note 6, Fair Value Disclosures, and Note 7, Derivative Financial Instruments, in our consolidated financial statements.

We are routinely involved with variable interest entities (“VIEs”) in connection with our mortgage-backed securities securitization activities. VIEs are entities in which equity investors lack the characteristics of a

 

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controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. VIEs are consolidated by the primary beneficiary. The primary beneficiary is the party who has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and who has an obligation to absorb losses of the entity or a right to receive benefits from the entity that could potentially be significant to the entity. Where we are the primary beneficiary of a VIE, such as is the case with Jefferies High Yield Holdings, LLC, we consolidate the VIE. We do not generally consolidate the various VIEs related to our mortgage-backed securities securitization activities because we are not the primary beneficiary.

At November 30, 2012, we did not have any commitments to purchase assets from our securitization vehicles. At November 30, 2012, we held $364.1 million of mortgage-backed securities issued by VIEs for which we were initially involved as transferor and placement agent, which are accounted for at fair value and recorded within Financial instruments owned on our Consolidated Statement of Financial Condition in the same manner as our other financial instruments. For additional information regarding our involvement with VIEs, see Note 9, Securitization Activities and Note 10, Variable Interest Entities, in our consolidated financial statements.

Due to the uncertainty regarding the timing and amounts that will ultimately be paid, our liability for unrecognized tax benefits has been excluded from the above contractual obligations table. See Note 20, Income Taxes, in our consolidated financial statements for further information.

Equity Capital

Common stockholders’ equity increased to $3,436.0 million at November 30, 2012 from $3,224.3 million at November 30, 2011. The increase in our common stockholders’ equity during the year ended November 30, 2012 is principally attributed to net earnings to common shareholders, tax benefits for issuance of share-based awards and share-based compensation. This increase in our common stockholders’ equity is partially offset by dividends paid during the year ended November 30, 2012 and repurchases of approximately 7.7 million shares of our common stock during the period for $113.6 million.

The following table sets forth book value, adjusted book value, tangible book value and adjusted tangible book value per share (in thousands, except per share amounts):

 

     November 30,  
     2012     2011  

Common stockholders’ equity

   $ 3,436,015      $ 3,224,312   

Less: Goodwill and intangible assets

     (380,929     (385,589
  

 

 

   

 

 

 

Tangible common stockholders’ equity

   $ 3,055,086      $ 2,838,723   

Shares outstanding

     203,312        197,160   

Unearned restricted stock(5)

     (8,058     (9,032

Earned restricted stock units(6)

     16,656        18,994   

Other issuable shares(7)

     2,706        11,284   
  

 

 

   

 

 

 

Adjusted shares outstanding

     214,616        218,406   

Common book value per share(1)

   $ 16.90      $ 16.35   
  

 

 

   

 

 

 

Adjusted common book value per share(2)

   $ 16.01      $ 14.76   
  

 

 

   

 

 

 

Tangible common book value per share(3)

   $ 15.03      $ 14.40   
  

 

 

   

 

 

 

Adjusted tangible common book value per share(4)

   $ 14.24      $ 13.00   
  

 

 

   

 

 

 

 

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

 

(2) Adjusted common book value per share equals common stockholders’ equity divided by adjusted shares outstanding.

 

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

 

(4) Adjusted tangible common book value per share equals tangible common stockholders’ equity divided by adjusted shares outstanding.

 

(5) Unearned restricted stock represent shares that contain future service requirements and have either previously been issued and are included in shares outstanding or have previously been granted and are expected to be issued in the near-term and included in other issuable shares.

 

(6) Earned restricted stock units, which give the recipient the right to receive common shares at the end of a specified deferral period, are granted in connection with our share-based employee incentive plans and includes awards for which the future service requirements have been met.

 

(7) Other issuable shares primarily includes shares issuable to settle previously granted restricted stock awards and shares issuable under the deferred compensation plan. As of November 30 2011, other shares issuable included restricted stock granted as part of year-end compensation, which were issued in the first quarter of 2012.

Tangible common stockholders’ equity, adjusted common book value per share, tangible common book value per share, and adjusted tangible common 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 U.S. GAAP, or for which there is no specific U.S. GAAP guidance. Goodwill and other intangible assets are subtracted from common stockholders’ equity in determining tangible common stockholders’ equity as we believe that goodwill and other intangible assets do not constitute operating assets, which can be deployed in a liquid manner. We calculate adjusted common book value per share as common stockholders’ equity divided by adjusted shares outstanding. We believe the adjustments to shares outstanding for unearned restricted stock, earned restricted stock units and other issuable shares reflect potential economic claims on our net assets enabling shareholders to better assess their standing with respect to our financial condition. Valuations of financial companies are often measured as a multiple of tangible common stockholders’ equity, inclusive of any dilutive effects, making these ratios, and changes in these ratios, a meaningful measurement for investors. At November 30, 2012, we have modified the calculation of adjusted common book value per share and adjusted tangible common book value per share from that utilized in prior periods and the prior period presented has been conformed to the new calculation method. We made this revision as we believe the new calculation presents a more straightforward presentation of the historical impact of earned restricted stock and restricted stock units on our net assets.

At November 30, 2012, we have $125.0 million of Series A convertible preferred stock outstanding, which is convertible into 4,110,128 shares of our common stock at an effective conversion price of approximately $30.41 per share and $345.0 million of convertible senior debentures outstanding, which is convertible into 9,236,409 shares of our common stock at an effective conversion price of approximately $37.35 per share.

 

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The following table sets for the declaration dates, record dates, payment dates and per common share amounts for the dividends declared during the years ended November 30, 2012 and 2011:

 

Declaration Date

  

Record Date

  

Payment Date

   Dividend per
common share

Year ended November 30, 2012:

        

December 19, 2011

   January 17, 2012    February 15, 2012    $0.075

March 19, 2012

   April 16, 2012    May 15, 2012    $0.075

June 18, 2012

   July 16, 2012    August 15, 2012    $0.075

September 19, 2012

   October 15, 2012    November 15, 2012    $0.075

Year ended November 30, 2011:

        

December 17, 2010

   January 17, 2011    February 15, 2011    $0.075

March 21, 2011

   April 15, 2011    May 16, 2011    $0.075

June 20, 2011

   July 15, 2011    August 15, 2011    $0.075

September 20, 2011

   October 17, 2011    November 15, 2011    $0.075

Additionally, on December 6, 2012, a quarterly dividend was declared of $0.075 per share of common stock payable on December 31, 2012 to stockholders of record as of December 21, 2012.

Net Capital

As broker-dealers registered with the SEC and member firms of the Financial Industry Regulatory Authority (“FINRA”), Jefferies, Jefferies Execution and Jefferies High Yield Trading are subject to the Securities and Exchange Commission Uniform Net Capital Rule (“Rule 15c3-1”), which requires the maintenance of minimum net capital and which may limit distributions from the broker-dealers. Jefferies, Jefferies Execution and Jefferies High Yield Trading have elected to calculate minimum capital requirements using the alternative method permitted by Rule 15c3-1 in calculating net capital. Additionally, Jefferies Bache, LLC is registered as a Futures Commission Merchant and is subject to Rule 1.17 of the Commodities Futures Trading Commission (“CFTC”). Our designated self-regulatory organization is FINRA for our U.S. broker-dealers and the Chicago Mercantile Exchange for Jefferies Bache, LLC.

As of November 30, 2012, Jefferies, Jefferies Execution, Jefferies High Yield Trading and Jefferies Bache, LLC’s net capital, adjusted net capital, and excess net capital were as follows (in thousands):

 

     Net
Capital
     Excess Net
Capital
 

Jefferies

   $ 841,263       $ 794,419   

Jefferies Execution

     12,749         12,499   

Jefferies High Yield Trading

     566,040         565,790   
     Adjusted  Net
Capital
     Excess Net
Capital
 

Jefferies Bache, LLC

   $ 252,281       $ 85,241   

Certain other U.S. and non-U.S. subsidiaries are subject to capital adequacy requirements as prescribed by the regulatory authorities in their respective jurisdictions, including Jefferies International Limited and Jefferies Bache Limited which are subject to the regulatory supervision and requirements of the Financial Services Authority in the United Kingdom. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law on July 21, 2010. The Dodd-Frank Act contains provisions that require

 

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the registration of all swap dealers, major swap participants, security-based swap dealers, and/or major security-based swap participants. While entities that register under these provisions will be subject to regulatory capital requirements, these regulatory capital requirements have not yet been finalized. We expect that these provisions will result in modifications to the regulatory capital requirements of some of our entities, and will result in some of our other entities becoming subject to regulatory capital requirements for the first time, including Jefferies Derivative Products, Inc. and Jefferies Bache Financial Services, Inc., which registered as swap dealers with the CFTC during January 2013.

The regulatory capital requirements referred to above may restrict our ability to withdraw capital from our subsidiaries.

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, viability and profitability. Accordingly, we have a comprehensive risk management approach, with a formal governance structure and processes to identify, assess, monitor and manage risk. Principal risks involved in our business activities include market, credit, liquidity and capital, operational, legal and compliance, new business, and reputational risk.

Risk management is a multifaceted process that requires communication, judgment and knowledge of financial products and markets. Accordingly, our risk management process encompasses the active involvement of executive and senior management, and also many departments independent of the revenue-producing business units, including the Risk Management, Operations, Compliance, Legal and Finance Departments. Our risk management policies, procedures and methodologies are fluid in nature and are subject to ongoing review and modification.

For discussion of liquidity and capital risk management refer to, “Liquidity, Financial Condition and Capital Resources” within Item 7. Management’s Discussion and Analysis in this Annual Report on Form 10-K.

Governance and Risk Management Structure

Our Board of Directors    Our Board of Directors and the Audit Committee of the Board play an important role in reviewing our risk management process and risk tolerance. Our Board of Directors and Audit Committee are provided with data relating to risk at each of its regularly scheduled meetings. Our Chief Risk Officer and Global Treasurer meet with the Board of Directors on not less than a quarterly basis to present our risk profile and liquidity profile and to respond to questions.

Risk Committees    We make extensive use of internal committees to govern risk taking and ensure that business activities are properly identified, assessed, monitored and managed. Our Risk Management Committee meets weekly to discuss our risk, capital, and liquidity profile in detail. In addition, business or market trends and their potential impact on the risk profile are discussed. Membership is comprised of our Chief Executive Officer and Chairman, Chairman of the Executive Committee, Chief Financial Officer, Chief Risk Officer and Global Treasurer. The Committee approves limits for us as a whole, and across risk categories and business lines. It also reviews all limit breaches. Limits are reviewed on at least an annual basis. Other risk related committees include Market Risk Management, Credit Risk Management, New Business, Underwriting Acceptance, Margin Oversight, Executive Management and Operating Committees. These Committees govern risk taking and ensure that business activities are properly managed for their area of oversight.

Risk Related Policies    We make use of various policies in the risk management process:

 

   

Market Risk Policy — This policy sets out roles, responsibilities, processes and escalation procedures regarding market risk management.

 

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Independent Price Verification Policy — This policy sets out roles, responsibilities, processes and escalation procedures regarding independent price verification for securities and other financial instruments.

 

   

Operational Risk Policy — This policy sets out roles, responsibilities, processes and escalation procedures regarding operational risk management.

 

   

Credit Risk Policy — This policy provides standards and controls for credit risk-taking throughout our global business activities. This policy also governs credit limit methodology and counterparty review.

Risk Management Key Metrics

We apply a comprehensive framework of limits on a variety of key metrics to constrain the risk profile of our business activities. The size of the limit reflects our risk tolerance for a certain activity under normal business conditions. Key metrics included in our framework include inventory position and exposure limits on a gross and net basis, scenario analysis and stress tests, Value-at-Risk, sensitivities (greeks), exposure concentrations, aged inventory, amount of Level 3 assets, counterparty exposure, leverage, cash capital, and performance analysis metrics.

Market Risk

The potential for changes in the value of 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, commodity prices and foreign exchange rates, 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. Market risk arises from market making, proprietary trading, underwriting, specialist and investing activities. We seek to manage our exposure to market risk by diversifying exposures, controlling position sizes, and establishing economic hedges in related securities or derivatives. 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.

Value-at-Risk

We estimate Value-at-Risk (VaR) using a model that simulates revenue and loss distributions on substantially all financial instruments by applying historical market changes to the current portfolio. Using the results of this simulation, VaR measures the potential loss in value of our financial instruments over a specified time horizon at a given confidence level. We calculate a one-day VaR using a one year look-back period measured at a 95% confidence level. This implies that, on average, we expect to realize a loss of daily trading net revenue at least as large as the VaR amount on one out of every twenty trading days.

As with all measures of VaR, our estimate has inherent limitations due to the assumption that historical changes in market conditions are representative of the future. Furthermore, the VaR model measures the risk of a current static position over a one-day horizon and might not capture the market risk of positions that cannot be liquidated or offset with hedges in a one-day period. Published VaR results reflect past trading positions while future risk depends on future positions.

 

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While we believe the assumptions and inputs in our risk model are reasonable, 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. Consequently, this VaR estimate is only one of a number of tools we use in our daily risk management activities. When comparing our VaR numbers to those of other firms, it is important to remember that different methodologies and assumptions could produce significantly different results.

The VaR numbers below are shown separately for interest rate, equity, currency and commodity products, as well as for our overall trading positions, excluding corporate investments in asset management positions, using the past 365 days of historical date. The aggregated VaR presented here is less than the sum of the individual components (i.e., interest rate risk, foreign exchange rate risk, equity risk and commodity price risk) due to the benefit of diversification among the risk categories. Diversification benefit equals the difference between aggregated VaR and the sum of VaRs for the four risk categories and arises because the market risk categories are not perfectly correlated. The following table illustrates the VaR for each component of market risk (in millions).

 

     Daily VaR(1) Value-at-Risk In Trading Portfolios  
      VaR as of November 30,     Daily VaR for the Year Ended November 30,  

Risk Categories

       2012             2011         2012      2011  
                 Average     High      Low      Average     High      Low  

Interest Rates

   $ 5.37      $ 6.17      $ 6.74      $ 13.40       $ 4.40       $ 8.41      $ 13.98       $ 3.26   

Equity Prices

     8.02        2.06        4.99        13.81         1.15         5.33        12.70         1.25   

Currency Rates

     0.37        0.32        0.66        1.94         0.18         0.77        2.07         0.04   

Commodity Prices

     0.77        1.25        1.26        2.55         0.45         1.36        2.90         0.53   

Diversification Effect(2)

     (3.12     (3.29     (2.99     N/A         N/A         (4.96     N/A         N/A   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Firmwide

   $ 11.41      $ 6.51      $ 10.66      $ 17.96       $ 5.38       $ 10.91      $ 19.17       $ 6.51   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

 

(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, with a one year look-back period, and a 95% confidence level were used.

 

(2) The diversification effect is not applicable for the maximum and minimum VaR values as the firmwide VaR and the VaR values for the four risk categories might have occurred on different days during the period.

Our average daily VaR decreased to $10.66 million for the year ended November 30, 2012 from $10.91 million for the year ended November 30, 2011. The decrease is primarily due to decreased interest rates risk resulting from reduced interest rate positioning in U.S. and European interest rate products and lower volatility in interest rate asset classes. Decreases across all the risk categories was partially offset by a decrease in the diversification benefit. Excluding our investment in Knight Capital, average VaR for the year ended November 30, 2012 was $8.75 million.

 

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The chart below reflects our daily VaR over the last four quarters:

 

LOGO

Our average VaR for the three months ended November 30, 2012 increased from the third fiscal quarter primarily from maintaining our holding in Knight Capital. Excluding Knight Capital, the decrease in our VaR over the three months ended November 30, 2012 resulted primarily from lower interest rate exposure due to lower volatility and interest rate spreads.

The primary method used to test the efficacy of the VaR model is to compare actual daily net revenue with the daily VaR estimate. This evaluation is performed at various levels of the trading portfolio, from the holding company level down to specific business lines. For the VaR model, trading related revenue is defined as principal transaction revenue, trading related commissions, revenue from securitization activities and net interest income. (Prior to the second quarter of 2012, trading related revenue had excluded revenue from securitization activities for purposes of this analysis.) For a 95% confidence one day VaR model (i.e. no intra-day trading), assuming current changes in market value are consistent with the historical changes used in the calculation, net trading losses would not be expected to exceed the VaR estimates more than twelve times on an annual basis (i.e. once in every 20 days). During the three months ended and year ended November 30, 2012, results of the evaluation at the aggregate level demonstrated no days when the net trading loss exceeded the 95% one day VaR.

 

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Daily Net Trading Revenue

The chart below presents the distribution of our daily net trading revenue for substantially all of our trading activities for the year ended November, 2012 (in millions).

 

LOGO

There were four days with trading losses out of a total of 253 trading days in the year ended November 30, 2012.

Scenario Analysis and Stress Tests

While VaR measures potential losses due to adverse changes in historical market prices and rates, we use stress testing to analyze the potential impact of specific events or moderate or extreme market moves on our current portfolio both firm wide and within business segments. Stress scenarios comprise both historical market price and rate changes and hypothetical market environments, and generally involve simultaneous changes of many risk factors. Indicative market changes in our scenarios include, but are not limited to, a large widening of credit spreads, a substantial decline in equities markets, significant moves in selected emerging markets, large moves in interest rates, changes in the shape of the yield curve and large moves in European markets. In addition, we also perform ad hoc stress tests and add new scenarios as market conditions dictate. Because our stress scenarios are meant to reflect market moves that occur over a period of time, our estimates of potential loss assume some level of position reduction for liquid positions. Unlike our VaR, which measures potential losses within a given confidence interval, stress scenarios do not have an associated implied probability; rather, stress testing is used to estimate the potential loss from market moves that tend to be larger than those embedded in the VaR calculation.

Stress testing is performed and reported regularly as part of the risk management process. Stress testing is used to assess our aggregate risk position as well as for limit setting and risk/reward analysis.

Counterparty Credit Risk and Issuer Country Exposure

Counterparty Credit Risk

Credit risk is the risk of loss due to adverse changes in a counterparty’s credit worthiness or its ability or willingness to meet its financial obligations in accordance with the terms and conditions of a financial contract. We are exposed to credit risk as trading counterparty to other broker-dealers and customers, as a direct lender and through extending loan commitments, as a holder of securities and as a member of exchanges and clearing organizations.

 

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It is critical to our financial soundness and profitability that we properly and effectively identify, assess, monitor, and manage the various credit and counterparty risks inherent in our businesses. Credit is extended to counterparties in a controlled manner in order to generate acceptable returns, whether such credit is granted directly or is incidental to a transaction. All extensions of credit are monitored and managed on an enterprise level in order to limit exposure to loss related to credit risk.

Our Credit Risk Framework is responsible for identifying credit risks throughout the operating businesses, establishing counterparty limits and managing and monitoring those credit limits. Our framework includes:

 

   

defining credit limit guidelines and credit limit approval processes;

 

   

providing a consistent and integrated credit risk framework across the enterprise;

 

   

approving counterparties and counterparty limits with parameters set by the Risk Management Committee;

 

   

negotiating, approving and monitoring credit terms in legal and master documentation;

 

   

delivering credit limits to all relevant sales and trading desks;

 

   

maintaining credit reviews for all active and new counterparties;

 

   

operating a control function for exposure analytics and exception management and reporting;

 

   

determining the analytical standards and risk parameters for on-going management and monitoring of global credit risk books;

 

   

actively managing daily exposure, exceptions, and breaches;

 

   

monitoring daily margin call activity and counterparty performance (in concert with the Margin Department); and

 

   

setting the minimum global requirements for systems, reports, and technology.

Credit Exposures

Credit exposure exists across a wide-range of products including cash and cash equivalents, loans, securities finance transactions and over-the-counter derivative contracts.

 

   

Loans and lending arise in connection with our capital markets activities and represents the notional value of loans that have been drawn by the borrower and lending commitments that were outstanding at November 30, 2012.

 

   

Securities and margin finance includes credit exposure arising on securities financing transactions (reverse repurchase agreements, repurchase agreements and securities lending agreements) to the extent the fair value of the underlying collateral differs from the contractual agreement amount and from margin provided to customers.

 

   

Derivatives represent over-the-counter (“OTC”) derivatives, which are reported net by counterparty when a legal right of setoff exists under an enforceable master netting agreement. Derivatives are accounted for at fair value net of cash collateral received or posted under credit support agreements. In addition, credit exposures on forward settling trades are included within our derivative credit exposures.

 

   

Cash and cash equivalents include both interest-bearing and non-interest bearing deposits at banks.

 

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Current counterparty credit exposures at November 30, 2012 and November 30, 2011 are summarized in the table below and provided by credit quality, region and industry. Credit exposures presented take netting and collateral into consideration by counterparty and master agreement. Collateral taken into consideration includes both collateral received as cash as well as collateral received in the form of securities or other arrangements. Current exposure is the loss that would be incurred on a particular set of positions in the event of default by the counterparty, assuming no recovery. Current exposure equals the fair value of the positions less collateral. Issuer risk is the credit risk arising from inventory positions (for example, corporate debt securities and secondary bank loans). Issuer risk is included in our country risk exposure tables below. Of our counterparty credit exposure at November 30, 2012, excluding cash and cash equivalents, 59% are investment grade counterparties, compared to 69% at November 30, 2011, and are mainly concentrated in North America. Of the credit exposure in Europe, approximately 85% are investment grade counterparties, with the largest exposures arising from securities and margin financing products. When comparing our credit exposure at November 30, 2012 with credit exposure at November 30, 2011, excluding cash and cash equivalents, current exposure has increased 14% to approximately $1.1 billion from $925.6 million. The increase is primarily due to an increase in loan and repo balances.

Counterparty Credit Exposure by Credit Rating

 

    Loans and
Lending
    Securities  and
Margin
Finance
    OTC
Derivatives
    Total     Cash and Cash
Equivalents
    Total with Cash
and Cash
Equivalents
 
    As of
November 30,
    As of
November 30,
    As of
November 30,
    As of
November 30,
    As of
November 30,
    As of
November 30,
 
(in millions)  

2012

    2011     2012     2011     2012     2011     2012     2011     2012     2011     2012     2011  

AAA Range

                  0.9        0.4                      0.9        0.4        1,322.7        1,546.3        1,323.6        1,546.6   

AA Range

                  178.3        80.9        18.9        116.7        197.2        197.6        149.7        211.8        346.9        409.4   

A Range

                  157.8        227.6        71.7        149.5        229.5        377.1        1,134.0        634.6        1,363.5        1,011.7   

BBB Range

    50.0               120.2        41.5        20.7        20.3        190.9        61.8        86.2        1.7        277.1        63.5   

BB or Lower

    255.0        147.0        109.6        81.4        13.0        19.6        377.6        248.0                      377.6        248.0   

Unrated

    57.5        35.0                      1.7        6.0        59.2        41.0                      59.2        41.0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    362.5        182.0        566.8        431.8        126.0        312.1        1,055.3        925.9        2,692.6        2,394.3        3,747.9        3,320.2   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Counterparty Credit Exposure by Region

 

    Loans and
Lending
    Securities and
Margin
Finance
    OTC
Derivatives
    Total     Cash and Cash
Equivalents
    Total with Cash
and Cash
Equivalents
 
    As of
November 30,
    As of
November 30,
    As of
November 30,
   

As of

November 30,

   

As of

November 30,

   

As of

November 30,

 
(in millions)  

2012

    2011     2012     2011     2012     2011     2012     2011     2012     2011     2012     2011  

Asia/Latin America/Other

    12.5               75.2        75.7        5.9        30.2        93.6        105.9        4.8        14.1        98.4        120.0   

Europe

                  131.3        194.3        39.8        117.2        171.1        311.5        713.5        509.2        884.6        820.7   

North America

    350.0        182.0        360.3        161.9        80.3        164.6        790.6        508.5        1,974.3        1,871.0        2,764.9        2,379.5   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    362.5        182.0        566.8        431.8        126.0        312.1        1,055.3        925.9        2,692.6        2,394.3        3,747.9        3,320.2   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Counterparty Credit Exposure by Industry

 

    Loans and
Lending
    Securities and
Margin
Finance
    OTC
Derivatives
    Total     Cash and Cash
Equivalents
    Total with Cash
and Cash
Equivalents
 
    As of
November 30,
    As of
November 30,
    As of
November 30,
   

As of

November 30,

   

As of

November 30,

   

As of

November 30,

 
(in millions)   2012     2011     2012     2011     2012     2011     2012     2011     2012     2011     2012     2011  

Asset Managers

                  57.0        64.2        0.2        3.3        57.2        67.5        1,322.7        1,546.3        1,379.9        1,613.8   

Banks, Broker-dealers

                  389.8        255.7        66.9        214.1        456.7        469.7        1,369.9        848.0        1,826.6        1,317.8   

Commodities

                  21.7        41.5        33.2        34.2        54.9        75.8                 54.9        75.8   

Other

    362.5        182.0        98.3        70.4        25.7        60.4        486.5        312.8                 486.5        312.8   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    362.5        182.0        566.8        431.8        126.0        312.1        1,055.3        925.9        2,692.6        2,394.3        3,747.9        3,320.2   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

For additional information regarding credit exposure to OTC derivative contracts, refer to Note 7, Derivative Financial Instruments, in our consolidated financial statements included within this Annual Report on Form 10-K.

Country Risk Exposure

Country risk is the risk that events or developments that occur in the general environment of a country or countries due to economic, political, social, regulatory, legal or other factors, will affect the ability of obligors of the country to honor their obligations. We define country risk as the country of jurisdiction or domicile of the obligor’s ultimate group parent. The following tables reflect our top exposure at November 30, 2012 and November 30, 2011 to the sovereign governments, corporations and financial institutions in those non- U.S. countries in which we have a net long issuer and counterparty exposure (in millions):

 

    As of November 30, 2012  
    Issuer Risk     Counterparty Risk     Issuer and Counterparty Risk  
    Fair Value of
Long Debt
Securities
    Fair Value of
Short Debt
Securities
    Net Derivative
Notional
Exposure
    Securities and
Margin Finance
    OTC
Derivatives
    Cash and Cash
Equivalents
    Excluding Cash
and Cash
Equivalents
    Including Cash
and Cash
Equivalents
 

Great Britain

  $ 679.2      $ (458.5   $ (64.3   $ 13.0      $ 8.3      $ 409.9      $ 177.7      $ 587.6   

Germany

    516.8        (326.5     (94.8     62.4        5.1        122.2        163.0        285.2   

Canada

    149.0        (64.2     (24.6     103.9        13.0               177.1        177.1   

Spain

    283.3        (95.6     (26.0     4.6               0.2        166.3        166.5   

Switzerland

    46.6        (17.6     (1.5     16.2        22.2        84.4        65.9        150.3   

Netherlands

    247.5        (131.6     (9.2     11.6        0.2        0.4        118.5        118.9