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UNITED STATES

Form 10-K

For the transition period from                 to               

Commission File Number: 1-14947

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

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

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

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

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).     Yes x     No o

      State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. $1,126,017,973 as of June 27, 2003.

      Indicate the number of shares outstanding of the registrant’s class of common stock, as of the latest practicable date. 56,841,601 shares as of the close of business February 24, 2004.

DOCUMENTS INCORPORATED BY REFERENCE

Information from the Registrant’s Definitive Proxy Statement with respect to the 2004 Annual Meeting of Stockholders to be held on May 4, 2004 to be filed with the Commission is incorporated by reference into Part III of this Form 10-K.

LOCATION OF EXHIBIT INDEX

JEFFERIES GROUP, INC.

2003 FORM 10-K ANNUAL REPORT

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Exhibit Index located on page 56 of this report.

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PART I

ITEM 1. BUSINESS.

      Jefferies Group, Inc. and its subsidiaries (the “Company”) operate as a full-service investment bank and institutional securities firm focused on the middle market. The Company offers financial advisory, capital raising, mergers and acquisitions, and restructuring services to small and mid-cap companies and provides trade execution in equity, high yield, convertible and international securities, as well as research and asset management capabilities, to institutional investors. The Company also offers correspondent clearing, prime brokerage, private client services and securities lending services.

      As of December 31, 2003, the Company had 1,626 employees. The Company maintains offices throughout the world and has its executive offices located at 520 Madison Avenue, New York, New York 10022. The telephone number is (212) 284-2550 and its Internet address is www.jefco.com.

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

	•	Code of Ethics and Standards of Employee Conduct;
	•	Board of Directors Corporate Governance Guidelines;
	•	Annual report on Form 10-K;
	•	Quarterly reports on Form 10-Q; and
	•	Current reports on Form 8-K

Jefferies & Company, Inc.

      Jefferies & Company, Inc. (“Jefferies”) was founded in 1962 and is engaged in equity, convertible debt and high yield securities brokerage and trading and investment banking. Jefferies is one of the leading national firms engaged in the distribution and trading of blocks of equity securities both on the national securities exchanges and in the “third market.” The term “third market” refers to transactions in listed equity securities effected away from national securities exchanges. Jefferies’ revenues are derived primarily from commission revenues and market making or trading as principal in equity, high yield, convertible securities, options, futures and international securities with or on behalf of institutional investors, with the balance generated by investment banking and other activities. Jefferies currently provides equity and/or convertible and/or high yield research to its customers in the areas of: Aerospace & Defense; Apparel; Biotechnology; Consumer; Energy; Financial Services; Food Products & Restaurants; Gaming & Leisure; Government & Commercial IT; Healthcare; Home Building; Home Goods Retailing; Industrial; Knowledge Services; Post-Reorganization; Printing, Packaging & Printing-Related Industries; Maritime/ Shipping; Media & Entertainment; Retail; Specialty Retail; Special Situations; Technology; Transportation and Telecommunications.

Jefferies International Limited

      Jefferies International Limited (“JIL”) was incorporated in 1986 in England. JIL is a member of The International Stock Exchange and The Securities and Futures Authority. JIL introduces customers trading in U.S. securities to Jefferies and also trades as a broker-dealer in international equity and convertible securities and American Depositary Receipts (“ADRs”). In 1995, JIL formed a wholly owned Swiss subsidiary, Jefferies (Switzerland) Ltd. In 1996, JIL formed a wholly owned English subsidiary, Jefferies (Japan) Limited, which maintains a branch office in Tokyo.

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Helfant Group, Inc.

      Helfant Group, Inc. (“Helfant”) has been a member of the NYSE since 1927. Providing agency-only execution services to institutional investors, Helfant offers electronic and floor trading capabilities for stocks and options listed on the NYSE, AMEX, and all other major U.S. exchanges, as well as OTC. In September 2001, the Company acquired Lawrence Helfant, Inc. and Lawrence Helfant LLC and in January 2002, the Company merged Lawrence Helfant, Inc. and Lawrence Helfant LLC into W & D Securities, Inc. and changed its name to Helfant Group, Inc.

Quarterdeck Investment Partners, LLC

      The Company acquired Quarterdeck Investment Partners, LLC (“Quarterdeck”) in December 2002. Quarterdeck is an investment banking firm specializing in mergers and acquisitions in the global aerospace, defense, and federal information technology industries.

Broadview International LLC

      The Company acquired Broadview International LLC (“Broadview”) in December 2003. Broadview is an investment banking firm specializing in mergers and acquisitions in the information, communications and healthcare technology industries.

Bonds Direct Securities LLC

      Bonds Direct Securities LLC (“Bonds Direct”) provides investment grade fixed income transaction execution for institutions acting as principal, through a combination of professional sales and trading coverage, and a technology platform that enables true on-line real-time trading. Bonds Direct was formed in February 2001 and is a majority-owned subsidiary of the Company.

Separation of Investment Technology Group, Inc. from Jefferies Group, Inc.

      The Company was originally incorporated in 1998 as a holding company under the name JEF Holding Company, Inc. At the time of its incorporation, JEF Holding Company, Inc. was a wholly owned subsidiary of a predecessor company also named Jefferies Group, Inc. (“Old Group”). On April 20, 1999, the stockholders of Old Group approved and adopted the Agreement and Plan of Merger (the “Merger Agreement”) between Old Group and Old Group’s approximately 80.5% owned subsidiary, Investment Technology Group, Inc. (“ITGI”).

      On April 27, 1999, Old Group and ITGI consummated the transactions (the “Transactions”) that resulted in the separation of ITGI from the other Old Group businesses. On April 22, 1999, Old Group transferred all non-ITGI assets and liabilities to JEF Holding Company, Inc., a holding company. Old Group then distributed all of the common stock of JEF Holding Company, Inc. to Old Group stockholders through a tax-free spin-off. After the transfers, Old Group’s 15 million shares of ITGI became its only asset. The spin-off was immediately followed by a tax-free merger of ITGI with and into Old Group. Following the merger, Old Group was renamed Investment Technology Group, Inc. and JEF Holding Company, Inc. was renamed Jefferies Group, Inc., the Registrant in this annual report.

      The Transactions were treated for financial reporting purposes as if Old Group had spun-off its entire 80.5% stake in ITGI to Old Group stockholders. Accordingly, since the results of ITGI were previously consolidated with Old Group, all financial information for the periods prior to April 27, 1999 have been restated to reflect the results of ITGI as a discontinued operation. The net assets of ITGI have been segregated for prior periods from the other assets and liabilities of Old Group. For financial reporting purposes, the net assets of ITGI as of April 27, 1999 have been treated as a distribution to Old Group stockholders.

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Commission Business

      A substantial portion of the Company’s revenues is derived from customer commissions on brokerage transactions in equity and debt securities for domestic and international investors such as investment advisors, banks, mutual funds, insurance companies, hedge funds, and pension and profit sharing plans. These investors normally purchase and sell securities in block transactions, the execution of which requires special marketing and trading expertise. Jefferies is one of the leading national firms in the execution of equity block transactions, and believes that its institutional customers are attracted by the quality of its execution (with respect to considerations of quantity, timing and price) and its competitive commission rates, which are negotiated on the basis of market conditions, the size of the particular transaction and other factors. In addition to domestic equity securities, Jefferies executes transactions in high yield securities, domestic and international convertible securities, international equity securities, ADRs, options, preferred stocks, financial futures and other similar products. Jefferies’ Private Client Services group focuses on transactions with retail customers, including high net worth clients, which typically involve a greater risk of litigation than would normally be assumed in Jefferies’ traditional institutional activities.

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

Principal Transactions

      In the regular course of its business, Jefferies takes securities positions as a market maker to facilitate customer transactions and for investment purposes. In making markets and when trading for its own account, Jefferies exposes its own capital to the risk of fluctuations in market value. Trading profits (or losses) depend primarily upon the skills of the employees engaged in market making and position taking, the amount of capital allocated to positions in securities and the general trend of prices in the securities markets.

      Jefferies monitors its risk by maintaining its securities positions at or below certain pre-established levels. These levels reduce certain opportunities to realize profits in the event that the value of such securities increases. However, they also reduce the risk of loss in the event of a decrease in such value and result in controlled interest costs incurred on funds provided to maintain such positions.

      Equities. The Equities Division of Jefferies makes markets in over 4,000 over-the-counter equity securities, OTC Bulletin Board securities, pink sheet securities and ADRs, and trades securities for its own account, as well as to facilitate customer transactions. Included in principal transactions are commission-equivalents charged on certain principal trades for Nasdaq securities. During 2002, Jefferies hired a group of traders who specialize in trading OTC Bulletin Board and pink sheet securities. These securities are typically more illiquid, have smaller capitalizations and may involve more risk than Nasdaq traded securities.

      High Yield. The High Yield Division of Jefferies principally trades non-investment grade public and private debt securities, as well as distressed securities and bank debt. The Division specializes in trading and making markets in over 1,000 unrated or less than investment grade corporate debt securities and accounts for these positions at market value. At December 31, 2003, the aggregate long and short market value of these positions was $205.4 million and $34.2 million, respectively. Risk of loss upon default by the borrower is significantly greater with respect to unrated or less than investment grade corporate debt securities than with other corporate debt securities. These securities are generally unsecured and are often subordinated to other creditors of the issuer. These issuers usually have high levels of indebtedness and are more sensitive to adverse economic conditions, such as recession or increasing interest rates, than are investment grade issuers. There is a limited market for some of these securities and market quotes are available only from a small number of dealers.

      Three funds managed by Jefferies invest on a pari passu basis in all trading and investment activities (with limited exceptions) undertaken by the High Yield Division. Two of these funds, the Jefferies Partners

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      Convertible Securities. Jefferies trades domestic and international convertible securities and assists corporate and institutional clients in identifying attractive investments in these securities.

      Other Proprietary Trading. The Company trades investment grade corporate bonds, U.S. treasury securities, and U.S. government agency securities through its Bonds Direct Securities LLC (“Bonds Direct”) subsidiary. The Company also engages in structured trading within its securities lending activities, engages in exchange traded commodities futures transactions, and has investments in partnerships, hedge funds, and mutual funds as well as other relationships with independent management firms, which contribute to revenues from principal transactions.

Investment Banking

      Jefferies’ Investment Banking Division offers corporations (primarily middle-market growth companies) a full range of financial advisory services as well as debt, equity, and convertible financing services. Services include acquisition financing, bridge and senior loan financing, private placements and public offerings of debt and equity securities, debt refinancings, restructuring, merger and acquisition and exclusive sales advice, structured financings and securitizations, consent and waiver solicitations, and company and bondholder representations in corporate restructurings. Investment banking activity involves both economic and regulatory risks. An underwriter may incur losses if it is unable to sell the securities it is committed to purchase or if it is forced to liquidate its commitments at less than the agreed upon purchase price. In addition, under the federal securities laws and other laws and court decisions with respect to underwriters’ liability and limitations on indemnification of underwriters by issuers, an underwriter is subject to substantial potential liability for material misstatements or omissions in prospectuses and other communications with respect to underwritten offerings. Further, underwriting commitments constitute a charge against net capital and Jefferies’ underwriting commitments may be limited by the requirement that it must, at all times, be in compliance with the Uniform Net Capital Rule 15c3-1 of the Securities and Exchange Commission (the “Commission”).

      Jefferies intends to continue to pursue opportunities for its corporate customers, which may require it to finance and/or underwrite the issuance of securities. Under circumstances where Jefferies is required to act as an underwriter or to take a position in the securities of its customers, Jefferies may assume greater risk than would normally be assumed in its normal trading activity.

Interest

      Jefferies derives a substantial portion of its interest revenues, and incurs a substantial portion of its interest expenses, in connection with its securities borrowed/ securities loaned activity. Jefferies also earns

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      Securities Borrowed/ Securities Loaned. In connection with both its trading and brokerage activities, Jefferies borrows securities to cover short sales and to complete transactions in which customers have failed to deliver securities by the required settlement date, and lends securities to other brokers and dealers for similar purposes. Jefferies has an active securities borrowed and lending matched book business (“Matched Book”), in which Jefferies borrows securities from one party and lends them to another party. When Jefferies borrows securities, Jefferies provides cash to the lender as collateral, which is reflected in the Company’s financial statements as receivable from brokers and dealers. Jefferies earns interest revenues on this cash collateral. Similarly, when Jefferies lends securities to another party, that party provides cash to Jefferies as collateral, which is reflected in the Company’s financial statements as payable to brokers and dealers. Jefferies pays interest expense on the cash collateral received from the party borrowing the securities. A substantial portion of Jefferies’ 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. Jefferies monitors the fair value of the securities borrowed and loaned on a daily basis and requests additional collateral or returns excess collateral, as appropriate.

      Margin Lending. Customers’ transactions are executed on either a cash or margin basis. In a margin transaction, Jefferies extends credit to the customer, collateralized by securities and cash in the customer’s account, for a portion of the purchase price, and receives income from interest charged on such extensions of credit.

      In permitting a customer to purchase securities on margin, Jefferies is subject to the risk that a market decline could reduce the value of its collateral below the amount of the customer’s indebtedness and that the customer might otherwise be unable to repay the indebtedness.

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

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

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

Asset Management

      The Company receives asset management fees in connection with management and investment advisory services the Company performs for various domestic and international funds and managed accounts. These

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Competition

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

Regulation

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

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

      As registered broker-dealers, Jefferies, Helfant Group and Bonds Direct are required by law to belong to the Securities Investor Protection Corporation (“SIPC”). In the event of a member’s insolvency, the SIPC fund provides protection for customer accounts up to $500,000 per customer, with a limitation of $100,000 on claims for cash balances. Jefferies carries an excess policy that provides additional protection for securities of up to $9.5 million per customer with an aggregate limit of $100 million.

      Net Capital Requirements. Every U.S. registered broker-dealer doing business with the public is subject to the Commission’s Uniform Net Capital Rule (the “Rule”), which specifies minimum net capital requirements. Jefferies Group, Inc. is not a registered broker-dealer and is therefore not subject to the Rule; however, its United States broker-dealer subsidiaries are registered and are subject to the Rule.

      The Rule provides that a broker-dealer doing business with the public shall not permit its aggregate indebtedness to exceed 15 times its adjusted net capital (the “basic method”) or, alternatively, that it not permit its adjusted net capital to be less than 2% of its aggregate debit balances (primarily receivables from

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

      As of December 31, 2003, Jefferies’, Helfant’s and Bonds Direct’s net capital and excess net capital were as follows (in thousands of dollars):

Risk Management

      As an international investment bank and securities firm, risk is an inherent part of the Company’s business. Global markets, by their nature, are prone to uncertainty and subject participants to a variety of risks. The Company has developed policies and procedures to identify, measure and monitor the risks involved in its trading, brokerage and investment banking activities on an international basis. The Company devotes significant resources to the measurement, management and analysis of risk, including investments in personnel, information technology infrastructure and systems. Since 1997, the Company has retained the services of Ernst & Young LLP (“E&Y”) to perform internal audit procedures on an outsource basis for the benefit of the Company’s management and Audit Committee. In this capacity, E&Y coordinates the scope and results of internal audit procedures with the Company’s management and Audit Committee. The Company’s independent auditors, KPMG LLP, consider the internal audit work performed by E&Y, among other things, in determining the scope of the annual audit of the Company’s consolidated financial statements.

ITEM 2. PROPERTIES.

      The Company maintains offices throughout the world including New York, Atlanta, Boston, Chicago, Dallas, Hong Kong, Houston, Jersey City, London, Los Angeles, Nashville, New Orleans, Philadelphia, Richmond, Silicon Valley, Paris, San Francisco, Short Hills, Stamford, Tokyo, Washington, D.C. and Zurich. In addition, the Company maintains back-up facilities with redundant technologies in Dallas. The Company leases all of its office space which management believes is adequate for its business. For information concerning leasehold improvements and rental expense, see notes 1, 5 and 11 of Notes to Consolidated Financial Statements.

ITEM 3. LEGAL PROCEEDINGS.

      Many aspects of the Company’s business involve substantial risks of liability. In the normal course of business, the Company and its subsidiaries have been named as defendants or co-defendants in lawsuits involving primarily claims for damages. The Company’s management believes that pending litigation should not have a material adverse effect on the Company.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

      None.

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PART II

      The Company’s Common Stock trades on the NYSE under the symbol JEF. The following table sets forth for the periods indicated the range of high and low prices per share for the Common Stock as reported by the NYSE.

      On July 14, 2003, the Company declared a 2-for-1 split of all outstanding shares of common stock, payable August 15, 2003 to stockholders of record as of July 31, 2003. The stock split was effected as a stock dividend of one share for each one share outstanding on the record date. All share, share price and per share information has been restated to retroactively reflect the effect of the two-for-one stock split.

      There were approximately 538 holders of record of the Company’s Common Stock at February 25, 2004.

      In 1988, the Company instituted a policy of paying regular quarterly cash dividends. There are no restrictions on the Company’s present ability to pay dividends on Common Stock, other than the applicable provisions of the Delaware General Corporation Law.

      During 2003, the Company increased its quarterly dividend to $0.08 per share.

      Dividends per Common Share (declared and paid):

      During December 2003, the Company issued 557,711 shares of restricted common stock to Broadview Holdings LLP in connection with and as partial consideration for the Company’s acquisition of Broadview International, LLC. The securities were issued in a transaction not involving a public offering and were exempt from registration pursuant to Section 4(2) of the Securities Act of 1933.

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ITEM 6. SELECTED FINANCIAL DATA.

      The selected data presented below as of and for each of the years in the five-year period ended December 31, 2003, are derived from the consolidated financial statements of Jefferies Group, Inc. and its subsidiaries, which financial statements have been audited by KPMG LLP, the Company’s independent auditors. The data should be read in connection with the consolidated financial statements including the related notes contained on pages 23 through 54. On July 14, 2003, the Company declared a 2-for-1 split of all outstanding shares of common stock, payable August 15, 2003 to stockholders of record as of July 31, 2003. The stock split was effected as a stock dividend of one share for each one share outstanding on the record date. All share, share price and per share information has been restated to retroactively reflect the effect of the two-for-one stock split. Certain reclassifications have been made to the prior period amounts to conform to the current period’s presentation.

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

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      There are included or incorporated by reference in this report statements that may constitute “forward-looking statements” within the meaning of the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements include statements about the Company’s 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, whether in the negative or affirmative. 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 the Company’s strategies for future development of its business and products. Forward-looking statements represent only the Company’s belief regarding future events, many of which, by their nature, are inherently uncertain and outside of the Company’s control. It is possible that the actual results may differ, possibly materially, from the anticipated results indicated in these forward-looking statements. Information regarding important factors that could cause actual results to differ, perhaps materially, from those in our forward-looking statements is contained in this report, particularly under the headings “Business” and “Factors Affecting the Company’s Business,” and in documents incorporated by reference in this report. The Company does not assume any obligation to update any forward-looking statement it makes.

Overview

      The Company operates as a full-service investment bank and institutional securities firm focused on the middle market. The Company offers financial advisory, capital raising, mergers and acquisitions, and restructuring services to small and mid-cap companies and provides trade execution in equity, high yield, convertible and international securities, as well as research and asset management capabilities, to institutional investors. The Company also offers correspondent clearing, prime brokerage, private client services and securities lending services.

      The Company believes that its middle market niche is largely under-served by its competitors. The Company actively looks to enhance its middle market position by continued leveraging of its internal resources and through acquisitions and strategic partnering. In 2003, the Company began the development of a broadly based asset management infrastructure which will support the development of various investment strategies including those focused on long-short equity, real assets, fixed income and foreign exchange through a variety of pooled investment vehicles. The Company expects to support and make investments in these various vehicles. Furthermore, the addition of Quarterdeck in 2002, with its specialization in mergers and acquisitions in the global aerospace, defense, and federal information technology industries and the addition of Broadview in 2003, with its specialization in mergers and acquisitions in the information, communications and healthcare technology industries represent additional important continuations of the Company’s strategy to create the leading investment bank serving middle-market companies and their investors.

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 will inevitably differ from estimates. These differences could be material to the financial statements.

      The Company believes its application of accounting policies and the estimates required therein are reasonable. These accounting policies and estimates are constantly reevaluated, and adjustments are made when facts and circumstances dictate a change. Historically, the Company has found its application of accounting policies to be appropriate, and actual results have not differed materially from those determined using necessary estimates.

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      Management believes its 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 its valuation methodologies applied to investments and to securities positions.

      Investments are stated at estimated fair value as determined in good faith by management. Generally, the Company initially values these investments at cost and requires that changes in value be established by meaningful third-party transactions or a significant change in the financial condition or operating performance of the issuer, unless meaningful developments occur that otherwise warrant a change in the valuation of an investment. 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 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. The Company believes that its 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.

Analysis of Financial Condition

      Total assets increased $4,093.6 million from $6,898.7 million at December 31, 2002 to $10,992.3 million at December 31, 2003. The increase in total assets mostly relates to net increases of $3,249.0 million in securities borrowed and $501.4 million in securities pledged. Total investments increased $94.5 million from $334.4 million at December 31, 2002 to $428.9 million at December 31, 2003. The increase in investments mostly relates to approximately $78.9 million of investments in managed funds and fund managers related to the Company’s expansion of its asset management business. The Company expects to continue to devote capital to these types of strategic investments as it expands its asset management business.

      Total liabilities increased $3,883.7 million from $6,270.2 million at December 31, 2002 to $10,153.9 million at December 31, 2003. The increase in total liabilities mostly relates to net increases of $3,347.6 million in securities loaned and $433.9 million in securities sold, not yet purchased.

      The increase in securities borrowed and securities loaned is mostly related to the Company’s Matched Book business. See “Business — Interest.”

      Net stockholders’ equity increased $209.9 million from $628.5 million at December 31, 2002 to $838.4 million at December 31, 2003. The increase was due to net common stock activity of $135.9 million, including $37.9 million related to the reclassification of prior years’ stock portion of deferred compensation plan deferrals, net earnings of $84.1 million, and other comprehensive income of $1.7 million, partially offset by cash dividends of $11.8 million.

Revenues by Source

      The earnings of the Company are subject to wide fluctuations since many factors over which the Company has little or no control, particularly the overall volume of trading and the volatility and general level of market prices, may significantly affect its operations. The following provides a summary of revenues by source for the past three years.

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2003 Compared to 2002

      Revenues, net of interest expense, were up $154.9 million, or 23%, to $829.6 million, compared to $674.7 million for 2002. The increase was due primarily to a $62.7 million, or 12%, increase in trading revenues (commissions and principal transactions), a $89.8 million, or 64%, increase in investment banking, a $5.2 million, or 44%, increase in asset management, and a $3.8 million, or 58%, increase in other revenues, partially offset by a $6.6 million decrease in net interest income (interest revenues less interest expense). Principal transaction revenues include our proportionate share of the results of the High Yield Funds, which are described under “Business — Principal Transactions — High Yield.” For 2003, our share of these funds accounted for $9.8 million of revenues, up from $7.2 million for 2002. Trading revenues increased mostly due to other proprietary, Bonds Direct, International and High Yield, partially offset by reduced execution revenues. Investment banking revenues increased partly due to various high yield and related financings and advisory fees, including mergers and acquisition and restructuring. During 2003, the Company participated in 44 public and private debt financings, managed or co-managed 44 public and private equity financings. The advisory and restructuring business was strong as the Company worked on many different assignments. During 2002, the Company participated in 20 public and private debt financings, managed or co-managed 25 public and private equity financings. Asset management revenues increased primarily related to an international fund. Asset management revenues include management fees and a 20% “carried” interest from the Jefferies Partners Opportunity funds and management fees and/or incentive fees for certain other funds. Other revenues increase was substantially due to proceeds from a business interruption insurance settlement. Net interest income was down largely due to decreased interest income on proprietary securities positions.

      Total non-interest expenses were up $114.1 million, or 20%, to $685.1 million, compared to $571.0 million for 2002. Compensation and benefits increased $89.1 million, or 23%, in line with the increase in revenues. The Company’s compensation/ net revenues ratio was approximately 57% for both 2003 and 2002. This was possible even with increased headcount, due to the variable nature of the Company’s compensation structure. Compensation and benefits is net of amounts reimbursed to Jefferies by the High Yield Funds. Floor brokerage and clearing fees decreased $6.5 million, or 12%, primarily due to increased trade volumes internally executed by Helfant. Other expenses increased $15.2 million, or 52%, mostly due to higher litigation, legal and business insurance costs. With more employees, more transactions, and more businesses, the Company does

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      Earnings before income taxes and minority interest were up 39% to $144.5 million, compared to $103.7 million for 2002. The effective tax rate was approximately 37% for 2003 compared to 40% for 2002. The decrease in the tax rate was partially due to reductions in the effective state tax rates and partially due to the effect of increased minority interests in limited liability subsidiaries, which are not subject to tax. Net earnings were up $21.5 million, or 34%, to $84.1 million, compared to $62.6 million for 2002.

      Minority interest (approximately 41% of the earnings of Bonds Direct, 40% of the earnings of RTS, 72% of JEOF, and 50% of the earnings of ACM) was $7.6 million for 2003. The increase in minority interest expense was due to earnings in Bonds Direct, RTS, JEOF, and ACM.

      Basic net earnings per share were $1.58 in 2003 on 53.1 million shares compared to $1.27 in 2002 on 49.2 million shares. Diluted net earnings per share were $1.42 in 2003 on 59.3 million shares compared to $1.14 in 2002 on 55.0 million shares.

2002 Compared to 2001

      Revenues, net of interest expense, increased $4.4 million, or 1%, in 2002 as compared to 2001. The increase was due primarily to a $15.7 million, or 13%, increase in investment banking revenues, partially offset by a $5.7 million, or 32%, decrease in asset management revenues, a $3.3 million, or 1%, decrease in trading revenues (commissions and principal transactions) and a $4.8 million, or 28%, decrease in net interest income (interest revenues less interest expense). Principal transaction revenues include the Company’s proportionate share of the results of the High Yield Funds, which are described under “Business — Principal Transactions — High Yield”. For 2002, the Company’s share of these funds accounted for $7.2 million of revenues, down from $10.2 million for 2001. Trading revenues decreased mostly due to the High Yield Division. Investment banking revenues increased due mostly to an increase in advisory fees. Net interest income was down largely due to decreased interest rates and a reduction in the spread on the securities borrowed and loaned matched book business. Asset management revenues decreased due to the decrease in revenue attributable to the High Yield Funds, which contributed $8.9 million for 2002, down from $14.8 million for 2001. Asset management revenues include management fees and a 20% “carried” interest from the Jefferies Partners Opportunity funds (Jefferies Employees Opportunity Fund does not have a 20% “carried” interest), and management fees for certain other funds.

      Total non-interest expenses increased slightly in 2002 as compared to 2001. Compensation and benefits decreased $14.6 million, or 4%. The Company was able to reduce its compensation/ net revenues ratio to approximately 57% from approximately 60% in 2001. This was possible even with the increased headcount, due to the variable nature of the Company’s compensation plans and a reduction in the management bonuses and a voluntary reduction in executive officer bonuses payable under the plan previously approved by the Compensation Committee of the Board of Directors. Compensation and benefits is net of amounts reimbursed to Jefferies by the High Yield Funds. Technology and communications increased $7.6 million, or 17%, mostly due to the addition of Helfant and negotiated refunds in the 2001 period. Floor brokerage and clearing fees increased $7.2 million, or 15%, primarily due to additional volume related to Helfant. Occupancy and equipment rental increased $3.2 million, or 14%, mostly due to office expansion. Other expense decreased $1.8 million, or 6%, primarily due to a decrease in charitable contributions, because of special contributions in 2001 related to the September 11 incident. Business development expenses increased $1.6 million, or 8%, largely due to increased advertising and promotion.

      As a result of the above, earnings before income taxes increased $1.0 million, or 1%. The effective tax rate was approximately 40% in 2002 and approximately 42% in 2001. The mix of business (geographically and by

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      Basic net earnings per share were $1.27 in 2002 on 49.2 million shares compared to $1.21 in 2001 on 49.2 million shares. Diluted earnings per share were $1.14 in 2002 on 55.0 million shares compared to $1.14 in 2001 on 52.3 million shares.

Liquidity and Capital Resources

      A substantial portion of the Company’s assets is liquid, consisting of cash or assets readily convertible into cash. The majority of securities positions (both long and short) in the Company’s trading accounts are readily marketable and actively traded. Receivables from brokers and dealers are primarily current open transactions or securities borrowed transactions, which can be settled or closed out within a few days. Receivables from customers include margin balances and amounts due on uncompleted transactions. Most of the Company’s receivables are secured by marketable securities.

      The Company’s assets are funded by equity capital, senior debt, subordinated 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. The Company has arrangements with banks for unsecured financing of $255 million. Secured bank loans are collateralized by a combination of customer, non-customer and firm securities. The Company has always been able to obtain necessary short-term borrowings in the past and believes that it will continue to be able to do so in the future. Additionally, the Company has $20.0 million in letters of credit outstanding, which are used in the normal course of business mostly to satisfy various collateral requirements in lieu of depositing cash or securities.

      Jefferies, Helfant and Bonds Direct 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, Helfant and Bonds Direct have consistently operated in excess of the minimum requirements (“excess net capital”). Jefferies, Helfant and Bonds Direct use the alternative method of calculation. As of December 31, 2003, Jefferies’, Helfant’s and Bonds Direct’s net capital and excess net capital were as follows (in thousands of dollars):

      During 2003, the Company purchased 274,330 shares of its common stock for $6.6 million, at prices ranging from $16.69 to $32.76 per share. During 2002, the Company purchased 2,990,688 shares of common stock for $59.1 million, at prices ranging from $16.50 to $24.28 per share. The Company typically repurchases its own common stock in open market transactions in accordance with Rule 10b-18 and on occasion, in transactions directly with stockholders. These repurchases are generally to cover future common stock commitments under the Company’s various stock based compensation and incentive plans. The Company believes that it has sufficient liquidity and capital resources to make these repurchases without any material adverse effect on the Company.

      During 2003, approximately $3.6 million in zero coupon unsecured Euro denominated convertible loan notes were converted into 219,472 shares of the Company’s common stock. The conversion price for the notes was approximately 14.40 Euros (as of August 4, 2003, this was equivalent to approximately $16.36).

      During 2002, the Company issued $325.0 million aggregate principal amount of 7 3/4% senior notes due March 15, 2012 and retired $50.0 million aggregate principal amount of 8 7/8% senior notes due 2004.

      In the normal course of business, the Company had letters of credit outstanding aggregating $20.0 million at December 31, 2003, mostly to satisfy various collateral requirements in lieu of depositing cash or securities. These letters of credit have a current carrying amount of aggregate liability of $0.

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      At December 31, 2003, the Company had outstanding guarantees of $26.0 million relating to undrawn bank credit obligations of two associated investment funds in which the Company has an interest. Also, the Company has guaranteed collateralized obligations of Jefferies International Limited (“JIL”) to various banks which provide clearing and credit services to JIL and to counterparties of JIL in JIL’s securities borrowed business. These guarantees on behalf of JIL amounted to over $600 million as of December 31, 2003. In addition, as of December 31, 2003, the Company had commitments to invest up to $15.0 million in various investments. Additionally, in February of 2004, the Company committed to invest approximately $40 million in a new fund to be managed by the Company.

      The table below provides information about the Company’s commitments related to debt obligations, interest rate swaps, leases, guarantees, letters of credit and investments as of December 31, 2003. For debt obligations, leases and investments, the table presents principal cash flows with expected maturity dates. For interest rate swaps, guarantees and letters of credit, the table presents notional amounts with expected maturity dates.

Off Balance Sheet Arrangements

      At December 31, 2003, the Company had outstanding guarantees of $26.0 million relating to undrawn bank credit obligations of two associated investment funds in which the Company has an interest. The Company does not believe that these guarantees are reasonably likely to have any material effect on the Company.

Effects of Changes in Foreign Currency Rates

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

Effects of Inflation

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

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Risk Management

      Risk is an inherent part of the Company’s business and activities. The extent to which the Company properly and effectively identifies, assesses, monitors and manages each of the various types of risk involved in its activities is critical to the Company’s soundness and profitability. The Company seeks to identify, assess, monitor and manage the following principal risks involved in its business activities: market, credit, operational and legal. Risk management at the Company is a multi-faceted process that requires communication, judgment and knowledge of financial products and markets. Senior management takes an active role in the risk management process and requires specific administrative and business functions to assist in the identification, assessment and control of various risks. The Company’s risk management policies, procedures and methodologies are fluid in nature and are subject to ongoing review and modification.

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

      Credit Risk. Credit risk represents the loss that the Company would incur if a client, counterparty or issuer of securities or other instruments held by the Company fails to perform its contractual obligations. The Company follows industry practice to reduce credit risk related to various investing and financing activities by obtaining and maintaining collateral. The Company adjusts margin requirements if it believes the risk exposure is not appropriate based on market conditions.

      Operational Risk. Operational risk generally refers to the risk of loss resulting from the Company’s operations, including, but not limited to, improper or unauthorized execution and processing of transactions, deficiencies in its operating systems, business disruptions and inadequacies or breaches in its internal control processes. The Company operates in diverse markets and it is reliant on the ability of its employees and systems to process high numbers of transactions often within short time frames. In the event of a breakdown or improper operation of systems, human error or improper action by employees, the Company could suffer financial loss, regulatory sanctions or damage to its reputation. In order to mitigate and control operational risk, the Company has developed and continues to enhance policies and procedures that are designed to identify and manage operational risk at appropriate levels. September 11 heightened the need for comprehensive disaster recovery plans. Disaster recovery plans exist for the Company’s critical systems, and redundancies are built into the systems as deemed appropriate. The Company believes that its disaster recovery program, including off-site back-up technology and operational facilities, is adequate to handle a reasonable business disruption. However, there can be no assurances that a disaster directly affecting the Company’s headquarters or its operations center would not have a material adverse impact. Insurance and other safeguards might only partially reimburse the Company for its losses. The Company also uses periodic self-assessments, internal audit reviews and independent consultants as a further check on operational risk and exposure.

      Legal Risk. Legal risk includes the risk of non-compliance with applicable legal and regulatory requirements. The Company is subject to extensive regulation in the different jurisdictions in which it conducts its business. The Company has various procedures addressing issues such as regulatory capital requirements, sales and trading practices, use of and safekeeping of customer funds, credit granting, collection activities, anti money-laundering and record keeping.

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Recent Accounting Developments

      New Amendment of FASB Statement No. 123 on Stock Based Compensation. Financial Accounting Standards Board (“FASB”) No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure — an amendment of FASB Statement No. 123”, amends FASB No. 123, “Accounting for Stock-Based Compensation”, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of FASB No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. On February 5, 2003, the Company announced that it would adopt the fair-value-based method of recording stock-based compensation contained in FASB No. 123, “Accounting for Stock-Based Compensation”. The Company implemented this statement in the first quarter of 2003. For more information concerning stock-based compensation, see note 1 of Notes to Consolidated Financial Statements.

      New Accounting Standards on Derivative Instruments and Hedging Activities. FASB No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities”, amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB No. 133, “Accounting for Derivative Instruments and Hedging Activities”. This Statement is generally effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. The implementation of this statement did not have a material impact on the Company.

      New Accounting Standards for Certain Financial Instruments with Characteristics of both Liabilities and Equity. FASB No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity,” establishes standards for classifying and measuring certain financial instruments with characteristics of both liabilities and equity. FASB No. 150 also includes required disclosures for financial instruments within its scope. FASB No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective as of January 1, 2004, except for mandatorily redeemable financial instruments. For certain mandatorily redeemable financial instruments, FASB No. 150 will be effective on January 1, 2005. The effective date has been deferred indefinitely for certain other types of mandatorily redeemable financial instruments. The adoption of FASB No. 150 did not have a material impact on the consolidated financial statements.

      New Accounting Standards and Disclosures on Guarantees. FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others, an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34,” elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued. The Interpretation also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and measurement provisions of the Interpretation are applicable to guarantees issued or modified after December 31, 2002. The disclosure requirements were effective for financial statements of interim and annual periods ending after December 31, 2002. The adoption of FASB Interpretation No. 45 did not have a material impact on the consolidated financial statements.

      New Accounting Standards on Energy Contracts. In November 2002, the Emerging Issues Task Force (“EITF”) reached a consensus on 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.” EITF Issue No. 02-3 precludes mark-to-market accounting for energy-trading contracts that are not derivatives pursuant to SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” The Company has adopted the provisions of EITF Issue No. 02-3 related to energy-trading contracts as of the beginning of 2003, and the effect of adoption was not material to the Company’s financial condition, results of operations or cash flows. EITF Issue No. 02-3 also communicates the FASB staff’s view that the transaction price for a derivative contract is the best information available with which to estimate fair value at the inception of a contract when the estimate is not based on other observable market data. The application of the

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      New Accounting Standards on Consolidations. In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities”, which addresses how a business enterprise should evaluate whether it has a controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46, “Consolidation of Variable Interest Entities”, which was issued in January 2003. The Company will be required to apply FIN 46R to variable interests in variable interest entities (“VIEs”) created after December 31, 2003. For variable interests in VIEs created before January 1, 2004, the Interpretation will be applied beginning on January 1, 2005.

      For any VIEs that must be consolidated under FIN 46R that were created before January 1, 2004, the assets, liabilities and noncontrolling interests of the VIE initially would be measured at their carrying amounts with any difference between the net amount added to the balance sheet and any previously recognized interest being recognized as the cumulative effect of an accounting change. If determining the carrying amounts is not practicable, fair value at the date FIN 46R first applies may be used to measure the assets, liabilities and noncontrolling interest of the VIE. The Company is evaluating the impact of applying FIN 46R to existing VIEs in which it has variable interests and has not yet completed this analysis. As the Company continues to evaluate the impact of applying FIN 46R, additional entities may be identified that would need to be consolidated by the Company.

      FASB Interpretation No. 46, “Consolidation of Variable Interest Entities”, addressed the consolidation by companies of variable interest entities as defined in the Interpretation. A company is required to consolidate a variable interest entity if that company is the “primary beneficiary” as defined by the Interpretation. For purposes of determining whether it is the primary beneficiary, a company is required to treat variable interests in the variable interest entity held by its related parties as its own interests. The Company together with its employees (related parties) is the primary beneficiary of Jefferies Employees Opportunity Fund (“JEOF”), one of the three high yield funds that the Company manages. Therefore, JEOF starting in the third quarter of 2003 is consolidated into the Company and is no longer treated as an investment.

Factors Affecting the Company’s Business

      In addition to the factors mentioned in the rest of this report, the Company is also affected by changes in general economic and business conditions, acts of war, terrorism and natural disasters.

Changing Conditions in Financial Markets and the Economy Could Result in Decreased Revenues.

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

	•	a market downturn could lead to a decline in the volume of transactions executed for customers and, therefore, to a decline in the revenues received from commissions and spreads;
	•	unfavorable financial or economic conditions would likely reduce the number and size of transactions in underwriting, financial advisory and other services. Investment banking revenues, in the form of financial advisory and underwriting fees, are directly related to the number and size of the transactions in which the Company participates and would therefore be adversely affected by a sustained market downturn;
	•	adverse changes in the market could lead to a reduction in revenues from principal transactions and commissions. Continued increases in the Company’s investments would make the Company more susceptible to adverse changes in the market;
	•	adverse changes in the market could also lead to a reduction in revenues from asset management fees.

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Proprietary Trading Activities Expose the Company to Risk of Loss.

      A significant amount of the Company’s revenues are derived from proprietary trading in which the Company acts as principal. The Company may incur trading losses relating to the purchase, sale or short sale of high yield, international, convertible, equity securities, futures and commodities for its own account and from other program or proprietary trading. In any period, the Company may experience losses as a result of price declines, lack of trading volume, and illiquidity. From time to time, the Company may have large position concentrations in a single security, securities of a single issuer or issuers engaged in a specific industry. In general, because the Company’s inventory of securities is marked to market on a daily basis, any downward price movement in those securities will result in a reduction of the Company’s operating profits.

Increased Competition May Adversely Affect the Company’s Revenues and Profitability.

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

The Company’s Business is Substantially Dependent on the Company’s Chief Executive Officer.

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

The Company’s Business Depends on its Ability to Maintain Adequate Levels of Personnel.

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

Extensive Regulation of the Company’s Business Limits its Activities and, if it Violates These Regulations, May Subject it to Significant Penalties.

      The securities industry in the United States is subject to extensive regulation under both federal and state laws. The Securities and Exchange Commission is the federal agency responsible for the administration of federal securities laws. In addition, self-regulatory organizations, principally NASD and the securities exchanges, are actively involved in the regulation of broker-dealers. Securities firms are also subject to regulation by state securities commissions and state attorneys general in those states in which they do business. Broker-dealers are subject to regulations which cover all aspects of the securities business, including

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Legal Liability May Harm the Company’s Business.

      Many aspects of the Company’s business involve substantial risks of liability, and in the normal course of business, the Company has been named as a defendant or co-defendant in lawsuits involving primarily claims for damages. Additionally, the Company’s expansion into private client services involves an aspect of the business that has historically had a heightened risk of more litigation than the Company’s institutional business. The risks associated with potential legal liabilities often may be difficult to assess or quantify and their existence and magnitude often remain unknown for substantial periods of time. Substantial legal liability against the Company could have a material financial effect or cause significant reputational harm to the Company, which in turn could seriously harm its business prospects.

Operational Risks May Disrupt the Company’s Business, Result in Regulatory Action Against it or Limit its Growth.

      The Company faces operational risks arising from mistakes made in the confirmation or settlement of transactions or from transactions not being properly recorded, evaluated or accounted. The Company’s business is highly dependent on its ability to process, on a daily basis, a large number of transactions across numerous and diverse markets, and the transactions it processes have become increasingly complex. Consequently, the Company relies heavily on its financial, accounting and other data processing systems. If any of these systems do not operate properly or are disabled, the Company could suffer financial loss, a disruption of our business, liability to clients, regulatory intervention or reputational damage. The inability of the Company’s systems to accommodate an increasing volume of transactions could also constrain its ability to expand its business.

      The Company maintains equity securities inventories in exchange-listed, Nasdaq, OTC Bulletin Board, pink sheet and private securities on both a long and short basis as well as various partnership interests. The fair value of these securities at December 31, 2003, was $367 million in long positions and $168 million in short positions. The potential loss in fair value, using a hypothetical 10% decline in prices, is estimated to be approximately $20 million due to the offset of losses in long positions with gains in short positions. In addition, the Company generally enters into exchange-traded option and index futures contracts to hedge against potential losses in inventory positions, thus reducing this potential loss exposure. This hypothetical 10% decline in prices would not be material to the Company’s financial condition.

      The Company also invests in money market funds, high yield, corporate and U.S. Government agency debt and mutual bond funds. Money market funds do not have maturity dates and do not present a material market risk. The fair value of the Company’s high yield, corporate and U.S. Government agency debt at December 31, 2002 was $741 million in long positions and $501 million in short positions. Mutual bond funds do not have maturity dates; the Company’s position in these funds totaled $216 million at December 31, 2003. The potential loss in fair value of the high yield, corporate and U.S. Government agency debt and the mutual bond funds, using a hypothetical 5% decline in value, is estimated to be approximately $23 million due to the offset of losses in long positions with gains in short positions. This hypothetical 5% decline in value would not be material to the Company’s financial condition.

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      At December 31, 2003, the Company had $425.0 million aggregate principal amount of Senior Notes outstanding, with fixed interest rates. The Company has 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 7 3/4% 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 7 3/4% senior notes, after giving effect to the swaps, is 3.33%. The fair value of the mark to market of the swaps was positive $24.6 million as of December 31, 2003, which was recorded as an increase in the book value of the debt and an increase in other assets.

      The tables below provide information about the Company’s derivative financial instruments and other financial instruments that are sensitive to changes in interest rates, exchange rates and price movements as of December 31, 2003 and 2002. For debt obligations and reverse repurchase agreements, the table presents principal cash flows with expected maturity dates. For interest rate swaps, foreign exchange forward contracts, index futures contracts, commodities futures contracts and option contracts, the table presents notional amounts with expected maturity dates.