10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2006

OR

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

For the transition period from                      to                     

Commission file number 1-14947

JEFFERIES GROUP, INC.

(Exact name of registrant as specified in its charter)

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

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

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

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

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

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

Indicate the number of shares outstanding of the registrant’s class of common stock, as of the latest practicable date. 118,884,385 shares as of the close of business October 31, 2006.

JEFFERIES GROUP, INC. AND SUBSIDIARIES
INDEX TO QUARTERLY REPORT ON FORM 10-Q
SEPTEMBER 30, 2006

	Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Financial Condition (unaudited) - September 30, 2006 and December 31, 2005		3
Consolidated Statements of Earnings (unaudited) - Three Months and Nine Months Ended September 30, 2006 and 2005		4
Consolidated Statement of Changes in Stockholders’ Equity (unaudited) - Nine Months Ended September 30, 2006 and Year Ended December 31, 2005		5
Consolidated Statements of Cash Flows (unaudited) - Nine Months Ended September 30, 2006 and 2005		6
Notes to Consolidated Financial Statements (unaudited)		8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		39
Item 3. Quantitative and Qualitative Disclosures About Market Risk		52
Item 4. Controls and Procedures		56
PART II. OTHER INFORMATION
Item 1. Legal Proceedings		56
Item 1A. Risk Factors		56
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		56
Item 6. Exhibits		57
Signature		58
Ex-10.2
Ex-10.3
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32

Page 2 of 58

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

JEFFERIES GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED)

(Dollars in thousands, except per share amounts)

	September 30,			December 31,
	2006			2005
ASSETS
Cash and cash equivalents	$	326,509		$	255,933
Cash and securities segregated and on deposit for regulatory purposes or deposited with clearing and depository organizations		767,982			629,360
Short term bond funds		¾			7,037
Investments		126,968			107,684
Investments in managed funds		291,704			278,116
Securities borrowed		8,027,821			8,143,478
Receivable from brokers, dealers and clearing organizations		531,977			389,994
Receivable from customers		583,957			457,839
Financial instruments owned		2,991,989			1,650,080
Securities pledged to creditors		1,115,667			178,686
Premises and equipment		76,693			69,821
Goodwill		237,544			220,607
Other assets		405,913			392,296
Total Assets	$	15,484,724		$	12,780,931
LIABILITIES AND STOCKHOLDERS’ EQUITY
Securities loaned	$	7,192,169			7,729,544
Securities sold under agreements to repurchase		65,125			¾
Payable to brokers, dealers and clearing organizations		523,653			303,480
Payable to customers		934,599			813,896
Financial instruments sold, not yet purchased		3,086,009			1,300,317
Accrued expenses and other liabilities		764,907			530,477
		12,566,462			10,677,714
Long-term debt		1,268,582			779,873
Mandatorily redeemable convertible preferred stock		125,000			¾
Minority interest		31,267			36,494
Total Liabilities		13,991,311			11,494,081
STOCKHOLDERS’ EQUITY
Common stock, $.0001 par value. Authorized 500,000,000 shares; issued 144,640,474 shares in 2006 and 140,857,994 shares in 2005		14			7
Additional paid-in capital		826,889			709,447
Retained earnings		912,281			803,262
Less:
Treasury stock, at cost, 25,764,084 shares in 2006 and 24,637,210 shares in 2005		(245,984	)		(220,703	)
Accumulated other comprehensive gain (loss):
Currency translation adjustments		6,338			962
Additional minimum pension liability		(6,125	)		(6,125	)
Total accumulated other comprehensive gain (loss)		213			(5,163	)
Total stockholders’ equity		1,493,413			1,286,850
Total Liabilities and Stockholders’ Equity	$	15,484,724		$	12,780,931

See accompanying unaudited notes to consolidated financial statements.

Page 3 of 58

JEFFERIES GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS (Unaudited)

(In thousands, except per share and ratio amounts)

	Three Months Ended				Nine Months Ended
	Sept. 30,		Sept. 30,		Sept. 30,		Sept. 30,
	2006		2005		2006		2005
Revenues:
Commissions	$	67,953	$	58,157	$	208,589	$	185,304
Principal transactions		98,984		104,415		353,088		261,887
Investment banking		144,763		107,556		395,429		327,517
Asset management fees and investment income from managed funds		16,783		21,667		80,132		63,385
Interest		132,424		81,467		385,035		212,738
Other		7,757		4,822		27,587		15,309
Total revenues		468,664		378,084		1,449,860		1,066,140
Interest expense		128,054		78,804		366,493		204,292
Revenues, net of interest expense		340,610		299,280		1,083,367		861,848
Non-interest expenses:
Compensation and benefits		184,421		167,033		593,830		481,024
Floor brokerage and clearing fees		15,496		11,059		46,363		35,350
Technology and communications		21,490		16,432		59,863		50,053
Occupancy and equipment rental		15,819		10,936		44,390		32,852
Business development		12,653		9,651		36,057		27,698
Other		14,394		16,632		48,405		44,851
Total non-interest expenses		264,273		231,743		828,908		671,828
Earnings before income taxes, minority interest and cumulative effect of change in accounting principle		76,337		67,537		254,459		190,020
Income taxes		29,734		26,143		99,523		73,209
Earnings before minority interest and cumulative effect of change in accounting principle		46,603		41,394		154,936		116,811
Minority interest in earnings of consolidated subsidiaries, net		663		2,799		6,575		6,107
Earnings before cumulative effect of change in accounting principle, net		45,940		38,595		148,361		110,704
Cumulative effect of change in accounting principle, net		¾		¾		1,606		¾
Net earnings	$	45,940	$	38,595	$	149,967	$	110,704
Earnings per basic share:
Basic-
Earnings before cumulative effect of change in accounting principle, net	$	0.34	$	0.31	$	1.12	$	0.90
Cumulative effect of change in accounting principle, net		¾		¾		0.01		¾
Net earnings	$	0.34	$	0.31	$	1.13	$	0.90
Diluted-
Earnings before cumulative effect of change in accounting principle, net	$	0.32	$	0.28	$	1.03	$	0.82
Cumulative effect of change in accounting principle, net		¾		¾		0.01		¾
Net earnings	$	0.32	$	0.28	$	1.04	$	0.82
Weighted average shares:
Basic		135,140		124,447		133,048		122,868
Diluted		148,908		136,225		146,502		134,747
Fixed charge coverage ratio		4.0X		5.6X		4.5X		5.4X

See accompanying unaudited notes to consolidated financial statements.

Page 4 of 58

JEFFERIES GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited)

NINE MONTHS ENDED SEPTEMBER 30, 2006 AND YEAR ENDED DECEMBER 31, 2005

(Dollars in thousands, except per share amounts)

	Nine Months			Year
	Ended			Ended
	September 30,			December 31,
	2006			2005
Common stock, par value $.0001 per share
Balance, beginning of year	$	7		$	7
Stock split		7			—
Balance, end of period	$	14		$	7
Additional paid in capital
Balance, beginning of year	$	709,447		$	508,221
Benefit plan share activity		24,294			13,432
Amortization expense		62,615			100,217
Proceeds from exercise of stock options		12,852			33,661
Acquisitions		—			26,998
Tax benefits		17,681			26,918
Balance, end of period	$	826,889		$	709,447
Retained earnings
Balance, beginning of year	$	803,262		$	677,464
Net earnings		149,967			157,443
Dividends		(40,948	)		(31,645	)
Balance, end of period	$	912,281		$	803,262
Treasury stock, at cost
Balance, beginning of year	$	(220,703	)	$	(149,039	)
Purchases		(16,638	)		(76,291	)
Returns / forfeitures		(8,643	)		(6,717	)
Issued		—			11,344
Balance, end of period	$	(245,984	)	$	(220,703	)
Accumulated other comprehensive income (loss)
Balance, beginning of year	$	(5,163	)	$	2,480
Currency adjustment		5,376			(8,386	)
Pension adjustment		—			743
Balance, end of period	$	213		$	(5,163	)
Total stockholders’ equity	$	1,493,413		$	1,286,850
Comprehensive income
Net earnings	$	149,967		$	157,443
Other comprehensive income (loss)		5,376			(7,643	)
Total comprehensive income	$	155,343		$	149,800

See accompanying unaudited notes to consolidated financial statements.

Page 5 of 58

JEFFERIES GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(Dollars in thousands)

	Nine Months Ended
	Sept. 30,			Sept. 30,
	2006			2005
Cash flows from operating activities:
Net earnings	$	149,967		$	110,704
Adjustments to reconcile net earnings to net cash used in operating activities:
Cumulative effect of accounting change, net		1,606			¾
Depreciation and amortization		14,478			7,913
Tax benefit from the issuance of stock based awards		¾			23,533
Accruals related to various benefit plans, stock issuances, net of forfeitures		75,510			47,442
Increase in cash and securities segregated and on deposit for regulatory purposes or deposited with clearing and depository organizations		(138,744	)		(117,416	)
(Increase) decrease in receivables:
Securities borrowed		115,658			1,819,112
Brokers, dealers and clearing organizations		(137,169	)		(234,576	)
Customers		(118,512	)		(513,173	)
Increase in financial instruments owned		(1,340,965	)		(938,936	)
(Increase) decrease in securities pledged to creditors		(936,981	)		519,628
Increase in other assets		(15,935	)		(227,292	)
Increase (decrease) in operating payables:
Securities loaned		(537,375	)		(1,332,353	)
Securities sold under agreements to repurchase		65,125			¾
Brokers, dealers and clearing organizations		213,445			104,829
Customers		117,025			519,712
Increase in financial instruments sold, not yet purchased		1,785,692			168,957
Increase in accrued expenses and other liabilities		238,015			277,502
(Decrease) increase in minority interest		(5,227	)		2,787
Net cash (used in) provided by operating activities		(454,387	)		238,373

Continued on next page.

Page 6 of 58

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

	Nine Months Ended
	Sept. 30,			Sept. 30,
	2006			2005
Cash flows from investing activities:
Decrease (increase) in short term bond funds		7,037			(128	)
Increase in investments		(19,196	)		(18,388	)
Increase in investments in managed funds		(13,588	)		(64,625	)
Business acquisitions, net of cash received		(19,944	)		(67,261	)
Purchase of premises and equipment		(20,104	)		(16,773	)
Net cash used in investing activities		(65,795	)		(167,175	)
Cash flows from financing activities
Tax benefit from the issuance of stock based awards		17,681			¾
Net proceeds from (payments on):
Bank loans		¾			(70,000	)
Issuance of senior notes		492,155			¾
Issuance of mandatorily redeemable convertible preferred stock		125,000			¾
Repurchase of treasury stock		(16,638	)		(69,951	)
Dividends		(40,948	)		(22,058	)
Exercise of stock options, not including tax benefits		12,852			29,062
Net cash provided by (used in) financing activities		590,102			(132,947	)
Effect of foreign currency translation on cash and cash equivalents		656			(1,993	)
Net increase (decrease) in cash and cash equivalents		70,576			(63,742	)
Cash and cash equivalents – beginning of period		255,933			284,111
Cash and cash equivalents – end of period	$	326,509		$	220,369
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest	$	374,388		$	208,510
Income taxes	$	140,472		$	54,344

See accompanying unaudited notes to consolidated financial statements.

Page 7 of 58

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Index

	Page
Note 1. Organization and Summary of Significant Accounting Policies		9
Note 2. Asset Management Fees and Investment Income From Managed Funds		16
Note 3. Cash, Cash Equivalents, and Short-Term Investments		19
Note 4. Financial Instruments Owned, Securities Pledged to Creditors and Financial Instruments Sold, Not Yet Purchased		19
Note 5. Long-Term Debt		20
Note 6. Mandatorily Redeemable Convertible Preferred Stock		20
Note 7. Benefit Plans		21
Note 8. Minority Interest		21
Note 9. Earnings Per Share		22
Note 10. Derivative Financial Instruments		22
Note 11. Other Comprehensive Gain (Loss)		25
Note 12. Net Capital Requirements		26
Note 13. Commitments, Contingencies and Guarantees		27
Note 14. Segment Reporting		29
Note 15. Goodwill		30
Note 16. Quarterly Dividends		31
Note 17. Variable Interest Entities (“VIEs”)		31
Note 18. Related Party Disclosures		32
Note 19. Stock Based Compensation		33

Page 8 of 58

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

Note 1. Organization and Summary of Significant Accounting Policies

Organization

The accompanying unaudited consolidated financial statements include the accounts of Jefferies Group, Inc. and all its subsidiaries (together, “we” or “us”), including Jefferies & Company, Inc. (“Jefferies”), Jefferies Execution Services, Inc., (“Jefferies Execution”), Jefferies International Limited, Jefferies Asset Management, LLC, Jefferies Financial Products, LLC and all other entities in which we have a controlling financial interest or are the “primary beneficiary”, including Jefferies Employees Opportunity Fund, LLC (“JEOF”). The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S.”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the U.S. for complete financial statements. In the opinion of our management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the nine-month period ended September 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. These unaudited consolidated financial statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2005.

Reclassifications

Certain reclassifications have been made to previously reported balances to conform to the current presentation. These reclassifications had no effect on net earnings.

Commencing this quarter, we included contingent consideration paid in subsequent periods relating to prior business combinations as investing activities in the Consolidated Statements of Cash Flows included in this report and accordingly have corrected the September 30, 2005 period to be consistent with the current presentation. These changes were made to comply with accounting principles generally accepted in the U.S. The cash payments related to the contingent consideration were paid during the first quarter of 2006 and 2005. For the nine months ended September 30, 2006, this correction had the effect of reducing net cash used in operating activities and increasing net cash used in investing activities by $19.9 million from that previously reported. For the nine months ended September 30, 2005, this correction had the effect of increasing net cash provided by operating activities and increasing net cash used in investing activities by $8.9 million from that previously reported. The amounts involved are immaterial to the Consolidated Financial Statements. In addition, the change only affects presentation within the Consolidated Statements of Cash Flows and does not impact the Consolidated Statements of Financial Condition or the Consolidated Statements of Earnings, debt balances or compliance with debt covenants.

Common Stock

On April 18, 2006, we declared a 2-for-1 split of all outstanding shares of common stock, payable May 15, 2006 to stockholders of record as of April 28, 2006. The stock split was effected as a stock dividend of one share for each one share outstanding on the record date. All share, share price and per share information included in this quarterly report, including the consolidated financial statements and the notes thereto, have been restated to retroactively reflect the effect of the two-for-one stock split.

Summary of Significant Accounting Policies

Principles of Consolidation

Our policy is to consolidate all entities in which we own more than 50% of the outstanding voting stock and have control. In addition, in accordance with Financial Accounting Standards Board (“FASB”) Interpretation No. 46(R), Consolidation of Variable Interest Entities (“FIN 46(R)”), as revised, we consolidate entities which lack characteristics of an operating entity or business for which we are the primary beneficiary. Under FIN 46(R), the primary beneficiary is the party that absorbs a majority of the entity’s expected losses, receives a majority of its expected residual returns, or both, as a result of holding variable interests, direct or implied. In situations where we

Page 9 of 58

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

have significant influence but not control of an entity that does not qualify as a variable interest entity, we apply the equity method of accounting. In those cases where our investment is less than 20% and significant influence does not exist, the investments are carried at fair value. Significant influence generally is deemed to exist when we own 20% to 50% of the voting equity of a corporation, or when we hold at least 3% of a limited partnership interest. If we do not consolidate an entity or apply the equity method of accounting, we account for our investment at fair value. We also have formed nonconsolidated investment vehicles with third-party investors that are typically organized as limited partnerships and accounted for under the equity method of accounting. We act as general partner for these investment vehicles and have generally provided the third-party investors with termination or “kick-out” rights as defined by EITF 04-5, Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights.

All material intercompany accounts and transactions are eliminated in consolidation.

Revenue Recognition Policies

Commissions. All customer securities transactions are reported on the consolidated statement of financial condition on a settlement date basis with related income reported on a trade-date basis. Under clearing agreements, we clear trades for unaffiliated correspondent brokers and retain a portion of commissions as a fee for our services. Correspondent clearing revenues are included in other revenue. We permit institutional customers to allocate a portion of their gross commissions to pay for research products and other services provided by third parties. The amounts allocated for those purposes are commonly referred to as soft dollar arrangements. Soft dollar expenses amounted to $7.2 million and $8.6 million for the three month periods ended September 30, 2006 and 2005, respectively. Soft dollar expenses amounted to $24.3 million and $29.6 million for the nine month periods ended September 30, 2006 and 2005, respectively. We are accounting for the cost of these arrangements on an accrual basis. Our accounting for commission revenues includes the guidance contained in Emerging Issues Task Force (“EITF”) Issue No. 99-19, Reporting Revenues Gross versus Net, because we are not the primary obligor of such arrangements, and accordingly, expenses relating to soft dollars are netted against the commission revenues.

Principal Transactions. Financial instruments owned, financial instruments pledged and financial instruments sold, but not yet purchased (all of which are recorded on a trade-date basis) are valued at market or fair value, as appropriate, with unrealized gains and losses reflected in Principal transactions in the Consolidated Statement of Earnings on a trade date basis. Market value generally is determined based on listed prices or broker quotes. In certain instances, such price quotations may be deemed unreliable when the instruments are thinly traded and the listed price is not deemed to be readily realizable. In these instances we determine fair value based on our management’s best estimate, giving appropriate consideration to reported prices, the extent of public trading in similar securities and the discount from the listed price associated with the cost at the date of acquisition, among other factors. When listed prices or broker quotes are not available, we determine fair value based on pricing models or other valuation techniques, including the use of implied pricing from similar instruments. We typically use pricing models to derive fair value based on the net present value of estimated future cash flows including adjustments, when appropriate, for liquidity, credit and/or other factors.

Investment Banking. Underwriting revenues and fees from mergers and acquisitions, restructuring and other investment banking advisory assignments are recorded when the services related to the underlying transaction are completed under the terms of the assignment or engagement. Expenses associated with such transactions are deferred until reimbursed by the client, the related revenue is recognized or the engagement is otherwise concluded. Expenses are recorded net of client reimbursements. Revenues are presented net of related unreimbursed expenses. Unreimbursed expenses with no related revenues are included in business development in the Consolidated Statements of Earnings. Reimbursed expenses totaled approximately $2.0 million and $6.9 million for the three month periods ended September 30, 2006 and 2005, respectively and totaled approximately $8.7 million and $12.4 million for the nine month periods ended September 30, 2006 and 2005, respectively.

Page 10 of 58

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

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

Page 11 of 58

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

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

Cash Equivalents

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

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

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

Foreign Currency Translation

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

Investments

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

Investments in Managed Funds

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

Page 12 of 58

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

Receivable from, and Payable to, Customers

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

Fair Value of Financial Instruments

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

In addition to the interest rate swaps mentioned above, we have derivative financial instrument positions in exchange traded and over-the-counter option contracts, foreign exchange forward contracts, index futures contracts, commodities swap and option contracts and commodities futures contracts, which are measured at fair value with gains and losses recognized in principal transactions. The gross contracted or notional amount of these contracts is not reflected in the Consolidated Statements of Financial Condition.

We follow Emerging issues Task Force (“EITF”) Statement No. 02-3, Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities. This guidance generally prohibits recognizing profit at the inception of a derivative contract unless the fair value of the derivative is obtained from a quoted market price in an active market or is otherwise evidenced by comparison to other observable current market transactions or based on a valuation technique that incorporates observable market data. Subsequent to the transaction date, we recognize trading profits deferred at inception of the derivative transaction in the period in which the valuation of an instrument becomes observable.

Securities Borrowed and Securities Loaned

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

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Securities Sold Under Agreements to Repurchase

Securities sold under agreements to repurchase are treated as collateralized financing transactions and are recorded at their contracted repurchase amount.

We monitor the fair value of the securities purchased and sold under these agreements daily versus the related receivable or payable balances. Should the fair value of the securities purchased decline or the fair value of the securities sold increase, additional collateral is requested or excess collateral is returned, as appropriate.

We carry securities sold under agreements to repurchase on a net basis when permitted under the provisions of FASB Interpretation No. 41, Offsetting of Amounts Related to Certain Repurchase and Reverse Repurchase Agreements (“FIN 41”).

Premises and Equipment

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

Goodwill

In accordance with FASB No. 142, Goodwill and Other Intangible Assets, goodwill is not amortized, instead it is reviewed, on at least an annual basis, for impairment. Goodwill is impaired when the carrying amount of the reporting unit exceeds the implied fair value of the reporting unit. While goodwill is no longer amortized, it is tested for impairment annually as of the third quarter or at the time of a triggering event requiring re-evaluation, if one were to occur. No triggering events occurred during the first nine months of 2006 that required a re-evaluation of goodwill for impairment purposes. Goodwill was tested for impairment as of September 30, 2006 and based on this impairment test/analysis no reporting units were considered impaired.

Income Taxes

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

Legal Reserves

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

We record reserves related to legal proceedings in “accrued expenses and other liabilities.” Such reserves are established and maintained in accordance with FASB No. 5, Accounting for Contingencies, and FASB Interpretation No. 14, Reasonable Estimation of the Amount of a Loss an Interpretation of FASB Statement No. 5. The determination of these reserve amounts requires significant judgment on the part of management. Our management

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considers many factors including, but not limited to: the amount of the claim; the basis and validity of the claim; previous results in similar cases; and legal precedents and case law. Each legal proceeding is reviewed with counsel in each accounting period and the reserve is adjusted as deemed appropriate by management.

Stock Based Compensation

We adopted FASB No. 123R, Share Based Payment (“FASB 123R”), as required, on January 1, 2006, using the modified prospective method. Upon adoption of FASB 123R on January 1, 2006, we recognized an after-tax gain of approximately $1.6 million as the cumulative effect of a change in accounting principle, attributable to the requirement to estimate forfeitures at the date of grant instead of recognizing them as incurred. The accounting treatment of share based awards granted to retirement-eligible employees prior to our adoption of FASB No.123R has not changed and financial statements for periods prior to adoption are not restated for the effects of adopting FASB No.123R. Awards granted to retirement-eligible employees after the adoption of FASB No. 123R must be either expensed on the grant date or accrued in the year prior to the grant date. Under FASB No. 123 we defined the service period (over which compensation costs should be recognized) to generally include the year prior to the grant and the subsequent vesting periods. With the adoption of FASB 123R, our policy regarding the timing of expense recognition for non retirement-eligible employees changed to recognize compensation cost over the period from the service inception date which is the grant date through the date the employee is no longer required to provide service to earn the award. We did not grant stock based awards to retirement-eligible employees that allowed for continuous vesting upon retirement during the first nine months of 2006.

Earnings per Common Share

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

Effects of Recently Issued Accounting Standards

EITF Issue No. 04-5. In June 2005, the FASB ratified the consensus reached by the Emerging Issues Task Force on Issue 04-5, Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights, (“EITF 04-5”). EITF 04-5 presumes that a general partner controls a limited partnership, and should therefore consolidate a limited partnership, unless the limited partners have the substantive ability to remove the general partner without cause based on a simple majority vote or can otherwise dissolve the limited partnership, or unless the limited partners have substantive participating rights over decision making. This guidance became effective upon ratification by the FASB on June 29, 2005 for all newly formed limited partnerships and for existing limited partnerships for which the partnership agreements have been modified. For all other limited partnerships, the guidance is effective no later than the beginning of the first reporting period in fiscal years beginning after December 15, 2005. As of January 1, 2006 we have generally provided limited partners with rights to remove us as general partner or rights to terminate the partnership, and therefore, the impact of adopting EITF Issue No. 04-5 was not material.

FSP FIN 46(R)-6. In April 2006, the FASB issued FASB Staff Position FIN 46(R)-6, Determining the Variability to Be Considered in Applying FASB Interpretation No. 46(R), (“FSP FIN 46(R)-6”). FSP FIN 46(R)-6 addresses how variability should be considered when applying FIN 46(R). Variability affects the determination of whether an entity is a variable interest entity (“VIE”), which interests are variable interests, and which party, if any, is the primary beneficiary of the VIE required to consolidate. FSP FIN 46(R)-6 clarifies that the design of the entity also should be considered when identifying which interests are variable interests. FSP FIN 46(R)-6 must be applied prospectively to all entities in which we first become involved, beginning July 1, 2006. The adoption of FSP FIN 46(R)-6 did not have a material effect on our consolidated financial statements.

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FASB Interpretation No. 48. In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. We do not believe that the adoption of FIN 48 will have a significant effect on our consolidated financial statements.

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

FASB No. 158. In September 2006, the FASB issued Statement No. 158, Accounting for Uncertainty in Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R) (“FASB 158”). FASB 158 improves financial reporting by requiring an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. This Statement also improves financial reporting by requiring an employer to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. An employer with publicly traded equity securities is required to initially recognize the funded status of a defined benefit postretirement plan and to provide the required disclosures as of the end of the fiscal year ending after December 15, 2006. The requirement to measure plan assets and benefit obligations as of the date of the employer’s fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008. We do not expect that the adoption of FSAB 158 will have a material effect on our consolidated financial statements.

Use of Estimates

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

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

Assets under management by predominate asset strategy were as follows (in millions of dollars):

	September 30,		September 30,
	2006		2005
Assets under management:
Fixed Income (1)	$	1,420	$	717
Equities (2)		517		523
Convertibles (3)		2,221		1,576
Real Assets (4)		¾		182
		4,158		2,998
Assets under management by third parties (5):
Equities, Convertibles and Fixed Income		260		399
Private Equity		600		409
		860		808
Total	$	5,018	$	3,806

(1)	Our managed or co-managed assets under management in two Jefferies Partners Opportunity funds, Jefferies Employees Opportunity Fund, LLC, the Summit Lake CLO, the Victoria Falls CLO, the Diamond Lake CLO and start-up funds in which we are the sole or primary investor, but does not include third-party managed funds.
(2)	The Jefferies RTS Fund, Jefferies Paragon Fund and start-up funds in which we are the sole or primary investor.
(3)	Convertible bond assets managed by us and Global Convertible Fund Ltd (formerly known as Asymmetric Convertible Fund). We began to manage the assets of the Global Convertible Fund Ltd. beginning October of 2005.
(4)	The Jefferies Real Asset Fund. The Jefferies Real Asset Fund was liquidated during the second quarter of 2006.
(5)	Third party managed funds in which we have a 50% or less interest in the entities that manage these assets or otherwise receive a portion of the management fees. Effective beginning during the third quarter of 2006, certain third-party managed funds are no longer considered assets under management.

The following summarizes revenues from asset management fees and investment income from managed funds relating to funds managed by us and funds managed by third parties for the three and nine-month periods ended September 30, 2006 and 2005 (in thousands of dollars):

	Three Months Ended					Nine Months Ended
	Sept. 30,			Sept. 30,		Sept. 30,		Sept. 30,
	2006			2005		2006		2005
Asset management fees:
Fixed Income (1)	$	3,868		$	6,246	$	19,978	$	16,427
Equities (2)		(823	)		5,348		11,060		16,448
Convertibles (3)		3,300			1,375		7,997		3,873
Real Assets (4)		¾			1,269		2,237		5,979
		6,345			14,238		41,272		42,727
Investment income from managed funds		10,438			7,429		38,860		20,658
Total	$	16,783		$	21,667	$	80,132	$	63,385

(1)	Our managed or co-managed assets under management in two Jefferies Partners Opportunity funds, Jefferies Employees Opportunity Fund, LLC, the Jackson Creek CDO, the Summit Lake CLO, the Victoria Falls CLO, the Diamond Lake CLO and certain third-party managed funds.
(2)	The Jefferies RTS Fund, Jefferies Paragon Fund, a third-party managed private equity fund and start-up funds in which we are the sole or primary investor.
(3)	Convertible bond assets managed by us and Global Convertible Fund Ltd. (formerly known as Asymmetric Convertible Fund). We began to manage the assets of the Global Convertible Fund Ltd. beginning October of 2005.
(4)	The Jefferies Real Asset Fund. The Jefferies Real Asset Fund was liquidated during the second quarter of 2006.

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The following tables detail our average investment in managed funds and investment income from managed funds relating to funds managed by us and funds managed by third parties for the three months ended September 30, 2006 and 2005 (in millions of dollars):

Three Months Ended September 30, 2006

					Investment		Net
			Investment		Income from		Investment
			Income from		Managed Funds –		Income from
	Average		Managed		Minority Interest		Managed
	Investment (5)		Funds		Portion		Funds
Fixed Income (1)	$	217.0	$	8.1	$	0.4	$	7.7
Equities (2)		85.4		2.3		¾		2.3
Convertibles (3)		12.9		0.0		¾		0.0
Real Assets (4)		¾		¾		¾		¾
Total	$	315.3	$	10.4	$	0.4	$	10.0

Three Months Ended September 30, 2005

						Investment		Net
			Investment			Income from		Investment
			Income from			Managed Funds –		Income from
	Average		Managed			Minority Interest		Managed
	Investment (5)		Funds			Portion		Funds
Fixed Income (1)	$	142.6	$	8.2		$	2.6	$	5.6
Equities (2)		65.0		(1.1	)		0.1		(1.2	)
Convertibles (3)		11.2		0.2			¾		0.2
Real Assets (4)		10.5		0.1			¾		0.1
Total	$	229.3	$	7.4		$	2.7	$	4.7

(1)	Our managed or co-managed assets under management in two Jefferies Partners Opportunity funds, Jefferies Employees Opportunity Fund, LLC, the Summit Lake CLO, the Victoria Falls CLO, the Diamond Lake CLO, start-up funds in which we are the sole or primary investor and certain third-party managed funds.
(2)	The Jefferies RTS Fund, Jefferies Paragon Fund, a third-party managed private equity fund and start-up funds in which we are the sole or primary investor.
(3)	Convertible bond assets managed by us and Global Convertible Fund Ltd. (formerly known as Asymmetric Convertible Fund). We began to manage the assets of the Global Convertible Fund Ltd. beginning October of 2005.
(4)	The Jefferies Real Asset Fund. The Jefferies Real Asset Fund was liquidated during the second quarter of 2006.
(5)	We have excluded the portion of average investment in managed funds that represent an economic hedge against certain employee deferred compensation obligations.

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The following tables detail our average investment in managed funds and investment income from managed funds relating to funds managed by us and funds managed by third parties for the nine months ended September 30, 2006 and 2005 (in millions of dollars):

Nine Months Ended September 30, 2006

					Investment		Net
			Investment		Income from		Investment
			Income from		Managed Funds –		Income from
	Average		Managed		Minority Interest		Managed
	Investment (5)		Funds		Portion		Funds
Fixed Income (1)	$	187.0	$	28.9	$	6.3	$	22.6
Equities (2)		77.8		8.2		¾		8.2
Convertibles (3)		12.7		1.1		¾		1.1
Real Assets (4)		4.7		0.7		¾		0.7
Total	$	282.2	$	38.9	$	6.3	$	32.6

Nine Months Ended September 30, 2005

					Investment		Net
			Investment		Income from		Investment
			Income from		Managed Funds –		Income from
	Average		Managed		Minority Interest		Managed
	Investment (5)		Funds		Portion		Funds
Fixed Income (1)	$	137.2	$	13.1	$	6.1	$	7.0
Equities (2)		62.9		6.6		0.2		6.4
Convertibles (3)		11.2		0.1		¾		0.1
Real Assets (4)		10.5		0.9		¾		0.9
Total	$	221.8	$	20.7	$	6.3	$	14.4

(1)	Our managed or co-managed assets under management in two Jefferies Partners Opportunity funds, Jefferies Employees Opportunity Fund, LLC, the Jackson Creek CDO, the Summit Lake CLO, the Victoria Falls CLO, the Diamond Lake CLO, start-up funds in which we are the sole or primary investor and certain third-party managed funds.
(2)	The Jefferies RTS Fund, Jefferies Paragon Fund, certain third-party managed private equity funds and start-up funds in which we are the sole or primary investor.
(3)	Convertible bond assets managed by us and Global Convertible Fund Ltd. (formerly known as Asymmetric Convertible Fund). We began to manage the assets of the Global Convertible Fund Ltd. beginning October of 2005.
(4)	The Jefferies Real Asset Fund. The Jefferies Real Asset Fund was liquidated during the second quarter of 2006.
(5)	We have excluded the portion of average investment in managed funds that represent an economic hedge against certain employee deferred compensation obligations.

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

We generally invest our excess cash in money market funds and other short-term investments. Cash equivalents include highly liquid investments not held for resale with original maturities of three months or less. The following are financial instruments that are cash and cash equivalents or are deemed by our management to be generally readily convertible into cash as of September 30, 2006 and December 31, 2005 (in thousands of dollars):

	September 30, 2006		December 31, 2005
Cash and cash equivalents:
Cash in banks	$	72,986	$	85,191
Money market investments		253,523		170,742
Total cash and cash equivalents		326,509		255,933
Cash and securities segregated (1)		767,982		629,360
Short-term bond funds		¾		7,037
Auction rate preferreds (2)		¾		28,756
Mortgage-backed securities (2)		43,160		13,458
Asset-backed securities (2)		33,705		33,159
	$	1,171,356	$	967,703

(1)	In accordance with Rule 15c3-3 of the Securities Exchange Act of 1934, Jefferies, as a broker-dealer carrying client accounts, is subject to requirements related to maintaining cash or qualified securities in a segregated reserve account for the exclusive benefit of its clients. In addition, deposits with clearing and depository organizations are included in this caption.
(2)	Items are included in Financial Instruments Owned (see Note 4 below). Items are financial instruments utilized in our overall cash management activities and are readily convertible to cash.

Note 4. Financial Instruments Owned, Securities Pledged to Creditors and Financial Instruments Sold, Not Yet Purchased

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 September 30, 2006 and December 31, 2005 (in thousands of dollars):

	September 30, 2006				December 31, 2005
			Financial				Financial
			Instruments				Instruments
	Financial		Sold,		Financial		Sold,
	Instruments		Not Yet		Instruments		Not Yet
	Owned		Purchased		Owned		Purchased
Corporate equity securities	$	601,104	$	1,591,646	$	291,724	$	224,235
High-yield securities		162,594		46,026		107,560		34,853
Corporate debt securities		1,300,941		963,801		756,931		589,967
U.S. Government and agency obligations		463,934		328,640		402,316		370,863
Auction rate preferreds		¾		¾		28,756		¾
Mortgage-backed securities		43,160		¾		¾		¾
Asset-backed securities		33,705		¾		¾		¾
Other		8,655		323		500		665
Swaps		282,897		3,873		37,298		39,752
Options		94,999		151,700		24,995		39,982
	$	2,991,989	$	3,086,009	$	1,650,080	$	1,300,317

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The following is a summary of the fair value of major categories of securities pledged to creditors as of September 30, 2006 and December 31, 2005 (in thousands of dollars):

	September 30, 2006		December 31, 2005
Corporate equity securities	$	752,434	$	99,764
Corporate debt securities		363,233		16,882
Mortgage-backed securities		¾		13,458
Asset-backed securities		¾		33,159
High-yield securities		¾		15,423
	$	1,115,667	$	178,686

Note 5. Long-Term Debt

The following summarizes long-term debt outstanding as of September 30, 2006 and December 31, 2005 (in thousands of dollars):

	September 30, 2006		December 31, 2005
71/2% Senior Notes, due 2007, net of unamortized discount of $25 (2006)	$	99,975	$	99,954
73/4% Senior Notes, due 2012, net of unamortized discount of $4,867 (2006)		328,117		331,781
51/2% Senior Notes, due 2016, net of unamortized discount of $1,726 (2006)		348,274		348,138
61/4% Senior Notes, due 2036, net of unamortized discount of $7,784 (2006)		492,216		¾
	$	1,268,582	$	779,873

We previously entered into a fair value hedge with no ineffectiveness using interest rate swaps in order to convert $200 million aggregate principal amount of unsecured 7³/4% senior notes due March 15, 2012 into floating rates based upon LIBOR. The effective interest rate on the $200 million aggregate principal amount of unsecured 7³/4% senior notes, after giving effect to the swaps, is 7.6%. The fair value of the swaps was $8.0 million as of September 30, 2006, which was recorded as an increase in the book value of the debt and an increase in other assets.

Note 6. Mandatorily Redeemable Convertible Preferred Stock

In February 2006, Massachusetts Mutual Life Insurance Company (“MassMutual”) purchased in a private placement $125 million of our Series A convertible preferred stock. Our Series A convertible preferred stock has a 3.25% annual, cumulative cash dividend and is currently convertible into 4,046,438 shares of our common stock at conversion price of approximately $30.89 per share. The preferred stock is callable beginning in 2016 and will mature in 2036. The dividend is recorded as a component of interest expense as the Series A convertible preferred stock is treated as debt in accordance with FASB 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. The dividend is not deductible for tax purposes because the Series A convertible preferred stock is considered “equity” for tax purposes. As of September 30, 2006, 10,000,000 shares of preferred stock were authorized and 125,000 shares of preferred stock were issued and outstanding.

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Note 7. Benefit Plans

The following summarizes the net periodic pension cost for the three-month and nine-month periods ended September 30, 2006 and 2005 (in thousands of dollars):

	Three Months Ended						Nine Months Ended
	Sept. 30,			Sept. 30,			Sept. 30,			Sept. 30,
	2006			2005			2006			2005
Net pension cost included the following components:
Service cost — benefits earned during the period	$	137		$	543		$	137		$	1,535
Interest cost on projected benefit obligation		543			661			1,818			1,890
Expected return on plan assets		(697	)		(658	)		(1,816	)		(1,581	)
Amortization of prior service cost		¾			(3	)		¾			(9	)
Amortization of net loss		26			211			536			807
Net periodic pension cost	$	9		$	754		$	675		$	2,642

We have contributed $2.0 million to our pension plan during 2006 and do not anticipate contributing more during the remainder of 2006. Effective December 31, 2005, benefits under the pension plan have been frozen. There will be no further benefit accruals for service after December 31, 2005.

Note 8. Minority Interest

Minority interest primarily represents the minority equity holders’ proportionate share of the equity of JEOF. At September 30, 2006, we controlled and owned approximately 44% of JEOF.

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Note 9. Earnings Per Share

The following reconciles the numerators and denominators of the basic and diluted earnings per share computations for the three-month and nine-month periods ended September 30, 2006 and 2005. The convertible preferred stock dividends are treated as interest expense for accounting purposes, but are treated as dividends for tax purposes and are not tax deductible. Therefore, the convertible preferred stock dividends do not require a tax adjustment when added back to net earnings for the diluted earnings per share calculation (in thousands, except per share amounts):

	Three Months Ended				Nine Months Ended
	Sept. 30,		Sept. 30,		Sept. 30,		Sept. 30,
	2006		2005		2006		2005
Earnings before cumulative effect of change	$	45,940	$	38,595	$	148,361	$	110,704
Cumulative effect of change in accounting principle, net		¾		¾		1,606		¾
Net earnings	$	45,940	$	38,595	$	149,967	$	110,704
Add: Convertible preferred stock dividends		1,016		¾		2,528		¾
Net earnings for diluted earnings per share	$	46,956	$	38,595	$	152,495	$	110,704
Shares:
Average shares used in basic computation		135,140		124,447		133,048		122,868
Unvested restricted stock / restricted stock units		8,542		2,540		8,771		2,977
Stock options		1,184		9,238		1,341		8,902
Convertible preferred stock		4,042		¾		3,342		¾
Average shares used in diluted computation		148,908		136,225		146,502		134,747
Earnings per share:
Basic-
Earnings before cumulative effect of change	$	0.34	$	0.31	$	1.12	$	0.90
Cumulative effect of change in accounting principle, net		¾		¾		0.01		¾
Net earnings	$	0.34	$	0.31	$	1.13	$	0.90
Diluted-
Earnings before cumulative effect of change	$	0.32	$	0.28	$	1.03	$	0.82
Cumulative effect of change in accounting principle, net		¾		¾		0.01		¾
Net earnings	$	0.32	$	0.28	$	1.04	$	0.82

Note 10. Derivative Financial Instruments

Off-Balance Sheet Risk

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

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Jefferies Financial Products

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

Generally, the swap and option contract tenors range from 1 month to 2 years, and in some transactions both parties may settle the changes in the mark-to-market value of the transaction on a monthly basis. Where appropriate, JFP utilizes various credit enhancements, including guarantees, collateral and margin agreements to mitigate the credit exposure relating to these swaps and options. JFP establishes credit limits based on, among other things, the creditworthiness of the counterparties, the transaction’s size and tenor, and estimated potential exposure. In addition, swap and option transactions are generally documented under International Swaps and Derivatives Association Master Agreements. We believe that such agreements provide for legally enforceable set-off and close-out netting of exposures to specific counterparties. Under such agreements, in connection with an early termination of a transaction, JFP is permitted to set-off its receivables from a counterparty against its payables to the same counterparty arising out of all included transactions. As a result, the fair value represents the net sum of estimated positive fair values after the application of such netting. JFP has determined that the fair value of its swaps and options approximated $281.2 million and $(95.9) million, respectively at September 30, 2006 and $(0.6) million and $(28.8) million, respectively at December 31, 2005.

The following table sets forth the fair value of JFP’s outstanding OTC positions and exchange-traded futures and options by remaining contractual maturity as of September 30, 2006:

	0 – 12			1 – 5			5 – 10
(in millions)	Months			Years			Years			Total
Swaps	$	280.8		$	0.4		$	¾		$	281.2
Options		(43.0	)		(52.6	)		(0.3	)		(95.9	)
FX forwards		0.9			(0.3	)		¾			0.6
Exchange-traded futures and options		(270.4	)		(3.7	)		¾			(274.1	)
Total	$	(31.7	)	$	(56.2	)	$	(0.3	)	$	(88.2	)

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

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We determine counterparty credit quality by reference to ratings from independent rating agencies or, where such ratings are not available, by internal analysis. The maximum potential loss will increase or decrease during the life of the swap and option commitments as a function of maturity and changes in market prices.

At September 30, 2006 and December 31, 2005, the counterparty credit quality with respect to the fair value of commodities and foreign exchange futures, options and swap portfolios were as follows:

	Fair Value
	September 30,			December 31,
(in millions)	2006			2005
Counterparty credit quality:
A or higher	$	185.9		$	(29.5	)
Exchange-traded futures and options (1)		(274.1	)		95.7
Total	$	(88.2	)	$	66.2

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

At September 30, 2006 and December 31, 2005 the counterparty breakdown by industry with respect to the fair value of JFP’s commodities and foreign exchange futures, options and swap portfolio was as follows:

	Fair Value
	September 30,			December 31,
(in millions)	2006			2005
Foundations, trusts and endowments	$	35.3		$	(0.1	)
Financial services		119.3			(45.1	)
Collective investment vehicles (including pension plans, mutual funds and other institutional counterparties)		31.3			15.7
Exchanges (1)		(274.1	)		95.7
Total	$	(88.2	)	$	66.2

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

Derivative Financial Instruments

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

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

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

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We have also entered into a fair value hedge with no ineffectiveness using interest rate swaps in order to convert $200.0 million aggregate principal amount of unsecured 7³/4% senior notes due March 15, 2012 into floating rates based upon LIBOR. The effective interest rate on the $200.0 million aggregate principal amount of unsecured 7³/4% senior notes, after giving effect to the swaps, is 7.6%. The fair value of the swaps was $8.0 million as of September 30, 2006, which was recorded as an increase in the book value of the debt and an increase in derivative assets classified as part of other assets.

The following table presents the fair value of derivatives at September 30, 2006 and December 31, 2005. The fair value of assets/liabilities related to derivative contracts at September 30, 2006 and December 31, 2005 represent our receivable/payable for derivative financial instruments before consideration of securities collateral.

	September 30, 2006					December 31, 2005
(in millions)	Assets		Liabilities			Assets		Liabilities
Exchange traded futures contracts	$	137.7	$	(414.9	)	$	189.8	$	(96.5	)
Commodity related swaps		285.1		(3.9	)		37.3		(39.8	)
Option contracts		95.0		(151.7	)		25.0		(40.0	)
Foreign exchange forward contracts		1.0		(0.4	)		0.0		(0.0	)
Interest rate swaps		8.0		¾			12.2		¾

Note 11. Other Comprehensive Gain (Loss)

The following summarizes other comprehensive loss and accumulated other comprehensive gain at September 30, 2006 and for the three months then ended (in thousands of dollars):

				Minimum			Accumulated
	Currency			Pension			Other
	Translation			Liability			Comprehensive
	Adjustments			Adjustment			Gain
Beginning at June 30, 2006	$	6,502		$	(6,125	)	$	377
Change in third quarter of 2006		(164	)		¾			(164	)
Ending at September 30, 2006	$	6,338		$	(6,125	)	$	213

The following summarizes other comprehensive loss and accumulated other comprehensive loss at September 30, 2005 and for the three months then ended (in thousands of dollars):

				Minimum			Accumulated
	Currency			Pension			Other
	Translation			Liability			Comprehensive
	Adjustments			Adjustment			Loss
Beginning at June 30, 2005	$	3,440		$	(6,868	)	$	(3,428	)
Change in third quarter of 2005		(628	)		¾			(628	)
Ending at September 30, 2005	$	2,812		$	(6,868	)	$	(4,056	)

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Comprehensive income for the three months ended September 30, 2006 and 2005 was as follows (in thousands of dollars):

	September 30,			September 30,
	2006			2005
Net earnings	$	45,940		$	38,595
Other comprehensive gain (loss)		(164	)		(628	)
Comprehensive income	$	45,776		$	37,967

The following summarizes other comprehensive gain and accumulated other comprehensive gain (loss) at September 30, 2006 and for the nine months then ended (in thousands of dollars):

			Minimum			Accumulated
	Currency		Pension			Other
	Translation		Liability			Comprehensive
	Adjustments		Adjustment			Gain (Loss)
Beginning at December 31, 2005	$	962	$	(6,125	)	$	(5,163	)
Change in first nine months of 2006		5,376		¾			5,376
Ending at September 30, 2006	$	6,338	$	(6,125	)	$	213

The following summarizes other comprehensive loss and accumulated other comprehensive gain (loss) at September 30, 2005 and for the nine months then ended (in thousands of dollars):

				Minimum			Accumulated
	Currency			Pension			Other
	Translation			Liability			Comprehensive
	Adjustments			Adjustment			Gain (Loss)
Beginning at December 31, 2004	$	9,348		$	(6,868	)	$	2,480
Change in first nine months of 2005		(6,536	)		¾			(6,536	)
Ending at September 30, 2005	$	2,812		$	(6,868	)	$	(4,056	)

Comprehensive income for the nine months ended September 30, 2006 and 2005 was as follows (in thousands of dollars):

	September 30,		September 30,
	2006		2005
Net earnings	$	149,967	$	110,704
Other comprehensive gain (loss)		5,376		(6,536	)
Comprehensive income	$	155,343	$	104,168

Note 12. Net Capital Requirements

As registered broker-dealers, Jefferies and Jefferies Execution are subject to the Securities and Exchange Commission Uniform Net Capital Rule (Rule 15c3-1), which requires the maintenance of minimum net capital. Jefferies is also subject to the Commodity Futures Trading Commission Rule 1.17, which also requires the maintenance of minimum net capital. Jefferies and Jefferies Execution have elected to compute their net capital using the alternative method as permitted by the Rule.

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As of September 30, 2006, Jefferies’ and Jefferies Execution’s net capital and excess net capital were as follows (in thousands of dollars):

	Net Capital		Excess Net Capital
Jefferies	$	275,854	$	260,378
Jefferies Execution	$	22,032	$	21,782

Note 13. Commitments, Contingencies and Guarantees

The following table summarizes other commitments and guarantees at September 30, 2006:

			Maturity Date
	Notional /						2008		2010		2012
	Maximum						and		and		and
	Payout		2006		2007		2009		2011		Later
	(Dollars in Millions)
Standby letters of credit	$	214.6	$	152.5	$	62.1		—		—		—
Undrawn bank credit	$	56.0	$	56.0		—		—		—		—
Equity commitments	$	266.4		—		—		—	$	1.2	$	265.2
Derivative contracts	$	572.5	$	572.5		—		—		—		—

Standby Letters of Credit. In the normal course of business, we had letters of credit outstanding aggregating $214.6 million at September 30, 2006, mostly to satisfy various collateral requirements in lieu of depositing cash or securities. These letters of credit have a current carrying amount of $0. As of September 30, 2006, there were no draw downs on these letters of credit.

Undrawn Bank Credit. As of September 30, 2006, we had outstanding guarantees of $56.0 million relating to bank credit obligations ($40.4 million of which is undrawn) of three associated investment funds in which we have an interest. Also, we have guaranteed obligations of Jefferies International Limited (“JIL”) to various banks which provide clearing and credit services to JIL and to counterparties of JIL.

Equity Commitments. On October 7, 2004, we entered into an agreement with Babson Capital and MassMutual to form Jefferies Finance LLC, a joint venture entity created for the purpose of offering senior loans to middle market and growth companies. In February 2006, we and MassMutual reached an agreement to double our equity commitments to Jefferies Finance LLC. With an incremental $125 million from each partner, the new total committed equity capitalization of Jefferies Finance LLC is $500 million. Loans are expected to be originated primarily through the investment banking efforts of Jefferies & Company, Inc. with Babson Capital providing primary credit analytics and portfolio management services. As of September 30, 2006, we have funded $25.0 million of our aggregate commitment leaving $225.0 million unfunded.

During 2005, we committed to invest an aggregate of $36.9 million in Jefferies Capital Partners IV L.P. and its related parallel funds. As of September 30, 2006, we have funded approximately $6.2 million of our aggregate commitment leaving $30.7 million unfunded.

As of September 30, 2006, we had other equity commitments to invest up to $10.7 million in various other investments.

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Derivative Contracts. In accordance with FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (“FIN 45”), we disclose certain derivative contracts meeting the FIN 45 definition of a guarantee. Such derivative contracts include written equity put options. At September 30, 2006, the maximum payout value of derivative contracts deemed to meet the FIN 45 definition of a guarantee was approximately $572.5 million. For purposes of determining maximum payout, notional values are used; however, we believe the fair value of these contracts is a more relevant measure of these obligations because we believe the notional amounts greatly overstate our expected payout. At September 30, 2006, the fair value of such derivative contracts approximated $6.4 million. In addition, all amounts included above are before consideration of hedging transactions. We substantially mitigate our risk on these contracts through hedges, such as other derivative contracts and/or cash instruments. We manage risk associated with derivative guarantees consistent with our risk management policies.

High Yield Loan Commitments. From time to time we make commitments to extend credit to investment-banking clients in loan syndication and acquisition-finance transactions. These commitments and any related drawdowns of these facilities typically have fixed maturity dates and are contingent on certain representations, warranties and contractual conditions applicable to the borrower. We define high yield (non-investment grade) as debt securities or loan commitments to companies rated BB+ or lower or equivalent ratings by recognized credit rating agencies, as well as non-rated securities or loans that, in management’s opinion, are non-investment grade. We did not have commitments outstanding to non-investment grade borrowers as of September 30, 2006.

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

Other Guarantees. In the normal course of business we provide guarantees to securities clearinghouses and exchanges. These guarantees generally are required under the standard membership agreements, such that members are required to guarantee the performance of other members. To mitigate these performance risks, the exchanges and clearinghouses often require members to post collateral. Our obligations under such guarantees could exceed the collateral amounts posted; however, the potential for us to be required to make payments under such guarantees is deemed remote.

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Note 14. Segment Reporting

We currently have one reportable business segment, Capital Markets. The Capital Markets reportable segment includes our traditional securities brokerage and investment banking activities. The Capital Markets reportable segment operates as a single operating segment that provides the sales, trading and origination effort for various fixed income, equity and advisory products and services. Each division within the Capital Markets segment works in tandem to deliver these services to institutional and corporate clients. The Capital Markets segment comprises many divisions, with interactions among each. In addition, we choose to voluntarily disclose the Asset Management segment even though it is currently an “immaterial non-reportable” segment as defined by FASB 131, Disclosures about Segments of an Enterprise and Related Information. The Asset Management segment is primarily comprised of net revenue and expenses related to our non-integrated asset management businesses including Victoria Falls CLO, Summit Lake CLO, Diamond Lake CLO, Jefferies RTS Fund, Jefferies Paragon Fund and the Jefferies Real Asset Fund.

Our reportable business segment information is prepared using the following methodologies:

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

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

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

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Our net revenues, expenses, income (loss) before income taxes and total assets by reportable business segment are summarized below (amounts in millions):

	Capital		Asset
	Markets		Management			Total
Three months ended September 30, 2006
Net revenues	$	333.7	$	6.9		$	340.6
Expenses		252.2		12.1			264.3
Income before taxes	$	81.5	$	(5.2	)	$	76.3
Nine months ended September 30, 2006
Net revenues	$	1,049.9	$	33.5		$	1,083.4
Expenses		791.8		37.1			828.9
Income before taxes	$	258.1	$	(3.6	)	$	254.5
Segment assets	$	15,276.2	$	208.5		$	15,484.7
Three months ended September 30, 2005
Net revenues	$	291.6	$	7.7		$	299.3
Expenses		224.7		7.1			231.8
Income before taxes	$	66.9	$	0.6		$	67.5
Nine months ended September 30, 2005
Net revenues	$	830.1	$	31.7		$	861.8
Expenses		641.8		30.0			671.8
Income before taxes	$	188.3	$	1.7		$	190.0
Segment assets	$	13,571.9	$	29.7		$	13,601.6

Note 15. Goodwill

The following is a summary of goodwill as of September 30, 2006 (in thousands of dollars):

	December 31,		First Nine		September 30,
	2005		Months		2006		Acquisition
Acquisition	Balance		2006 Activity		Balance		Date
Broadview International LLC	$	54,825	$	3,799	$	58,624	Dec. 2003
Randall & Dewey		48,383		9,244		57,627	Jan. 2005
Quarterdeck Investment Partners, LLC		30,955		3,893		34,848	Dec. 2002
Helix Associates		25,307		¾		25,307	May 2005
Bonds Direct Securities LLC		20,943		¾		20,943	Sept. 2004
Other		40,194		1		40,195
	$	220,607	$	16,937	$	237,544

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The acquisitions of Helix Associates, Randall & Dewey, Bonds Direct Securities LLC, Broadview International LLC and Quarterdeck Investment Partners, LLC all contained a five-year contingency for additional consideration to the selling shareholders, based on future revenues. This additional consideration is paid in cash annually. There is no contractual dollar limit to the potential of additional consideration. During the quarter ended March 31, 2006, the Bonds Direct contingency for additional consideration was terminated pursuant to the terms of the acquisition agreement.

The activity for Broadview International LLC, Randall & Dewey and Quarterdeck Investment Partners, LLC mostly represents additional consideration based on operating net revenue.

None of the acquisitions listed above were considered material based on the small percentage they represent of our total assets, equity, revenues and net earnings.

Note 16. Quarterly Dividends

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 and the governing provisions of the Delaware General Corporation Law.

Dividends per Common Share (declared and paid):

	1st Quarter		2nd Quarter		3rd Quarter
2006	$	0.075	$	0.125	$	0.125
2005	$	0.060	$	0.060	$	0.060

On April 18, 2006, we declared a 2-for-1 stock split of all outstanding shares of common stock. The stock split was paid May 15, 2006 to stockholders of record as of April 28, 2006 and was effected as a stock dividend of one share of common stock for each one share outstanding on the record date. We also announced an increase to our quarterly dividend to $0.125 per post-split share, which represented a 67% increase from the previous dividend of $0.075 per post split share.

Note 17. Variable Interest Entities (“VIEs”)

Under the provisions of FIN 46(R) we determined that the Jefferies Employees Opportunity Fund (“JEOF”) meets the definition of a VIE. We and our employees (related parties) are the primary beneficiary of JEOF, one of the three high yield funds that we manage. Therefore, we consolidate JEOF.

We also own significant variable interests in Summit Lake CLO, Victoria Falls CLO and Diamond Lake CLO for which we are not the primary beneficiary and therefore do not consolidate these entities. In aggregate, these variable interest entities have assets approximating $924 million as of September 30, 2006. Our exposure to loss is limited to our capital contributions. The carrying value of our aggregate investment in Summit Lake CLO Victoria Falls CLO and the Diamond Lake CLO together is $11.7 million at September 30, 2006.

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Note 18. Related Party Disclosures

High Yield Funds

In January 2000, we created three broker-dealer entities that employ a trading and investment strategy substantially similar to that historically employed by our High Yield department. Although we refer to these three broker-dealer entities as funds, they are registered with the Securities and Exchange Commission as broker-dealers. Two of these funds, the Jefferies Partners Opportunity Fund and the Jefferies Opportunity Fund II, are principally capitalized with equity contributions from institutional and high net worth investors. The third fund, Jefferies Employees Opportunity Fund (and collectively with the two Jefferies Partners Opportunity Funds, referred to as the “High Yield Funds”), is principally capitalized with equity investments from our employees and is therefore consolidated into our consolidated financial statements. Our senior management (including our Chief Executive Officer, Chief Financial Officer, Chairman, Executive Committee, General Counsel and Controller) and certain of our employees have direct investments in these funds on terms identical to other fund participants. We have a 18% aggregate interest in the funds, senior management has a 3% interest and all employees (exclusive of senior management) have a 5% interest. The High Yield division and each of the funds share gains or losses on trading and investment activities of the High Yield division on the basis of a pre-established sharing arrangement related to the amount of capital each has committed. The sharing arrangement is modified from time to time to reflect changes in the respective amounts of committed capital. As of September 30, 2006, on a combined basis, the High Yield division had in excess of $1,024.8 million of combined pari passu capital available (including unfunded commitments and availability under a revolving credit facility) to deploy and execute the division’s investment and trading strategy. The High Yield Funds are managed by a team led by Richard Handler, our Chief Executive Officer.

Jefferies Capital Partners

In July 2005, we entered into a Share and Membership Interest Purchase Agreement (“Purchase Agreement”) with Brian P. Friedman (one of our directors and an executive officer), 2055 Partners L.P. (an affiliate of Mr. Friedman), James L. Luikart, and the manager and general partner of Jefferies Capital Partners IV L.P. Jefferies Capital Partners IV L.P., together with its related parallel funds (“Fund IV”), is a private equity fund managed by a team led by Messrs. Friedman and Luikart. We agreed to purchase a 49% interest in the manager of Fund IV and an amount, not less than 20% and not more than the percentage allocated to Mr. Friedman, of the carried interest attributed to Fund IV. In addition, we have the right, subject to certain conditions, to receive similar interests from future private equity funds overseen by Mr. Friedman. With the final closing of Fund IV during the second quarter of 2006, we are obligated to issue 1,040,000 shares of common stock (post 2-for-1 stock split) to Mr. Friedman. The shares of common stock to be issued are subject to clawback provisions based upon the size of a subsequent fund as well as certain other conditions.

During 2005, we committed to invest an aggregate of $36.9 million in Fund IV. As of September 30, 2006, our remaining commitment was approximately $30.7 million. We have also guaranteed certain of the obligations of an employee parallel fund to Fund IV, including a guarantee of up to an aggregate of approximately $36.0 million in third party bank loans committed to such employee fund as of September 30, 2006.

We have guaranteed the obligations of one other private equity fund managed by entities controlled by Mr. Friedman. These obligations may arise under a $20 million credit facility provided by a third party to these funds.

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

Note 19. Stock Based Compensation

Incentive Plans

We sponsor the following share based employee incentive plans:

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

Restricted Stock/Restricted Stock Units. The Incentive Plan allows for grants of restricted stock awards, whereby employees are granted restricted shares of common stock subject to forfeiture until the requisite service has been provided. Grants of restricted stock are generally subject to annual ratable vesting over a five year period (i.e., 20% of the number of shares granted vests each year for a five year award). In addition, vested shares are subject to transferability restrictions that lapse at the end of the award term. With certain exceptions, the employee must remain with us for a period of years after the date of grant to receive the full number of shares granted. The Incentive Plan also allows for grants of restricted stock units. Restricted stock units give a participant the right to receive fully vested shares at the end of a specified deferral period. Restricted stock units are generally subject to forfeiture conditions similar to those of our restricted stock awards. One advantage of restricted stock units, as compared to restricted stock, is that the period during which the award is deferred as to settlement can be extended past the date the award becomes non-forfeitable, allowing a participant to hold an interest tied to common stock on a tax deferred basis. Prior to settlement, restricted stock units carry no voting or dividend rights associated with the stock ownership, but dividend equivalents are paid or accrued.

Director Plan. We also have a Directors’ Stock Compensation Plan (“Directors’ Plan”) which provides for an annual grant to each non-employee director of $100,000 of restricted stock or deferred shares. These grants are made automatically on the date directors are elected or reelected at our annual shareholders’ meeting. These grants vest three years after the date of grant and are expensed over the vesting period.

Employee Stock Purchase Plan. We also have an Employee Stock Purchase Plan (“ESPP”). All regular full-time employees and employees who work part-time over 20 hours per week are eligible for the ESPP. Annual employee contributions are limited to $21,250, are voluntary and are made via payroll deduction. The employee contributions are used to purchase our common stock. The stock purchase price is based on the lower of 85% of the stock price at the beginning or end of the period. The stock price used is the Volume Weighted Average Price (“VWAP”) for the particular day.

In addition, we have a Supplemental Stock Purchase Plan (“SSPP”) that is similar to our ESPP. Employees may make monthly purchases of shares of our common stock under the SSPP at a discount to the VWAP for the particular month.

Deferred Compensation Plan. We also have a Deferred Compensation Plan which was established in 2001. In 2005, 2004 and 2003, employees with annual compensation of $200,000 or more were eligible to defer compensation and to invest at a 10% discount in deferred shares of our stock (“DCP deferred shares”), stock options (prior to 2004) and other alternatives on a pre-tax basis through the plan. The compensation deferred by our employees is expensed in the period earned.

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

Adoption of FASB 123R

We adopted the fair value recognition provisions for share based awards pursuant to FASB 123R effective January 1, 2006. See Note 1 “Summary of Significant Accounting Policies” for a further discussion. The following disclosures are also being provided pursuant to the requirements of FASB 123R.

Prior to the adoption of FASB 123R, we presented all tax benefits resulting from share based compensation as cash flows from operating activities in the consolidated statements of cash flows. FASB 123R requires cash flows resulting from tax deductions in excess of the grant-date fair value of share based awards to be included in cash flows from financing activities. Accordingly, we reflected the excess tax benefit of $17.7 million related to share based compensation in cash flows from financing activities in the first nine months of 2006.

In accordance with FASB 123R, the fair value of share based awards is estimated on the date of grant based on the market price of our stock less the impact of selling restrictions subsequent to vesting and is amortized as additional compensation expense on a straight-line basis over the related requisite service periods, which are generally five years. As of September 30, 2006, there was $240.5 million of total unrecognized compensation cost related to nonvested share based awards, which is expected to be recognized over a remaining weighted-average vesting period of 4 years. The unrecognized compensation cost related to nonvested share based awards was recorded as unearned compensation in shareholders’ equity at December 31, 2005 and was a reduction to shareholders’ equity. As part of the adoption of FASB 123R, the unrecognized compensation cost related to nonvested share based awards granted prior to September 30, 2006 is included as a component of additional paid-in capital. The total grant date fair value of the shares recognized as compensation expense during the three month and nine month periods ended September 30, 2006 and 2005 was $21.8 million and $15.8 million, and $65.0 million and $51.0 million, respectively.

We have historically and generally expect to issue new shares of common stock when satisfying our issuance obligations pursuant to share based awards, as opposed to reissuing common stock from treasury.

Restricted Stock and Restricted Stock Units (“Share Based Awards”)

The following tables detail the issuances of restricted stock and restricted stock units:

				Weighted
	Nine Months Ended			Average Grant
	September 30, 2006			Date Fair Value
	(Shares in 000s)
Restricted stock
Balance, beginning of year		7,358		$	16.56
Grants		403		$	24.83
Forfeited		(741	)	$	19.28
Vested		(2,333	)	$	12.34
Balance, end of period		4,687		$	18.98

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

							Weighted
	Nine Months Ended						Average Grant
	September 30, 2006						Date Fair Value
	(Shares in 000s)
	Future			No Future			Future		No Future
	Service			Service			Service		Service
	Required			Required			Required		Required
Restricted stock units
Balance, beginning of year		16,077			8,585		$	16.64	$	4.88
Grants, includes dividends		3,738			298		$	22.59	$	—
Deferral expiration		—			(204	)	$	—	$	16.39
Forfeited		(316	)		—		$	16.97	$	—
Vested		(3,722	)		3,722		$	12.38	$	12.38
Grants related to stock option exercises		—			237		$	—	$	—
Balance, end of period		15,777			12,638		$	19.05	$	6.71

Stock Options

The fair value of all option grants for all of our plans are estimated on the date of grant using the Black-Scholes option-pricing model. There were no option grants during the first nine months of 2006 or 2005. The following table summarizes stock option activity during the nine months ended September 30, 2006:

Dollars and shares in thousands, except per share data

				Weighted-
				Average
	Options			Exercise Price
Outstanding, December 31, 2005		4,533		$	9.75
Granted		¾			¾
Exercised		(1,700	)	$	8.40
Canceled		(19	)	$	11.53
Outstanding, September 30, 2006		2,814		$	10.55

The total intrinsic value of stock options exercised during the nine months ended September 30, 2006 and 2005 was $29.5 million and $44.9 million, respectively. Cash received from the exercise of stock options during the nine months ended September 30, 2006 totaled $12.9 million and the tax benefit realized from stock options exercised during the nine months ended September 30, 2006 was $7.1 million.

The table below provides additional information related to stock options outstanding at September 30, 2006:

Dollars and shares in thousands, except per share data

	Outstanding
	Net of Expected		Options
September 30, 2006	Forfeitures		Exercisable
Number of options		2,814		2,814
Weighted-average exercise price	$	10.55	$	10.55
Aggregate intrinsic value	$	50,508	$	50,508
Weighted-average remaining contractual term, in years		0.8		0.8

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

At September 30, 2006, the intrinsic value of vested options was approximately $50.5 million for which tax benefits expected to be recognized in equity upon exercise are approximately $21.1 million.

Upon adoption of FASB 123R, in the first quarter of 2006, our policy regarding the timing of expense recognition for employees eligible for retirement changed to recognize compensation cost over the period from the service inception date through the date that the employee first becomes eligible to retire and is no longer required to provide service to earn the award. During 2005, our policy was to recognize these compensation costs over the stated vesting term.

As required by FASB 123R, the following table sets forth the pro forma net earnings that would have been reported for the three months and nine months ended September 30, 2006 and 2005 if equity-based awards granted to retirement-eligible employees that allowed for continuous vesting upon retirement had been expensed on or prior to the grant date.

Proforma Compensation Costs (in thousands)

	Three Months Ended					Nine Months Ended
	Sept. 30,			Sept. 30,		Sept. 30,			Sept. 30,
	2006			2005		2006			2005
Compensation and benefits, as reported	$	184,421			167,033		593,830			481,024
Effect of expensing share based awards granted to retirement-eligible employees (1)		(2,461	)		5,040		(8,511	)		19,239
Pro forma compensation and benefits costs		181,960			172,073		585,319			500,263

(1) Compensation and benefits, as reported for 2006, includes the amortization of such pre-2006 awards. The 2006 pro forma impact represents the presumed benefit associated with amortizing pre-2006 awards over the service period prior to the grant date for retirement-eligible employees.

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

Adoption of FASB 123

The following table illustrates the effect on net earnings and earnings per share for the three month and nine month periods ended September 30, 2006 and 2005, if we had applied the fair value recognition provisions of FASB 123 to options granted under equity award plans for awards granted prior to January 1, 2003. For purposes of this pro forma disclosure, the value of options is estimated using the Black-Scholes option pricing model with share based awards amortized over the vesting periods pursuant to FASB 123.

	Three Months Ended						Nine Months Ended
	Sept. 30,			Sept. 30,			Sept. 30,			Sept. 30,
	2006			2005			2006			2005
Net earnings, as reported	$	45,940		$	38,595		$	149,967		$	110,704
Add: Stock based employee compensation expense included in reported net earnings, net of related tax effects		12,682			9,188			37,880			29,726
Deduct: Total stock based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(12,682	)		(9,337	)		(37,880	)		(30,458	)
Pro forma net earnings	$	45,940		$	38,446		$	149,967		$	109,972
Earnings per share:
Basic – as reported	$	0.34		$	0.31		$	1.13		$	0.90
Basic – pro forma	$	0.34		$	0.31		$	1.13		$	0.90
Diluted – as reported	$	0.32		$	0.28		$	1.04		$	0.82
Diluted – pro forma	$	0.32		$	0.28		$	1.04		$	0.82

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JEFFERIES GROUP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial
Condition and Results of Operations

This report contains or incorporates by reference “forward-looking statements” within the meaning of the safe harbor provisions of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements include statements about our future and statements that are not historical facts. These forward-looking statements are usually preceded by the words “believe,” “intend,” “may,” “will,” or similar expressions. Forward-looking statements may contain expectations regarding revenues, earnings, operations and other financial projections, and may include statements of future performance, plans and objectives. Forward-looking statements also include statements pertaining to our strategies for future development of our business and products. Forward-looking statements represent only our current belief regarding future events, many of which by their nature are inherently uncertain, outside of our control or subject to change. 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 risk factors contained in our annual report on Form 10-K for the fiscal year ended December 31, 2005 and filed with the SEC on March 1, 2006;

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

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

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

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

Critical Accounting Policies

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

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

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

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JEFFERIES GROUP, INC. AND SUBSIDIARIES

Fair Value of Financial Instruments

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

Furthermore, judgment is used to value certain securities (e.g., private securities, 144A securities, less liquid securities) if quoted current market prices are not available. These valuations are made with consideration for various assumptions, including time value, yield curve, volatility factors, liquidity, market prices on comparable securities and other factors. The subjectivity involved in this process makes these valuations inherently less reliable than quoted market prices. We believe that our comprehensive risk management policies and procedures serve to monitor the appropriateness of the assumptions used. The use of different assumptions, however, could produce materially different estimates of fair value.

Fair Value of Derivatives

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

Compensation and Benefits

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

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JEFFERIES GROUP, INC. AND SUBSIDIARIES

Reportable Business Segments

For presentation purposes, the remainder of “Results of Operations” is presented on a detailed product and expense basis rather than on a reportable business segment basis. Our earnings are subject to wide fluctuations since many factors over which we have little or no control, particularly the overall volume of trading, the volatility and general level of market prices, and the number and size of investment banking transactions may significantly affect our operations. The following provides a summary of revenues by source for the past three years.

Revenues by Source

The following provides a breakdown of total revenues by source for the past three years (in thousands of dollars).

	Year Ended December 31,
	2005					2004					2003
			% of					% of					% of
			Total					Total					Total
	Amount		Revenues			Amount		Revenues			Amount		Revenues
						(Dollars in Thousands)
Equity	$	438,080		29	%	$	503,848		42	%	$	441,181		48	%
Fixed income & commodities		178,674		12			126,353		11			120,755		13
Total		616,754		41			630,201		53			561,936		61
Investment banking		495,014		33			352,804		29			229,608		25
Asset management fees and investment income from managed funds:
Asset management fees		50,943		4			38,208		3			17,268		2
Investment income from managed funds		31,109		2			42,976		4			15,501		1
Total		82,052		6			81,184		7			32,769		3
Interest		304,053		20			134,450		11			102,403		11
Total revenues	$	1,497,873		100	%	$	1,198,639		100	%	$	926,716		100	%

The following provides a breakdown of total revenues by source for the three-month and nine-month periods ended September 30, 2006 and 2005 (in thousands of dollars).

	Three Months Ended
	September 30, 2006					September 30, 2005
			% of					% of
			Total					Total
	Amount		Revenues			Amount		Revenues
Equity	$	112,635		24	%	$	118,990		31	%
Fixed income & commodities		62,059		13			48,404		13
Total		174,694		37			167,394		44
Investment banking		144,763		31			107,556		28
Asset management fees and investment income from managed funds:
Asset management fees		6,345		2			14,239		4
Investment income from managed funds		10,438		2			7,428		2
Total		16,783		4			21,667		6
Interest		132,424		28			81,467		22
Total revenues	$	468,664		100	%	$	378,084		100	%

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JEFFERIES GROUP, INC. AND SUBSIDIARIES

	Nine Months Ended
	September 30, 2006					September 30, 2005
			% of					% of
			Total					Total
	Amount		Revenues			Amount		Revenues
Equity	$	386,917		27	%	$	326,274		30	%
Fixed income & commodities		202,347		14			136,226		13
Total		589,264		41			462,500		43
Investment banking		395,429		27			327,517		31
Asset management fees and investment income from managed funds:
Asset management fees		41,272		3			42,728		4
Investment income from managed funds		38,860		2			20,657		2
Total		80,132		5			63,385		6
Interest		385,035		27			212,738		20
Total revenues	$	1,449,860		100	%	$	1,066,140		100	%

Third Quarter 2006 Versus Third Quarter 2005

Overview

Revenues increased $90.6 million, or 24%, to $468.7 million, compared to $378.1 million for the third quarter of 2005. The increase was primarily due to a $7.3 million, or 4%, increase in equity and fixed income and commodities revenues, a $37.2 million, or 35%, increase in investment banking, a $51.0 million, 63%, increase in interest revenues (net interest income which is interest revenue less interest expense only increased $1.7 million), partially offset by a $4.9 million, or 23%, decrease in asset management fees and investment income from managed funds.

Equity Product Revenue

Equity product revenue is comprised of equity (including principal transaction and commission revenue), correspondent clearing and prime brokerage, and execution product revenues. Equity product revenue was $112.6 million, down 5% from the third quarter of 2005. The decrease in equity product revenue was due to a less favorable capital markets environment, a decline in customer-driven activity and a decrease in volatility levels.

Fixed Income & Commodities Revenue

Fixed income and commodities revenue is comprised of high yield, investment grade fixed income, convertible and commodities product revenue. Fixed income and commodities revenue was $62.1 million, up 28% over last year’s quarter driven by increased activity in the investment grade corporate bond and commodity markets. Investment grade income revenues increased primarily as a result of increased activity in the trading of corporate bonds. The increase in commodities revenue was due to the expansion of JFP, as well as, increased activity and volatility in most commodities markets, including energy related commodities markets.

Investment Banking Product Revenue

	Quarter Ended
	September 30,		September 30,		Percentage
	2006		2005		Change
	(Dollars in Thousands)
Capital markets	$	57,816	$	56,093		3	%
Advisory		86,947		51,463		69	%
Total	$	144,763	$	107,556		35	%

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JEFFERIES GROUP, INC. AND SUBSIDIARIES

Capital markets revenues, which consist primarily of debt, equity and convertible financing services were $57.8 million, an increase of 3% from the third quarter of 2005. The increase in capital markets revenues is primarily attributable to the increase in revenue generated from high yield underwritings as well as the expansion of our investment banking activities outside the United States.

Revenues from advisory activities were $86.9 million, an increase of 69% from the third quarter of 2005. The increase is primarily attributable to services rendered on assignments in the technology, industrial and energy sectors.

Asset Management Fee Revenue

Asset management revenue includes revenues from management, administrative and performance fees from funds managed by us, revenues from asset management and performance fees from third-party managed funds, and investment revenue from our investments in these funds. Asset management revenues were $16.8 million, down 23% over the third quarter of 2005. The decrease in asset management revenue was a result of a challenging environment faced by our equity and high yield funds.

Changes in Assets under Management

	Three		Three
	Month		Month
	Period		Period
	Ending		Ending
	Sept. 30,		Sept. 30,		Percent
In millions	2006		2005		Change
Balance, beginning of period (1)	$	4,383	$	3,710		18	%
Net cash flow in		562		32		1,656	%
Net market appreciation		73		64		14	%
		635		96		561	%
Balance, end of period	$	5,018	$	3,806		32	%

(1) Excludes certain 3^rd party managed funds that are no longer considered assets under management.

The increase in net cash flow in during the 3^rd quarter of 2006 is primarily due to the commencement of the Diamond Lake CLO.

Net Interest Revenue

Interest income increased $51.0 million primarily as a result of increased stock borrowing activity and increases in interest rates, and interest expense increased by $49.3 million primarily as a result of increased stock lending activity, increases in interest rates, the issuance of our $500 million of senior unsecured debentures and our $125 million in Series A Mandatorily Convertible Preferred Stock.

Compensation and Benefits

Compensation and benefits increased $17.4 million, or 10%, versus the 14% increase in net revenues. The increase was primarily due to our increase in headcount and changes to our revenue mix.

Average employee headcount increased 11% from 2,001 during the third quarter of 2005 to 2,212 during the third quarter of 2006. The ratio of compensation to net revenues was approximately 54.1% for the third quarter of 2006 as compared to 55.8% for the third quarter of 2005.

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JEFFERIES GROUP, INC. AND SUBSIDIARIES

Non-Personnel Expenses

Non-personnel expense was $79.9 million for the third quarter of 2006 versus $64.7 million for the third quarter of 2005 or 23.4% of net revenues for the third quarter of 2006 versus 21.6% of net revenues for the third quarter of 2005. The increase in non-personnel expenses is consistent with our revenue growth and primarily attributable to increased technology and communications, occupancy, legal and compliance and other costs associated with higher levels of business activity.

Earnings before Income Taxes and Minority Interest

Earnings before income taxes, minority interest and cumulative effect of change in accounting principle, net, were up $8.8 million, or 13%, to $76.3 million, compared to $67.5 million for the third quarter of 2005. The effective tax rates were approximately 39.0% for the third quarter of 2006 and 38.7% for the third quarter of 2005.

Earnings per Share

Basic net earnings per share were $0.34 for the third quarter of 2006 on 135,140,000 shares compared to $0.31 in the third quarter of 2005 on 124,447,000 shares. Diluted net earnings per share were $0.32 for the third quarter of 2006 on 148,908,000 shares compared to $0.28 in the third quarter of 2005 on 136,225,000 shares. The diluted earnings per share calculation for the third quarter of 2006 includes an addition of $1.0 million to net earnings for preferred dividends. The dividend is recorded as a component of interest expense as the Series A convertible preferred stock is treated as debt in accordance with FASB 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.

First Nine Months 2006 Versus First Nine Months 2005

Overview

Revenues increased $383.7 million, or 36%, to $1.4 billion, compared to $1.1 billion for the first nine months of 2005. The increase was primarily due to a $126.8 million, or 27%, increase in equity and fixed income and commodities revenues, a $16.7 million, or 26%, increase in asset management fees and investment income from managed funds, a $67.9 million, or 21%, increase in investment banking, and a $172.3 million, or 81%, increase in interest revenues (net interest income which is interest revenue less interest expense only increased $10.1 million). The 2006 results included an after-tax gain of $1.6 million, or $0.01 per diluted common share, as a cumulative effect of change in accounting principle associated with our adoption of FASB 123R on January 1, 2006.

Equity Product Revenue

Equity product revenue is comprised of equity (including principal transaction and commission revenue), correspondent clearing and prime brokerage, and execution product revenues. Equity product revenue was $386.9 million, up 19% from the first nine months of 2005. The increase in equity product revenue was due to several large block trading opportunities generated from our investment banking relationships offset by a less favorable capital markets environment, a decline in customer-driven activity and a decrease in volatility levels.

Fixed Income & Commodities Revenue

Fixed income and commodities revenue is comprised of high yield, investment grade fixed income, convertible and commodities product revenue. Fixed income and commodities revenue was $202.3 million, up 49% over last year’s comparable period driven by increased activity in the high yield, investment grade corporate bond and commodity markets. High Yield revenues increased primarily due to increased valuations on high yield energy related positions. Investment grade income revenues increased primarily as a result of increased activity in the trading of corporate bonds. The increase in commodities revenue was due to the expansion of JFP, as well as, increased activity in most commodities markets, including energy related commodities markets.

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Investment Banking Product Revenue

	Nine Months Ended
	September 30,		September 30,
	2006		2005		Percentage Change
	(Dollars in Thousands)
Capital markets	$	147,748	$	155,067		(5	%)
Advisory		247,681		172,450		44	%
Total	$	395,429	$	327,517		21	%

Capital markets revenues, which consist primarily of debt, equity and convertible financing services were $147.7 million, a decrease of 5% from the first nine months of 2005. The decrease in capital markets revenues is primarily attributable to the decrease in revenue generated from high yield underwritings, offset by increases in revenue from equity and convertible underwritings.

Revenues from advisory activities were $247.7 million, an increase of 44% from the first nine months of 2005. The increase is primarily attributable to services rendered on assignments in the technology, aerospace and defense, industrial and energy sectors.

Asset Management Fee Revenue

Asset management revenue includes revenues from management, administrative and performance fees from funds managed by us, revenues from asset management and performance fees from third-party managed funds, and investment revenue from our investments in these funds. Asset management revenues were $80.1 million, up 26% over the first nine months of 2005. The increase in asset management revenue was a result of strong performance during the first quarter of 2006 by the long-short equity funds along with solid first nine months of 2006 results from our High Yield Funds offset by a challenging environment faced by our long-short equity funds during the second and third quarters of 2006.

Changes in Assets under Management

	Nine Month		Nine Month
	Period		Period
	Ending		Ending
	Sept. 30,		Sept. 30,		Percent
In millions	2006		2005		Change
Balance, beginning of period	$	4,031	$	3,287		23	%
Net cash flow in		687		401		71	%
Net market appreciation		300		118		154	%
		987		519		90	%
Balance, end of period	$	5,018	$	3,806		32	%

(1) Excludes certain 3^rd party managed funds that are no longer considered assets under management.

Net Interest Revenue

Interest income increased $172.3 million primarily as a result of increased stock borrowing activity and increases in interest rates, and interest expense increased by $162.2 million primarily as a result of increased stock lending activity, increases in interest rates, the issuance of our $500 million of senior unsecured debentures and our $125 million in Series A Mandatorily Convertible Preferred Stock.

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Compensation and Benefits

Compensation and benefits increased $112.8 million, or 23%, versus the 26% increase in net revenues. The increase was primarily due to our increase in headcount and change to our revenue mix offset by changes to FASB 123R guidance regarding the timing of expense recognition for non retirement-eligible employees.

Average employee headcount increased 10% from 1,911 during the first nine months of 2005 to 2,107 during the first nine months of 2006. The ratio of compensation to net revenues was approximately 54.8% for the first nine months of 2006 as compared to 55.8% for the first nine months of 2005.

Non-Personnel Expenses

Non-personnel expense was $235.1 million or 21.7% of net revenues for the first nine months of 2006 versus 22.1% of net revenues for the first nine months of 2005. The increase in non-personnel expenses is consistent with our revenue growth and primarily attributable to increased technology and communications, occupancy, legal and compliance and other costs associated with higher levels of business activity.

Earnings before Income Taxes and Minority Interest

Earnings before income taxes, minority interest and cumulative effect of change in accounting principle, net, were up $64.4 million, or 34%, to $254.5 million, compared to $190.0 million for the first nine months of 2005. The effective tax rates were approximately 39.1% for the first nine months of 2006 and 38.5% for the first nine months of 2005.

Earnings per Share

Basic net earnings per share were $1.13 for the first nine months of 2006 on 133,048,000 shares compared to $0.90 in the first nine months of 2005 on 122,868,000 shares. Diluted net earnings per share were $1.04 for the first nine months of 2006 on 146,502,000 shares compared to $0.82 in the first nine months of 2005 on 134,747,000 shares. Both the 2006 basic and diluted calculations included an additional $0.01 per share related to the cumulative effect of the change in accounting principle, net.

Liquidity, Financial Condition and Capital Resources

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

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

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Liquidity

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

	September 30, 2006		December 31, 2005
Cash and cash equivalents:
Cash in banks	$	72,986	$	85,191
Money market investments		253,523		170,742
Total cash and cash equivalents		326,509		255,933
Cash and securities segregated (1)		767,982		629,360
Short-term bond funds		¾		7,037
Auction rate preferreds (2)		¾		28,756
Mortgage-backed securities (2)		43,160		13,458
Asset-backed securities (2)		33,705		33,159
	$	1,171,356	$	967,703

(1)	In accordance with Rule 15c3-3 of the Securities Exchange Act of 1934, Jefferies, as a broker-dealer carrying client accounts, is subject to requirements related to maintaining cash or qualified securities in a segregated reserve account for the exclusive benefit of its clients. In addition, deposits with clearing and depository organizations are included in this caption.
(2)	Items are included in Financial Instruments Owned and Securities Pledged to Creditors (see note 4 of the Notes to the Consolidated Financial Statements). Items are financial instruments utilized in our overall cash management activities and are readily convertible to cash.

Unsecured bank loans are typically overnight loans used to finance financial instruments owned or clearing related balances. At September 30, 2006 and December 31, 2005 we had no outstanding secured or unsecured bank loans.

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

Our assets are funded by equity capital, senior debt, securities loaned, customer free credit balances, bank loans and other payables. Bank loans represent temporary (usually overnight) secured and unsecured short-term borrowings, which are generally payable on demand. We have arrangements with banks for unsecured, uncommitted financing of up to $374 million. We have always been able to obtain necessary short-term borrowings in the past and believe that we will continue to be able to do so in the future. Additionally, we have $215 million in letters of credit outstanding as of September 30, 2006, which are used in the normal course of business mostly to satisfy various collateral requirements in lieu of depositing cash or securities.

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Excess Liquidity

Our policy is to maintain excess liquidity to cover all expected cash outflows for one year in a stressed liquidity environment. Liquid resources consist of unrestricted cash and unencumbered assets, readily converted to cash on a secured basis on short notice. Certain investments, short-term bond funds and auction rated convertibles are also deemed by management to be readily convertible to cash. In addition, we have $374 million of unsecured, uncommitted lines of credits with various banks.

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

• The repayment of our unsecured debt maturing within twelve months ($100 million outstanding at September 30, 2006);

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

• The anticipated funding of outstanding investment commitments;

• The anticipated fixed costs over the next 12 months;

• Potential stock repurchases; and

• Certain accrued expenses and other liabilities

Analysis of Financial Condition and Capital Resources

Financial Condition

As previously discussed, we have historically maintained a highly liquid balance sheet, with a substantial portion of our total assets consisting of cash, highly liquid marketable securities and short-term receivables, arising principally from traditional securities brokerage activity. Total assets increased $2,703.8 million, or 21%, from $12,780.9 million at December 31, 2005 to $15,484.7 million at September 30, 2006. Our financial instruments owned and securities pledged to creditors increased $2,278.9 million, while our financial instruments sold, not yet purchased and securities sold under agreements to repurchase, increased $1,850.8 million.

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

	September 30, 2006			December 31, 2005
Stockholders’ equity	$	1,493,413		$	1,286,850
Less: Goodwill		(237,544	)		(220,607	)
Tangible stockholders’ equity	$	1,255,869		$	1,066,243
Stockholders’ equity	$	1,493,413		$	1,286,850
Add: Projected tax benefit on vested portion of restricted stock		151,070			137,193
Pro forma stockholders’ equity	$	1,644,483		$	1,424,043
Tangible stockholders’ equity	$	1,255,869		$	1,066,243
Add: Projected tax benefit on vested portion of restricted stock		151,070			137,193
Pro forma tangible stockholders’ equity	$	1,406,939		$	1,203,436
Shares outstanding		118,876,390			116,220,784
Add: Shares not issued, to the extent of related expense amortization		23,324,278			21,093,398
Less:
Shares issued, to the extent related expense has not been amortized		(2,029,079	)		(2,618,570	)
Adjusted shares outstanding		140,171,589			134,695,612
Book value per share (1)	$	12.56		$	11.07
Pro forma book value per share (2)	$	11.73		$	10.57
Tangible book value per share (3)	$	10.56		$	9.17
Pro forma tangible book value per share (4)	$	10.04		$	8.93

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

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

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Capital Resources

We had total long term capital of $2.9 billion and $2.1 billion as of September 30, 2006 and December 31, 2005, respectively, resulting in a long-term debt to total capital ratio of 44% and 38%, respectively. Our total capital base as of September 30, 2006 and December 31, 2005 was as follows (in thousands):

	September 30,		December 31,
	2006		2005
Long-Term Debt	$	1,268,582	$	779,873
Mandatorily Redeemable Convertible Preferred Stock		125,000		—
Total Stockholders’ Equity		1,493,413		1,286,850
Total Capital	$	2,886,995	$	2,066,723

Our ability to support increases in total assets is largely a function of our ability to obtain short-term secured and unsecured funding, primarily through securities lending, and our $374 million of uncommitted unsecured bank lines.

At September 30, 2006, our senior debt, net of unamortized discount, consisted of contractual principal payments (adjusted for amortization) of $492.2 million, $348.3 million, $323.3 million and $100.0 million due in 2036, 2016, 2012 and 2007 respectively.

At September 30, 2006, we had outstanding Series A convertible preferred stock of $125 million. Our Series A convertible preferred stock has a 3.25% annual, cumulative cash dividend and is currently convertible into 4,046,438 shares of our common stock at a conversion price of approximately $30.89 per share. The preferred stock is callable beginning in 2016 and will mature in 2036.

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 operating results, operating margins, earnings trend and volatility, balance sheet composition, liquidity and liquidity management, our capital structure, our overall risk management, business diversification and our market share and competitive position in the markets in which we operate.

Our long term debt ratings are as follows:

	Rating
Moody’s Investors Services	Baa1
Standard and Poor’s	BBB+
Fitch Ratings	BBB+

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

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Net Capital

As of September 30, 2006, Jefferies’ and Jefferies Execution’s net capital and excess net capital were as follows (in thousands of dollars):

	Net Capital		Excess Net Capital
Jefferies	$	275,854	$	260,378
Jefferies Execution	$	22,032	$	21,782

Guarantees

As of September 30, 2006, we had outstanding guarantees of $20.0 million relating to undrawn bank credit obligations of one associated investment fund in which we have an interest. In addition, we guarantee up to an aggregate of approximately $36.0 million in bank loans committed to an employee parallel fund of Jefferies Capital Partners IV L.P.

Also, we have guaranteed the performance of JIL and JFP to their trading counterparties and various banks and other entities, which provide clearing and credit services to JIL and JFP. In addition, as of September 30, 2006, we had commitments to invest up to $266.4 million in various investments, including $225.0 million in Jefferies Finance LLC, $30.7 million in Fund IV and $10.7 million in other investments.

Leverage Ratios

The following table presents total assets, adjusted assets, and net adjusted assets with the resulting leverage ratios as of September 30, 2006 and December 31, 2005. With respect to leverage ratio, we believe that net adjusted leverage is the most relevant measure, given the low-risk, collateralized nature of our securities borrowed and segregated cash assets.

	September 30, 2006		December 31, 2005
Total assets	$	15,484,724	$	12,780,931
Adjusted assets (1)		14,716,742		12,151,571
Net adjusted assets (2)		6,688,921		4,008,093
Leverage ratio (3)		10.4		9.9
Adjusted leverage ratio (4)		9.9		9.4
Net adjusted leverage ratio (5)		4.5		3.1

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

Stock Repurchases

During 2006, we purchased 652,852 shares of our common stock for $16.6 million mostly in connection with our stock compensation plans which allow participants to use shares to pay the exercise price of options exercised and to use shares to satisfy tax liabilities arising from the exercise of options or the vesting of restricted stock. The number above does not include unvested shares forfeited back to us pursuant to the terms of our stock compensation plans. We believe that we have sufficient liquidity and capital resources to make these repurchases without any material adverse effect on us.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

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

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

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

Value-at Risk

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

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

     The VaR numbers below are shown separately for interest rate, equity, currency and commodity products, as well as for our overall trading positions, excluding corporate investments, using a historical simulation approach. 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. The following table illustrates the VaR for each component of market risk.

	Daily VaR (1)
	(In Millions)
	Value-at-Risk in trading portfolios
	VaR at						Average VaR 3 Months Ended
Risk Categories	9/30/06		6/30/06		12/30/05		9/30/06		6/30/06		12/30/05
Interest Rates	$	1.03	$	0.89	$	0.56	$	0.89	$	0.54	$	0.48
Equity Prices	$	4.76	$	4.38	$	2.11	$	4.83	$	3.32	$	2.50
Currency Rates	$	0.48	$	0.44	$	0.36	$	0.41	$	0.38	$	0.29
Commodity Prices	$	3.29	$	1.15	$	0.20	$	1.83	$	2.22	$	1.42
Diversification Effect2	-$	4.47	-$	2.30	-$	1.10	-$	2.89	-$	2.45	-$	1.64
Firmwide	$	5.09	$	4.56	$	2.13	$	5.07	$	4.01	$	3.05

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	Daily VaR (1)
	(In Millions)
	Value-at-Risk Highs and Lows
	for Three Months Ended
	9/30/06				6/30/06				12/30/05
Risk Categories	High		Low		High		Low		High		Low
Interest Rates	$	1.05	$	0.71	$	0.89	$	0.41	$	0.62	$	0.33
Equity Prices	$	5.34	$	4.26	$	5.66	$	1.23	$	3.38	$	1.99
Currency Rates	$	0.53	$	0.24	$	0.46	$	0.29	$	0.45	$	0.14
Commodity Prices	$	3.29	$	0.72	$	4.67	$	0.85	$	2.60	$	0.10
Firmwide	$	6.36	$	4.26	$	6.01	$	1.95	$	3.73	$	2.13

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

Average VaR of $5.07 million during the third quarter of 2006 increased from the $4.01 million average during the second quarter of 2006 due mainly to an increase in exposure to equity prices.

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

Daily VaR Trend

The increase in VaR in the first quarter of 2006 is related to a large block trading opportunity from an investment banking relationship that was closed during the quarter ended March 31, 2006.

VaR Back-Testing

The comparison of daily actual revenue fluctuations with the daily VaR estimate is the primary method used to test the efficacy of the VaR model. Back testing is performed at various levels of the trading portfolio, from the holding company level down to specific business lines. A back-testing exception occurs when the daily loss exceeds the daily VaR estimate. Results of the process at the aggregate level demonstrated no outliers when comparing the 95% one-day VaR with the back-testing profit and loss in the third quarter of 2006. A 95% confidence one-day VaR model should not have more than twelve (1 out of 20 days) back-testing exceptions on an annual basis. Back-testing profit and loss is a subset of actual trading revenue and includes only the profit and loss effects relevant to the VaR model,

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excluding fees, commissions and certain provisions. We compare the trading revenue with VaR for back-testing purposes because VaR assesses only the potential change in position value due to overnight movements in financial market variables such as prices, interest rates and volatilities under normal market conditions. The graph below illustrates the relationship between daily back-testing profit and loss and daily VaR for us in the third quarter of 2006.

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

Daily Trading Net Revenue
($ in millions)

Trading revenue used in the histogram below entitled “Third Quarter 2006 vs. Third Quarter 2005 Distribution of Daily Trading Revenue” is the actual daily trading revenue which excludes fee based revenue and commissions. The histogram below shows the distribution of daily trading revenue for substantially all of our trading activities.

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Item 4. Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2006. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of September 30, 2006 are functioning effectively to provide reasonable assurance that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding disclosure. A controls system cannot provide absolute assurance, however, that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

No change in our internal control over financial reporting occurred during the quarter ended September 30, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

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

Item 1A. Risk Factors

Information regarding our risk factors appears in Part I, Item 1A. of our annual report on Form 10-K for the fiscal year ended December 31, 2005 filed with the SEC on March 1, 2006. These risk 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. There have been no material changes from the risk factors previously disclosed in our annual report on Form 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities

					(c) Total Number of
	(a) Total		(b)		Shares Purchased as		(d) Maximum Number of
	Number of		Average		Part of Publicly		Shares that May Yet Be
	Shares		Price Paid		Announced Plans or		Purchased Under the
Period	Purchased (1)		per Share		Programs		Plans or Programs (2)
July 1 – July 31, 2006		—		—		—		6,000,000
August 1 – August 31, 2006		53,510		24.03		51,000		5,949,000
September 1 – September 30, 2006		4,722		24.38		—		5,949,000
Total		58,232		24.06		51,000

(1) We repurchased an aggregate of 7,232 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 options exercised and to use shares to satisfy tax liabilities arising from the exercise of options or the vesting of restricted stock. The number above does not include unvested shares forfeited back to us pursuant to the terms of our stock compensation plans.

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(2) On July 26, 2005, we issued a press release announcing the authorization by our Board of Directors to repurchase, from time to time, up to an aggregate of 3,000,000 shares of our common stock. After giving effect to the 2-for-1 stock split effected as a stock dividend on May 15, 2006, this authorization increased to 6,000,000 shares.

Item 6. Exhibits

Exhibits
3.1	Amended and Restated Certificate of Incorporation of Jefferies Group, Inc. is incorporated herein by reference to Exhibit 3 of the Registrant’s Form 8-K filed on May 26, 2004.
3.2	Registrant’s Certificate of Designations of 3.25% Series A Cumulative Convertible Preferred Stock is incorporated herein by reference to Exhibit 3.1 of the Registrant’s Form 8-K filed on February 21, 2006.
3.3	By-Laws of Jefferies Group, Inc are incorporated herein by reference to Exhibit 3.2 of Registrant’s Form 10-K filed on March 28, 2003.
10.1	Summary of the 2007 and 2008 Executive Compensation for Messrs. Handler and Friedman is incorporated herein by reference to Exhibit 10 of the Registrant’s Form 8-K filed on August 25, 2006.
10.2*	Restricted Stock Unit Grant dated as of August 25, 2006 to Richard B. Handler.
10.3*	Restricted Stock Unit Grant dated as of August 25, 2006 to Brian P. Friedman.
31.1*	Rule 13a-14(a)/15d-14(a) Certification by the Chief Financial Officer.
31.2*	Rule 13a-14(a)/15d-14(a) Certification by the Chief Executive Officer.
32*	Rule 13a-14(b)/15d-14(b) and Section 1350 of Title 18 U.S.C. Certification by the Chief Executive Officer and Chief Financial Officer.

* Filed herewith.

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SIGNATURE

     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		JEFFERIES GROUP, INC.
		(Registrant)
Date: November 8, 2006	By:	/s/	Joseph A. Schenk
				Joseph A. Schenk
				Chief Financial Officer

Page 58 of 58

EX-10.2

Ex. 10.2

JEFFERIES GROUP, INC.

2003 Incentive Compensation Plan
Restricted Stock Units Agreement

     This Restricted Stock Units Agreement (the “Agreement”) confirms the grant on August 25, 2006 (the “Grant Date”) by Jefferies Group, Inc., a Delaware corporation (the “Company”), to Richard B. Handler (“Employee”) of Restricted Stock Units (the “Units”), including rights to Dividend Equivalents as specified herein, as follows:

Number granted:	1,080,182 Units
How Units Vest:	The Units will not vest and 100% of the Units will be immediately forfeited in the event the Company’s net earnings for the fiscal year ending December 31, 2007 do not equal or exceed $25 million (the “Performance Criteria”)
	20% of the Units, if not previously forfeited, will vest on the date that the Compensation Committee of the Board of Directors of the Company certifies that the Performance Criteria has been met and 20% of the Units, if not previously forfeited, will vest on each of August 25, 2008, August 25, 2009, August 25, 2010 and August 25, 2011, provided that Employee continues to be employed by the Company or a subsidiary on each vesting date (each, a “Stated Vesting Date”).
	In addition, if not previously forfeited, the Units will become vested earlier upon the occurrence of certain events relating to Termination of Employment to the extent provided in Section 4 of the Terms and Conditions of Restricted Stock Units attached hereto (the “Terms and Conditions”). The terms “vest” and “vesting” mean that the Units have become non-forfeitable, except for forfeitures specified under Section 7.4 of the Plan and except for forfeitures provided in Section 4 of the Terms and Conditions. If Employee has a Termination of Employment prior to the Stated Vesting Date and the Units are not otherwise deemed vested by that date, the Units will be immediately forfeited except as otherwise provided in Section 4 of the Terms and Conditions.
Settlement:	Settlement of vested Units will occur on October 25, 2011, or as promptly as possible upon the death or Disability of Employee or Termination of Employment by the Company not for Cause following a Change in Control, except settlement shall be deferred in certain cases in accordance with Section 8(a) of the Terms and Conditions (the “Settlement Date”). Units granted hereunder will be settled by delivery of one Share for each Unit being settled (together with any cash or Shares resulting from Dividend Equivalents). Any settlement required to be made “promptly” under this Agreement shall in all cases be made not later than 60 days after the event that triggers such settlement.

     The Units are subject to the terms and conditions of the 2003 Incentive Compensation Plan (the “Plan”), and this Agreement, including the Terms and Conditions attached hereto. The number of Units, the kind of shares deliverable in settlement of Units, and other terms relating to the Units are subject to adjustment in accordance with Section 5 of the Terms and Conditions and Section 5.3 of the Plan.

     Employee acknowledges and agrees that (i) Units are nontransferable, except as provided in Section 3 of the Terms and Conditions and Section 9.2 of the Plan, (ii) Units, and certain amounts of gain

realized upon settlement of Units, are subject to forfeiture, whether during employment or following a Termination of Employment, in the event Employee fails to meet applicable requirements relating to non-solicitation, confidentiality, and related matters with respect to the Company and its subsidiaries and affiliates (together, “Group,” and each entity included in Group being a “Group Entity”), as set forth in Section 7.4 of the Plan and (iii) sales of shares delivered in settlement of Units will be subject to the Company’s policies regulating trading by employees if the recipient is then an employee of the Company.

     IN WITNESS WHEREOF, JEFFERIES GROUP, INC. has caused this Agreement to be executed by its officer thereunto duly authorized, and Employee has duly executed this Agreement, by which each has agreed to the terms of this Agreement.

Employee	JEFFERIES GROUP, INC.
/s/ Richard B. Handler	/s/ Roland T. Kelly
Richard B. Handler	Roland T. Kelly
	Assistant Secretary

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TERMS AND CONDITIONS OF RESTRICTED STOCK UNITS

     The following Terms and Conditions apply to the Units granted to Employee by JEFFERIES GROUP, INC. (the “Company”), and Units (if any) resulting from Dividend Equivalents, as specified in the Restricted Stock Units Agreement to which these Terms and Conditions are attached (and of which these Terms and Conditions form a part). Certain terms of the Units, including the number of Units granted, vesting date(s) and Settlement Date, are set forth on the preceding pages, referred to as the Cover Page in these Terms and Conditions. The Cover Page and these Terms and Conditions are collectively referred to as the “Agreement.”

     1. General. The Units are granted to Employee under the Company’s 2003 Incentive Compensation Plan (the “Plan”). A copy of the Plan and information regarding the Plan, including documents that constitute the “Prospectus” for the Plan under the Securities Act of 1933, can be viewed and printed out from the Company’s secure Intranet website, www.corp.jefco.com (go to People Services, then to Plan Documents). All of the applicable terms, conditions and other provisions of the Plan are incorporated by reference herein. Capitalized terms used in this Agreement but not defined herein shall have the same meanings as in the Plan. If there is any conflict between the provisions of this document and mandatory provisions of the Plan, the provisions of the Plan govern, otherwise, the terms of this document shall prevail. By accepting the grant of the Units, Employee agrees to be bound by all of the terms and provisions of the Plan (as presently in effect or later amended), the rules and regulations under the Plan adopted from time to time, and the decisions and determinations of the Company’s Compensation Committee (the “Committee”) made from time to time, provided that no such Plan amendment, rule or regulation or Committee decision or determination shall materially and adversely affect the rights of the Employee with respect to the Units.

     2. Account for Employee. The Company shall maintain a bookkeeping account for Employee (the “Account”) reflecting the number of Units then credited to Employee hereunder as a result of such grant of Units and any crediting of additional Units to Employee pursuant to payments equivalent to dividends paid on Common Stock under Section 5 hereof (“Dividend Equivalents”).

     3. Nontransferability. Until Units are settled in accordance with the terms of this Agreement, Employee may not sell, transfer, assign, pledge, margin or otherwise encumber or dispose of Units or any rights hereunder to any third party other than by will or the laws of descent and distribution, except for transfers to a Beneficiary or as otherwise permitted and subject to the conditions under Section 9.2 of the Plan.

     4. Termination Provisions. The following provisions will govern the vesting and forfeiture of the Units in the event of Employee’s Termination of Employment and/or occurrence of a post-termination Forfeiture Event (as defined below), unless otherwise determined by the Committee (subject to Section 9(a) hereof):

     (a) Death or Disability. In the event of Employee’s death or Termination of Employment due to Disability (as defined below), all Units then outstanding, if not previously vested, will immediately vest, and all Units (if not previously settled) will be settled in accordance with the settlement terms set out on the Cover Page, giving effect to any valid deferral election of Employee then in effect. The foregoing notwithstanding, any distribution resulting from a Disability that does not constitute an “unforeseeable emergency” under Section 409A(a)(2)(B)(ii) of the Internal Revenue Code (the “Code”) or as to which Employee became “Disabled” as defined under Code Section 409A(a)(2)(B)(i) will be subject to the six-month delay rule in Section 8(a)(i), if applicable.

     (b) Retirement. In the event of Employee’s Retirement prior to January 31, 2008, Units not previously forfeited will be immediately forfeited. In the event of Employee’s Retirement after January 31, 2008 and before December 31, 2008, one-half of the Units not

previously forfeited will be immediately forfeited and one-half of the Units not previously forfeited will not then be forfeited; and in the event of Employee’s Retirement after December 31, 2008, Units not previously vested shall not then be forfeited; provided in both cases that Employee executes a settlement agreement and release in such form as may be requested by the Company, but thereafter all unvested Units shall be forfeited if there occurs a Forfeiture Event prior to the Settlement Date. Upon such a Retirement, the then-outstanding Units that are vested at the date of Termination (if not already settled) and that become vested thereafter will be settled in accordance with the settlement terms set out on the Cover Page, giving effect to any valid deferral election of Employee then in effect. A “Forfeiture Event” shall be deemed to occur if, following Employee’s Retirement, Employee renders services for any organization or engages (either as owner, investor, partner, stockholder, employer, employee, consultant, advisor, or director) directly or indirectly, in any business which is or becomes competitive with the Company, its subsidiaries or affiliates. However, following Employee’s Retirement, Employee shall be free to purchase stock or other securities of an organization or business so long as it is listed upon a recognized securities exchange or traded over-the-counter and such investment does not represent a greater than five percent equity interest in the organization or business.

     (c) Involuntary Termination by the Company not for Cause (and not subject to Section 4(d)). In the event of Employee’s Termination of Employment by the Company not for Cause (other than a Termination not for Cause following a Change in Control), Units not previously vested shall not then be forfeited provided that Employee executes a settlement agreement and release in such form as may be requested by the Company, but thereafter all unvested Units shall be forfeited if there occurs a Forfeiture Event prior to the Settlement Date. Upon such a Termination of Employment not for Cause, the then-outstanding Units that are vested at the date of Termination (if not already settled) and that become vested thereafter will be settled in accordance with the settlement terms set out on the Cover Page, giving effect to any valid deferral election of Employee then in effect. A “Forfeiture Event” shall be deemed to occur if, following Employee’s Termination by the Company not for Cause, Employee renders services for any organization or engages (either as owner, investor, partner, stockholder, employer, employee, consultant, advisor, or director) directly or indirectly, in any business which is or becomes competitive with the Company, its subsidiaries or affiliates. However, following Employee’s Termination by the Company not for Cause, Employee shall be free to purchase stock or other securities of an organization or business so long as it is listed upon a recognized securities exchange or traded over-the-counter and such investment does not represent a greater than five percent equity interest in the organization or business.

     (d) Termination Following a Change in Control. If, following a Change in Control, Employee’s employment is terminated not for Cause by the Company or its successor, all of the then-outstanding Units not vested at the date of Termination will immediately vest and will be settled promptly thereafter, subject to the six-month delay rule in Section 8(a)(i), if applicable. If a Change in Control occurs followed by Termination of Employment by the Company not for Cause and a determination is made by the Company pursuant to Sections 280G and 4999 of the Code that a “golden parachute” excise tax will be payable in connection with compensation to Employee hereunder, Employee’s right to accelerated vesting of the Units upon the Change in Control, to the extent such right results in “parachute payments” (as such term is defined in Code Section 280G), shall be limited to the extent just necessary to avoid the excise tax. This limitation shall be applied in a manner that maximizes the number of Units as to which accelerated vesting can apply (or, stated conversely, any limitation on acceleration of vesting shall apply first to those Units with the lengthiest remaining vesting period, which Units would result in the highest “parachute payments”).

     (e) Termination by Employee for any Reason or by the Company for Cause. In the event of a Termination of Employment by the Employee for any reason (other than due to

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Retirement, death or Disability) or by the Company for Cause, the portion of the then-outstanding Units not vested at the date of Termination will be forfeited, and the portion of the then-outstanding Units that is vested at the date of Termination (if not already settled) will be settled on the Settlement Date specified on the Cover Page unless forfeited pursuant to the provisions of Section 7.4 of the Plan, except that any valid deferral election of Employee shall be given effect.

     (f) Certain Definitions. The following definitions apply for purposes of this Agreement, whether or not Employee has an employment agreement or other agreement with the Company, or any of its subsidiaries or affiliates (the Company and any subsidiary or affiliate each being a “Group Entity”) containing the same or similar defined terms:

     (i) “Cause” means Employee’s:

Neglect, failure or refusal to timely perform the duties of Employee’s employment (other than by reason of a physical or mental illness or impairment), or Employee’s gross negligence in the performance of his or her duties;

Material breach of any agreements, covenants and representations made in any employment agreement or other agreement with the Company or any of its subsidiaries or affiliates or violation of internal policies or procedures as are in effect as of the date such action is taken, including but not limited to the Company’s Code of Ethics and Standards of Employee Conduct, as amended from time to time;

Violation of any law, rule, regulation or by-law of any governmental authority (state, federal or foreign), any securities exchange or association or other regulatory or self-regulatory body or agency applicable to Employee, the Company, its subsidiaries or affiliates or any material general policy or directive of the Company, its subsidiaries or affiliates;

Conviction of, or plea of guilty or nolo contendere to, a crime involving moral turpitude, dishonesty, fraud or unethical business conduct, or any felony of any nature whatsoever;

Failure to obtain or maintain any registration, license or other authorization or approval that Employee is required to maintain or that the Company, its subsidiaries or affiliates reasonably believes is required in order for Employee to perform his or her duties, provided, however, that Employee shall be given written notice of any such registration, license or other authorization or approval that he or she is required to obtain and a reasonable period of time to obtain such registration, license, or other authorization or approval; or

Willful failure to execute a directive of the board of directors of the Company or any of its subsidiaries or affiliates, the Executive Committee of any of the Company’s subsidiaries or affiliates, or Employee’s supervisor (unless such directive would result in the commission of an act which is illegal or unethical) or commission of an act against the directive of such Board, such Executive Committee or Employee’s supervisor.

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     (ii) A “Change in Control” shall be deemed to have occurred if any of the following conditions shall have been satisfied after the Grant Date:

Any person (as defined in section 3(a)(9) of the Securities Exchange Act of 1934, as such term is modified in Section 13(d)), other than (i) an employee plan established by the Company or any of its subsidiaries; or (ii) any group of Company employees holding shares subject to agreements relating to the voting of such shares becomes a beneficial owner, directly or indirectly, of more than 51% of the voting stock of the Company;

The consummation of a merger or consolidation of the Company with any other corporation or any other entity, or the issuance of voting securities in connection with a merger or consolidation of the Company, if the holders of the Company’s voting securities immediately prior to such transaction hold in the aggregate less than a majority of the then outstanding voting securities of the Company (or any successor company or entity) entitled to vote generally in the election of the directors of the Company (or such other company or entity) after such transaction;

The sale or disposition by the Company of all or substantially all of its assets in which one person or more than one person acting as a group acquires assets from the Company that have a total gross fair market value equal to more than 50% of the total gross fair market value of all of the assets of the Company immediately prior to such acquisition; or

A change in the composition of the Board of Directors of the Company such that individuals who, as of the date of this agreement, constitute the Board of Directors of the Company (the “Incumbent Board”) cease for any reason to constitute at least a majority of the Board of Directors of the Company; provided, however, that any individual becoming a member of the Board of Directors of the Company subsequent to the date of this agreement whose election, or nomination for election by the shareholders of the Company, was approved by a vote of at least a majority of the directors then constituting the Incumbent Board shall be considered as if that individual were a member of the Incumbent Board.

     (iii) “Disability” means that Employee has commenced receipt of long-term disability benefits under the Company’s long-term disability policy as in effect at the date of Employee’s termination of employment.

     (iv) “Retirement” means retirement after attaining the age at which an Employee’s age plus his years of service equals 62, provided, however, that Employee has provided a minimum of seven and one-half years of service to the Company, its subsidiaries or affiliates. For this purpose, years of service shall be credited for each twelve month period beginning on the date of Employee’s commencement of employment with the Company and on each anniversary thereof during which the Employee was in active employment with the Company.

     (v) “Termination” or “Termination of Employment” means the event by which Employee ceases to be employed by a Group Entity and immediately thereafter is not employed by any other Group Entity.

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     5. Dividend Equivalents and Adjustments.

     (a) Dividend Equivalents. Subject to Section 5(d), Dividend Equivalents will be credited on Units (other than Units that, at the relevant record date, previously have been settled or forfeited) and deemed reinvested in additional Units, to the extent and in the manner as follows:

     (i) Cash Dividends. If the Company declares and pays a dividend or distribution on Shares in the form of cash, then a number of additional Units shall be credited to Employee’s Account as of the last day of the calendar quarter in which such dividend or distribution was paid equal to the number of Units credited to the Account as of the record date for such dividend or distribution multiplied by cash amount of the dividend or distribution paid on each outstanding share of Common Stock at such payment date, divided by the Fair Market Value of a share of Common Stock at the date of such crediting; provided, however, that in the case of an extraordinary cash dividend or distribution the Company may provide for such crediting at the dividend or distribution payment date instead of the last day of the calendar quarter.

     (ii) Non-Common Stock Dividends. If the Company declares and pays a dividend or distribution on Common Stock in the form of property other than shares of Common Stock, then a number of additional Units shall be credited to Employee’s Account as of the payment date for such dividend or distribution equal to the number of Units credited to the Account as of the record date for such dividend or distribution multiplied by the Fair Market Value of such property actually paid as a dividend or distribution on each outstanding share of Common Stock at such payment date, divided by the Fair Market Value of a share of Common Stock at such payment date.

     (iii) Common Stock Dividends and Splits. If the Company declares and pays a dividend or distribution on Common Stock in the form of additional shares of Common Stock, or there occurs a forward split of Common Stock, then a number of additional Units shall be credited to Employee’s Account as of the payment date for such dividend or distribution or forward split equal to the number of Units credited to the Account as of the record date for such dividend or distribution or split multiplied by the number of additional shares of Common Stock actually paid as a dividend or distribution or issued in such split in respect of each outstanding share of Common Stock.

     (b) Adjustments. The number of Units credited to Employee’s Account shall be appropriately adjusted, in order to prevent dilution or enlargement of Employee’s rights with respect to Units or to reflect any changes in the number of outstanding shares of Common Stock resulting from any event referred to in Section 5.3 of the Plan, taking into account any Units credited to Employee in connection with such event under Section 5(a) hereof, and any performance conditions relating to the Units may be likewise adjusted in the discretion of the Committee.

     (c) Risk of Forfeiture and Settlement of Units Resulting from Dividend Equivalents and Adjustments. Units which directly or indirectly result from Dividend Equivalents on or adjustments to a Unit granted hereunder and which do not result from a dividend or distribution on Shares in the form of cash shall be subject to the same risk of forfeiture (including Section 7.4 of the Plan) as applies to the granted Unit and, if not forfeited, will be settled at the same time as the granted Unit. Units which directly or indirectly result from Dividend Equivalents on or adjustments to a Unit granted hereunder and which result from an ordinary dividend or distribution on Shares in the form of cash shall not be subject to forfeiture and will be settled at

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the same time as the granted Unit (or if the granted Unit is forfeited, then at the time the granted Unit would have been settled if it were not forfeited). Units which directly or indirectly result from Dividend Equivalents on or adjustments to a Unit granted hereunder and which result from an extraordinary dividend or distribution on Shares in the form of cash shall, unless otherwise determined by the Company at the time of such extraordinary dividend or distribution, be subject to the same risk of forfeiture (including additional forfeiture terms of Section 7.4 of the Plan) as applies to the granted Unit and, if not forfeited, will be settled at the same time as the granted Unit.

     (d) Changes to Manner of Crediting Dividend Equivalents. The provisions of Section 5(a) notwithstanding, the Company may vary the manner and timing of crediting dividend equivalents for administrative convenience, including, for example, by crediting cash dividend equivalents rather than additional Units.

     6. Additional Forfeiture Provisions. Employee agrees that, by signing this Agreement and accepting the grant of the Units, the forfeiture conditions set forth in Section 7.4 of the Plan shall apply to all Units hereunder and to gains realized upon the settlement of the Units.

     7. Employee Representations and Warranties and Release. As a condition to any non-forfeiture of the Units at or after Termination of Employment and to any settlement of the Units, the Company may require Employee (i) to make any representation or warranty to the Company as may be required under any applicable law or regulation, to make a representation and warranty that no Forfeiture Event has occurred or is contemplated, and that otherwise the requirements of Section 7.4(d) of the Plan and Section 7 above have been met, and (ii) to execute a release of claims against the Company arising before the date of such release, in such form as may be specified by the Company.

     8. Other Terms Relating to Units.

     (a) Deferral of Settlement; Compliance with Code Section 409A. Settlement of any Unit, which otherwise would occur at the Settlement Date, will be deferred in certain cases if and to the extent Employee is permitted to participate in the Stock Option Gain and Stock Award Deferral Program or otherwise permitted to defer the Units and Employee makes a valid deferral election relating to the Units. Deferrals, whether elective or mandatory under the terms of this Agreement, shall comply with requirements under Code Section 409A. Deferrals will be subject to such other restrictions and terms as may be specified by the Company prior to deferral. It is understood that Code Section 409A and regulations thereunder may require any elective deferral to comply with Section 409A(a)(4)(C). Other provisions of this Agreement notwithstanding, under U.S. federal income tax laws and Treasury Regulations (including proposed regulations) as presently in effect or hereafter implemented, (i) a distribution in settlement of Units to Employee triggered by a Termination of Employment will occur only if the Termination constitutes a “separation from service” within the meaning of Code Section 409A(a)(2)(A)(i) and, if at the time of such separation from service Employee is a “specified employee” under Code Section 409A(a)(2)(B)(i) and a delay in distribution is required in order that Employee will not be subject to a tax penalty under Code Section 409A, such distribution in settlement of Units will occur at the date six months after Termination of Employment; and (ii) any rights of Employee or retained authority of the Company with respect to Units hereunder shall be automatically modified and limited to the extent necessary so that Employee will not be deemed to be in constructive receipt of income relating to the Units prior to the distribution and so that Employee shall not be subject to any penalty under Code Section 409A.

     (b) Fractional Units and Shares. The number of Units credited to Employee’s Account shall include fractional Units calculated to at least three decimal places, unless otherwise determined by the Committee. Unless settlement is effected through a broker or agent that can

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accommodate fractional shares (without requiring issuance of a fractional share by the Company), upon settlement of the Units Employee shall be paid, in cash, an amount equal to the value of any fractional share that would have otherwise been deliverable in settlement of such Units.

     (c) Tax Withholding. Employee shall make arrangements satisfactory to the Company, or, in the absence of such arrangements, a Group Entity may deduct from any payment to be made to Employee any amount necessary, to satisfy requirements of federal, state, local, or foreign tax law to withhold taxes or other amounts with respect to the lapse of the risk of forfeiture (including FICA due upon such lapse) or the settlement of the Units. Unless Employee has made separate arrangements satisfactory to the Company, the Company may elect to withhold shares deliverable in settlement of the Units having a fair market value (as determined by the Committee) equal to the amount of such tax liability required to be withheld in connection with the settlement of the Units, but the Company shall not be obligated to withhold such Shares. The Company may specify a reasonable deadline (for example, 90 days before the Settlement Date) by which separate arrangements must be made for payment of withholding taxes other than through withholding of shares.

     (d) Statements. An individual statement of Employee’s Account will be issued to Employee at such times as may be determined by the Company. Such a statement shall reflect the number of Units credited to Employee’s Account, transactions therein during the period covered by the statement, and other information deemed relevant by the Committee. Such a statement may be combined with or include information regarding other plans and compensatory arrangements for employees. Employee’s statements shall be deemed a part of this Agreement, and shall evidence the Company’s obligations in respect of Units, including the number of Units credited as a result of Dividend Equivalents (if any). Any statement containing an error shall not, however, represent a binding obligation to the extent of such error, notwithstanding the inclusion of such statement as part of this Agreement.

     9. Miscellaneous.

     (a) Binding Agreement; Written Amendments. This Agreement shall be binding upon the heirs, executors, administrators, and successors of the parties. This Agreement and the Plan, and any deferral election separately filed with the Company relating to this Award, constitute the entire agreement between the parties with respect to the Units, and supersede any prior agreements or documents with respect thereto. No amendment, alteration, suspension, discontinuation, or termination of this Agreement which may impose any additional obligation upon the Company or materially impair the rights of Employee with respect to the Units shall be valid unless in each instance such amendment, alteration, suspension, discontinuation, or termination is expressed in a written instrument duly executed in the name and on behalf of the Company and, if Employee’s rights are being materially impaired, by Employee.

     (b) No Promise of Employment. The Units and the granting thereof shall not constitute or be evidence of any agreement or understanding, express or implied, that Employee has a right to continue as an officer or employee of the Company for any period of time, or at any particular rate of compensation.

     (c) Unfunded Plan. Any provision for distribution in settlement of Employee’s Account hereunder shall be by means of bookkeeping entries on the books of the Company and shall not create in Employee or any Beneficiary any right to, or claim against any, specific assets of the Company, nor result in the creation of any trust or escrow account for Employee. With respect to any entitlement of Employee or any Beneficiary to any distribution hereunder, Employee or such Beneficiary shall be a general creditor of the Company.

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     (d) Governing Law. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK WITHOUT GIVING EFFECT TO CONFLICTS OF LAWS PRINCIPLES.

     (e) Legal Compliance. Employee agrees to take any action the Company reasonably deems necessary in order to comply with federal and state laws, or the rules and regulations of the New York Stock Exchange, the NASD, or any other stock exchange, or any other obligation of the Company or Employee relating to the Units or this Agreement.

     (f) Notices. Any notice to be given the Company under this Agreement shall be addressed to the Company at 520 Madison Avenue, 12th Floor, New York, NY 10022, attention: Corporate Secretary, and any notice to the Employee shall be addressed to the Employee at Employee’s address as then appearing in the records of the Company.

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EX-10.3

Ex. 10.3

JEFFERIES GROUP, INC.

2003 Incentive Compensation Plan
Restricted Stock Units Agreement

     This Restricted Stock Units Agreement (the “Agreement”) confirms the grant on August 25, 2006 (the “Grant Date”) by Jefferies Group, Inc., a Delaware corporation (the “Company”), to Brian P. Friedman (“Employee”) of Restricted Stock Units (the “Units”), including rights to Dividend Equivalents as specified herein, as follows:

Number granted:	540,091 Units
How Units Vest:	The Units will not vest and 100% of the Units will be immediately forfeited in the event the Company’s net earnings for the fiscal year ending December 31, 2007 do not equal or exceed $25 million (the “Performance Criteria”)
	20% of the Units, if not previously forfeited, will vest on the date that the Compensation Committee of the Board of Directors of the Company certifies that the Performance Criteria has been met and 20% of the Units, if not previously forfeited, will vest on each of August 25, 2008, August 25, 2009, August 25, 2010 and August 25, 2011, provided that Employee continues to be employed by the Company or a subsidiary on each vesting date (each, a “Stated Vesting Date”).
	In addition, if not previously forfeited, the Units will become vested earlier upon the occurrence of certain events relating to Termination of Employment to the extent provided in Section 4 of the Terms and Conditions of Restricted Stock Units attached hereto (the “Terms and Conditions”). The terms “vest” and “vesting” mean that the Units have become non-forfeitable, except for forfeitures specified under Section 7.4 of the Plan and except for forfeitures provided in Section 4 of the Terms and Conditions. If Employee has a Termination of Employment prior to the Stated Vesting Date and the Units are not otherwise deemed vested by that date, the Units will be immediately forfeited except as otherwise provided in Section 4 of the Terms and Conditions.
Settlement:	Settlement of vested Units will occur on October 25, 2011, or as promptly as possible upon the death or Disability of Employee or Termination of Employment by the Company not for Cause following a Change in Control, except settlement shall be deferred in certain cases in accordance with Section 8(a) of the Terms and Conditions (the “Settlement Date”). Units granted hereunder will be settled by delivery of one Share for each Unit being settled (together with any cash or Shares resulting from Dividend Equivalents). Any settlement required to be made “promptly” under this Agreement shall in all cases be made not later than 60 days after the event that triggers such settlement.

     The Units are subject to the terms and conditions of the 2003 Incentive Compensation Plan (the “Plan”), and this Agreement, including the Terms and Conditions attached hereto. The number of Units, the kind of shares deliverable in settlement of Units, and other terms relating to the Units are subject to adjustment in accordance with Section 5 of the Terms and Conditions and Section 5.3 of the Plan.

     Employee acknowledges and agrees that (i) Units are nontransferable, except as provided in Section 3 of the Terms and Conditions and Section 9.2 of the Plan, (ii) Units, and certain amounts of gain

realized upon settlement of Units, are subject to forfeiture, whether during employment or following a Termination of Employment, in the event Employee fails to meet applicable requirements relating to non-solicitation, confidentiality, and related matters with respect to the Company and its subsidiaries and affiliates (together, “Group,” and each entity included in Group being a “Group Entity”), as set forth in Section 7.4 of the Plan and (iii) sales of shares delivered in settlement of Units will be subject to the Company’s policies regulating trading by employees if the recipient is then an employee of the Company.

     IN WITNESS WHEREOF, JEFFERIES GROUP, INC. has caused this Agreement to be executed by its officer thereunto duly authorized, and Employee has duly executed this Agreement, by which each has agreed to the terms of this Agreement.

Employee	JEFFERIES GROUP, INC.
/s/ Brian P. Friedman	/s/ Roland T. Kelly
Brian P. Friedman	Roland T. Kelly
	Assistant Secretary

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TERMS AND CONDITIONS OF RESTRICTED STOCK UNITS

     The following Terms and Conditions apply to the Units granted to Employee by JEFFERIES GROUP, INC. (the “Company”), and Units (if any) resulting from Dividend Equivalents, as specified in the Restricted Stock Units Agreement to which these Terms and Conditions are attached (and of which these Terms and Conditions form a part). Certain terms of the Units, including the number of Units granted, vesting date(s) and Settlement Date, are set forth on the preceding pages, referred to as the Cover Page in these Terms and Conditions. The Cover Page and these Terms and Conditions are collectively referred to as the “Agreement.”

     1. General. The Units are granted to Employee under the Company’s 2003 Incentive Compensation Plan (the “Plan”). A copy of the Plan and information regarding the Plan, including documents that constitute the “Prospectus” for the Plan under the Securities Act of 1933, can be viewed and printed out from the Company’s secure Intranet website, www.corp.jefco.com (go to People Services, then to Plan Documents). All of the applicable terms, conditions and other provisions of the Plan are incorporated by reference herein. Capitalized terms used in this Agreement but not defined herein shall have the same meanings as in the Plan. If there is any conflict between the provisions of this document and mandatory provisions of the Plan, the provisions of the Plan govern, otherwise, the terms of this document shall prevail. By accepting the grant of the Units, Employee agrees to be bound by all of the terms and provisions of the Plan (as presently in effect or later amended), the rules and regulations under the Plan adopted from time to time, and the decisions and determinations of the Company’s Compensation Committee (the “Committee”) made from time to time, provided that no such Plan amendment, rule or regulation or Committee decision or determination shall materially and adversely affect the rights of the Employee with respect to the Units.

     2. Account for Employee. The Company shall maintain a bookkeeping account for Employee (the “Account”) reflecting the number of Units then credited to Employee hereunder as a result of such grant of Units and any crediting of additional Units to Employee pursuant to payments equivalent to dividends paid on Common Stock under Section 5 hereof (“Dividend Equivalents”).

     3. Nontransferability. Until Units are settled in accordance with the terms of this Agreement, Employee may not sell, transfer, assign, pledge, margin or otherwise encumber or dispose of Units or any rights hereunder to any third party other than by will or the laws of descent and distribution, except for transfers to a Beneficiary or as otherwise permitted and subject to the conditions under Section 9.2 of the Plan.

     4. Termination Provisions. The following provisions will govern the vesting and forfeiture of the Units in the event of Employee’s Termination of Employment and/or occurrence of a post-termination Forfeiture Event (as defined below), unless otherwise determined by the Committee (subject to Section 9(a) hereof):

     (a) Death or Disability. In the event of Employee’s death or Termination of Employment due to Disability (as defined below), all Units then outstanding, if not previously vested, will immediately vest, and all Units (if not previously settled) will be settled in accordance with the settlement terms set out on the Cover Page, giving effect to any valid deferral election of Employee then in effect. The foregoing notwithstanding, any distribution resulting from a Disability that does not constitute an “unforeseeable emergency” under Section 409A(a)(2)(B)(ii) of the Internal Revenue Code (the “Code”) or as to which Employee became “Disabled” as defined under Code Section 409A(a)(2)(B)(i) will be subject to the six-month delay rule in Section 8(a)(i), if applicable.

     (b) Retirement. In the event of Employee’s Retirement prior to January 31, 2008, Units not previously forfeited will be immediately forfeited. In the event of Employee’s Retirement after January 31, 2008 and before December 31, 2008, one-half of the Units not

previously forfeited will be immediately forfeited and one-half of the Units not previously forfeited will not then be forfeited; and in the event of Employee’s Retirement after December 31, 2008, Units not previously vested shall not then be forfeited; provided in both cases that Employee executes a settlement agreement and release in such form as may be requested by the Company, but thereafter all unvested Units shall be forfeited if there occurs a Forfeiture Event prior to the Settlement Date. Upon such a Retirement, the then-outstanding Units that are vested at the date of Termination (if not already settled) and that become vested thereafter will be settled in accordance with the settlement terms set out on the Cover Page, giving effect to any valid deferral election of Employee then in effect. A “Forfeiture Event” shall be deemed to occur if, following Employee’s Retirement, Employee renders services for any organization or engages (either as owner, investor, partner, stockholder, employer, employee, consultant, advisor, or director) directly or indirectly, in any business which is or becomes competitive with the Company, its subsidiaries or affiliates. However, following Employee’s Retirement, Employee shall be free to purchase stock or other securities of an organization or business so long as it is listed upon a recognized securities exchange or traded over-the-counter and such investment does not represent a greater than five percent equity interest in the organization or business.

     (c) Involuntary Termination by the Company not for Cause (and not subject to Section 4(d)). In the event of Employee’s Termination of Employment by the Company not for Cause (other than a Termination not for Cause following a Change in Control), Units not previously vested shall not then be forfeited provided that Employee executes a settlement agreement and release in such form as may be requested by the Company, but thereafter all unvested Units shall be forfeited if there occurs a Forfeiture Event prior to the Settlement Date. Upon such a Termination of Employment not for Cause, the then-outstanding Units that are vested at the date of Termination (if not already settled) and that become vested thereafter will be settled in accordance with the settlement terms set out on the Cover Page, giving effect to any valid deferral election of Employee then in effect. A “Forfeiture Event” shall be deemed to occur if, following Employee’s Termination by the Company not for Cause, Employee renders services for any organization or engages (either as owner, investor, partner, stockholder, employer, employee, consultant, advisor, or director) directly or indirectly, in any business which is or becomes competitive with the Company, its subsidiaries or affiliates. However, following Employee’s Termination by the Company not for Cause, Employee shall be free to purchase stock or other securities of an organization or business so long as it is listed upon a recognized securities exchange or traded over-the-counter and such investment does not represent a greater than five percent equity interest in the organization or business.

     (d) Termination Following a Change in Control. If, following a Change in Control, Employee’s employment is terminated not for Cause by the Company or its successor, all of the then-outstanding Units not vested at the date of Termination will immediately vest and will be settled promptly thereafter, subject to the six-month delay rule in Section 8(a)(i), if applicable. If a Change in Control occurs followed by Termination of Employment by the Company not for Cause and a determination is made by the Company pursuant to Sections 280G and 4999 of the Code that a “golden parachute” excise tax will be payable in connection with compensation to Employee hereunder, Employee’s right to accelerated vesting of the Units upon the Change in Control, to the extent such right results in “parachute payments” (as such term is defined in Code Section 280G), shall be limited to the extent just necessary to avoid the excise tax. This limitation shall be applied in a manner that maximizes the number of Units as to which accelerated vesting can apply (or, stated conversely, any limitation on acceleration of vesting shall apply first to those Units with the lengthiest remaining vesting period, which Units would result in the highest “parachute payments”).

     (e) Termination by Employee for any Reason or by the Company for Cause. In the event of a Termination of Employment by the Employee for any reason (other than due to

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Retirement, death or Disability) or by the Company for Cause, the portion of the then-outstanding Units not vested at the date of Termination will be forfeited, and the portion of the then-outstanding Units that is vested at the date of Termination (if not already settled) will be settled on the Settlement Date specified on the Cover Page unless forfeited pursuant to the provisions of Section 7.4 of the Plan, except that any valid deferral election of Employee shall be given effect.

     (f) Certain Definitions. The following definitions apply for purposes of this Agreement, whether or not Employee has an employment agreement or other agreement with the Company, or any of its subsidiaries or affiliates (the Company and any subsidiary or affiliate each being a “Group Entity”) containing the same or similar defined terms:

     (i) “Cause” means Employee’s:

Neglect, failure or refusal to timely perform the duties of Employee’s employment (other than by reason of a physical or mental illness or impairment), or Employee’s gross negligence in the performance of his or her duties;

Material breach of any agreements, covenants and representations made in any employment agreement or other agreement with the Company or any of its subsidiaries or affiliates or violation of internal policies or procedures as are in effect as of the date such action is taken, including but not limited to the Company’s Code of Ethics and Standards of Employee Conduct, as amended from time to time;

Violation of any law, rule, regulation or by-law of any governmental authority (state, federal or foreign), any securities exchange or association or other regulatory or self-regulatory body or agency applicable to Employee, the Company, its subsidiaries or affiliates or any material general policy or directive of the Company, its subsidiaries or affiliates;

Conviction of, or plea of guilty or nolo contendere to, a crime involving moral turpitude, dishonesty, fraud or unethical business conduct, or any felony of any nature whatsoever;

Failure to obtain or maintain any registration, license or other authorization or approval that Employee is required to maintain or that the Company, its subsidiaries or affiliates reasonably believes is required in order for Employee to perform his or her duties, provided, however, that Employee shall be given written notice of any such registration, license or other authorization or approval that he or she is required to obtain and a reasonable period of time to obtain such registration, license, or other authorization or approval; or

Willful failure to execute a directive of the board of directors of the Company or any of its subsidiaries or affiliates, the Executive Committee of any of the Company’s subsidiaries or affiliates, or Employee’s supervisor (unless such directive would result in the commission of an act which is illegal or unethical) or commission of an act against the directive of such Board, such Executive Committee or Employee’s supervisor.

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     (ii) A “Change in Control” shall be deemed to have occurred if any of the following conditions shall have been satisfied after the Grant Date:

Any person (as defined in section 3(a)(9) of the Securities Exchange Act of 1934, as such term is modified in Section 13(d)), other than (i) an employee plan established by the Company or any of its subsidiaries; or (ii) any group of Company employees holding shares subject to agreements relating to the voting of such shares becomes a beneficial owner, directly or indirectly, of more than 51% of the voting stock of the Company;

The consummation of a merger or consolidation of the Company with any other corporation or any other entity, or the issuance of voting securities in connection with a merger or consolidation of the Company, if the holders of the Company’s voting securities immediately prior to such transaction hold in the aggregate less than a majority of the then outstanding voting securities of the Company (or any successor company or entity) entitled to vote generally in the election of the directors of the Company (or such other company or entity) after such transaction;

The sale or disposition by the Company of all or substantially all of its assets in which one person or more than one person acting as a group acquires assets from the Company that have a total gross fair market value equal to more than 50% of the total gross fair market value of all of the assets of the Company immediately prior to such acquisition; or

A change in the composition of the Board of Directors of the Company such that individuals who, as of the date of this agreement, constitute the Board of Directors of the Company (the “Incumbent Board”) cease for any reason to constitute at least a majority of the Board of Directors of the Company; provided, however, that any individual becoming a member of the Board of Directors of the Company subsequent to the date of this agreement whose election, or nomination for election by the shareholders of the Company, was approved by a vote of at least a majority of the directors then constituting the Incumbent Board shall be considered as if that individual were a member of the Incumbent Board.

     (iii) “Disability” means that Employee has commenced receipt of long-term disability benefits under the Company’s long-term disability policy as in effect at the date of Employee’s termination of employment.

     (iv) “Retirement” means retirement after attaining the age at which an Employee’s age plus his years of service equals 62, provided, however, that Employee has provided a minimum of seven and one-half years of service to the Company, its subsidiaries or affiliates. For this purpose, years of service shall be credited for each twelve month period beginning on the date of Employee’s commencement of employment with the Company and on each anniversary thereof during which the Employee was in active employment with the Company.

     (v) “Termination” or “Termination of Employment” means the event by which Employee ceases to be employed by a Group Entity and immediately thereafter is not employed by any other Group Entity.

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     5. Dividend Equivalents and Adjustments.

     (a) Dividend Equivalents. Subject to Section 5(d), Dividend Equivalents will be credited on Units (other than Units that, at the relevant record date, previously have been settled or forfeited) and deemed reinvested in additional Units, to the extent and in the manner as follows:

     (i) Cash Dividends. If the Company declares and pays a dividend or distribution on Shares in the form of cash, then a number of additional Units shall be credited to Employee’s Account as of the last day of the calendar quarter in which such dividend or distribution was paid equal to the number of Units credited to the Account as of the record date for such dividend or distribution multiplied by cash amount of the dividend or distribution paid on each outstanding share of Common Stock at such payment date, divided by the Fair Market Value of a share of Common Stock at the date of such crediting; provided, however, that in the case of an extraordinary cash dividend or distribution the Company may provide for such crediting at the dividend or distribution payment date instead of the last day of the calendar quarter.

     (ii) Non-Common Stock Dividends. If the Company declares and pays a dividend or distribution on Common Stock in the form of property other than shares of Common Stock, then a number of additional Units shall be credited to Employee’s Account as of the payment date for such dividend or distribution equal to the number of Units credited to the Account as of the record date for such dividend or distribution multiplied by the Fair Market Value of such property actually paid as a dividend or distribution on each outstanding share of Common Stock at such payment date, divided by the Fair Market Value of a share of Common Stock at such payment date.

     (iii) Common Stock Dividends and Splits. If the Company declares and pays a dividend or distribution on Common Stock in the form of additional shares of Common Stock, or there occurs a forward split of Common Stock, then a number of additional Units shall be credited to Employee’s Account as of the payment date for such dividend or distribution or forward split equal to the number of Units credited to the Account as of the record date for such dividend or distribution or split multiplied by the number of additional shares of Common Stock actually paid as a dividend or distribution or issued in such split in respect of each outstanding share of Common Stock.

     (b) Adjustments. The number of Units credited to Employee’s Account shall be appropriately adjusted, in order to prevent dilution or enlargement of Employee’s rights with respect to Units or to reflect any changes in the number of outstanding shares of Common Stock resulting from any event referred to in Section 5.3 of the Plan, taking into account any Units credited to Employee in connection with such event under Section 5(a) hereof, and any performance conditions relating to the Units may be likewise adjusted in the discretion of the Committee.

     (c) Risk of Forfeiture and Settlement of Units Resulting from Dividend Equivalents and Adjustments. Units which directly or indirectly result from Dividend Equivalents on or adjustments to a Unit granted hereunder and which do not result from a dividend or distribution on Shares in the form of cash shall be subject to the same risk of forfeiture (including Section 7.4 of the Plan) as applies to the granted Unit and, if not forfeited, will be settled at the same time as the granted Unit. Units which directly or indirectly result from Dividend Equivalents on or adjustments to a Unit granted hereunder and which result from an ordinary dividend or distribution on Shares in the form of cash shall not be subject to forfeiture and will be settled at

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the same time as the granted Unit (or if the granted Unit is forfeited, then at the time the granted Unit would have been settled if it were not forfeited). Units which directly or indirectly result from Dividend Equivalents on or adjustments to a Unit granted hereunder and which result from an extraordinary dividend or distribution on Shares in the form of cash shall, unless otherwise determined by the Company at the time of such extraordinary dividend or distribution, be subject to the same risk of forfeiture (including additional forfeiture terms of Section 7.4 of the Plan) as applies to the granted Unit and, if not forfeited, will be settled at the same time as the granted Unit.

     (d) Changes to Manner of Crediting Dividend Equivalents. The provisions of Section 5(a) notwithstanding, the Company may vary the manner and timing of crediting dividend equivalents for administrative convenience, including, for example, by crediting cash dividend equivalents rather than additional Units.

     6. Additional Forfeiture Provisions. Employee agrees that, by signing this Agreement and accepting the grant of the Units, the forfeiture conditions set forth in Section 7.4 of the Plan shall apply to all Units hereunder and to gains realized upon the settlement of the Units.

     7. Employee Representations and Warranties and Release. As a condition to any non-forfeiture of the Units at or after Termination of Employment and to any settlement of the Units, the Company may require Employee (i) to make any representation or warranty to the Company as may be required under any applicable law or regulation, to make a representation and warranty that no Forfeiture Event has occurred or is contemplated, and that otherwise the requirements of Section 7.4(d) of the Plan and Section 7 above have been met, and (ii) to execute a release of claims against the Company arising before the date of such release, in such form as may be specified by the Company.

     8. Other Terms Relating to Units.

     (a) Deferral of Settlement; Compliance with Code Section 409A. Settlement of any Unit, which otherwise would occur at the Settlement Date, will be deferred in certain cases if and to the extent Employee is permitted to participate in the Stock Option Gain and Stock Award Deferral Program or otherwise permitted to defer the Units and Employee makes a valid deferral election relating to the Units. Deferrals, whether elective or mandatory under the terms of this Agreement, shall comply with requirements under Code Section 409A. Deferrals will be subject to such other restrictions and terms as may be specified by the Company prior to deferral. It is understood that Code Section 409A and regulations thereunder may require any elective deferral to comply with Section 409A(a)(4)(C). Other provisions of this Agreement notwithstanding, under U.S. federal income tax laws and Treasury Regulations (including proposed regulations) as presently in effect or hereafter implemented, (i) a distribution in settlement of Units to Employee triggered by a Termination of Employment will occur only if the Termination constitutes a “separation from service” within the meaning of Code Section 409A(a)(2)(A)(i) and, if at the time of such separation from service Employee is a “specified employee” under Code Section 409A(a)(2)(B)(i) and a delay in distribution is required in order that Employee will not be subject to a tax penalty under Code Section 409A, such distribution in settlement of Units will occur at the date six months after Termination of Employment; and (ii) any rights of Employee or retained authority of the Company with respect to Units hereunder shall be automatically modified and limited to the extent necessary so that Employee will not be deemed to be in constructive receipt of income relating to the Units prior to the distribution and so that Employee shall not be subject to any penalty under Code Section 409A.

     (b) Fractional Units and Shares. The number of Units credited to Employee’s Account shall include fractional Units calculated to at least three decimal places, unless otherwise determined by the Committee. Unless settlement is effected through a broker or agent that can

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accommodate fractional shares (without requiring issuance of a fractional share by the Company), upon settlement of the Units Employee shall be paid, in cash, an amount equal to the value of any fractional share that would have otherwise been deliverable in settlement of such Units.

     (c) Tax Withholding. Employee shall make arrangements satisfactory to the Company, or, in the absence of such arrangements, a Group Entity may deduct from any payment to be made to Employee any amount necessary, to satisfy requirements of federal, state, local, or foreign tax law to withhold taxes or other amounts with respect to the lapse of the risk of forfeiture (including FICA due upon such lapse) or the settlement of the Units. Unless Employee has made separate arrangements satisfactory to the Company, the Company may elect to withhold shares deliverable in settlement of the Units having a fair market value (as determined by the Committee) equal to the amount of such tax liability required to be withheld in connection with the settlement of the Units, but the Company shall not be obligated to withhold such Shares. The Company may specify a reasonable deadline (for example, 90 days before the Settlement Date) by which separate arrangements must be made for payment of withholding taxes other than through withholding of shares.

     (d) Statements. An individual statement of Employee’s Account will be issued to Employee at such times as may be determined by the Company. Such a statement shall reflect the number of Units credited to Employee’s Account, transactions therein during the period covered by the statement, and other information deemed relevant by the Committee. Such a statement may be combined with or include information regarding other plans and compensatory arrangements for employees. Employee’s statements shall be deemed a part of this Agreement, and shall evidence the Company’s obligations in respect of Units, including the number of Units credited as a result of Dividend Equivalents (if any). Any statement containing an error shall not, however, represent a binding obligation to the extent of such error, notwithstanding the inclusion of such statement as part of this Agreement.

     9. Miscellaneous.

     (a) Binding Agreement; Written Amendments. This Agreement shall be binding upon the heirs, executors, administrators, and successors of the parties. This Agreement and the Plan, and any deferral election separately filed with the Company relating to this Award, constitute the entire agreement between the parties with respect to the Units, and supersede any prior agreements or documents with respect thereto. No amendment, alteration, suspension, discontinuation, or termination of this Agreement which may impose any additional obligation upon the Company or materially impair the rights of Employee with respect to the Units shall be valid unless in each instance such amendment, alteration, suspension, discontinuation, or termination is expressed in a written instrument duly executed in the name and on behalf of the Company and, if Employee’s rights are being materially impaired, by Employee.

     (b) No Promise of Employment. The Units and the granting thereof shall not constitute or be evidence of any agreement or understanding, express or implied, that Employee has a right to continue as an officer or employee of the Company for any period of time, or at any particular rate of compensation.

     (c) Unfunded Plan. Any provision for distribution in settlement of Employee’s Account hereunder shall be by means of bookkeeping entries on the books of the Company and shall not create in Employee or any Beneficiary any right to, or claim against any, specific assets of the Company, nor result in the creation of any trust or escrow account for Employee. With respect to any entitlement of Employee or any Beneficiary to any distribution hereunder, Employee or such Beneficiary shall be a general creditor of the Company.

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     (d) Governing Law. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK WITHOUT GIVING EFFECT TO CONFLICTS OF LAWS PRINCIPLES.

     (e) Legal Compliance. Employee agrees to take any action the Company reasonably deems necessary in order to comply with federal and state laws, or the rules and regulations of the New York Stock Exchange, the NASD, or any other stock exchange, or any other obligation of the Company or Employee relating to the Units or this Agreement.

     (f) Notices. Any notice to be given the Company under this Agreement shall be addressed to the Company at 520 Madison Avenue, 12th Floor, New York, NY 10022, attention: Corporate Secretary, and any notice to the Employee shall be addressed to the Employee at Employee’s address as then appearing in the records of the Company.

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EX-31.1

Exhibit 31.1

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

I, Joseph A. Schenk, certify that:

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

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

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

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

a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b)	Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

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

a)	All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b)	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 8, 2006	By:	/s/	Joseph A. Schenk
				Joseph A. Schenk
				Chief Financial Officer

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EX-31.2

Exhibit 31.2

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

I, Richard B. Handler, certify that:

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

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

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

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

a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b)	Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

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

a)	All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b)	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 8, 2006	By:	/s/	Richard B. Handler
				Richard B. Handler
				Chief Executive Officer

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EX-32

Exhibit 32

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

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

(1) The Company’s periodic report on Form 10-Q for the period ended September 30, 2006 (the “Form 10-Q”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

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

* * *

CHIEF EXECUTIVE OFFICER	CHIEF FINANCIAL OFFICER
/s/ Richard B. Handler	/s/ Joseph A. Schenk
Richard B. Handler	Joseph A. Schenk
Date: November 8, 2006	Date: November 8, 2006

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

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