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

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

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

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

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

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

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

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

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

JEFFERIES GROUP, INC.

2005 FORM 10-K ANNUAL REPORT

TABLE OF CONTENTS

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

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

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

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

Our Major Operating Companies

Jefferies & Company, Inc.

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

Jefferies International Limited

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

Jefferies Execution Services, Inc.

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

Jefferies Asset Management, LLC

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

Jefferies Financial Products LLC

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

Our Sources of Revenues

Commissions

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

Principal Transactions

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

Investment Banking

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

Interest

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

Asset Management Fees and Investment Income from Managed Funds

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

Business Segment

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

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

CAPITAL MARKETS SEGMENT

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

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

EQUITIES

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

Equity Sales and Trading

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

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

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

Jefferies Execution

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

Convertible Securities

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

Research

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

FIXED INCOME AND COMMODITIES

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

High Yield

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

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

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

Investment Grade Fixed Income

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

Jefferies Financial Products LLC

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

INVESTMENT BANKING

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

Jefferies Quarterdeck

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

Jefferies Broadview

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

Randall & Dewey

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

Helix Associates Limited

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

INTEREST

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

Securities Lending

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

ASSET MANAGEMENT SEGMENT

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

Jefferies Asset Management

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

Competition

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

Regulation

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

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

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

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

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

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

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

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

Business Risks

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

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

Margin Risk

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

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

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

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

Underwriting Risk

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

Factors Affecting Our Business

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

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

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

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

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

Increased competition may adversely affect our revenues and profitability.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Our business is substantially dependent on our Chief Executive Officer.

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

Legal liability may harm our business.

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

Our business is subject to significant credit risk.

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

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

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

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

None.

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

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

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

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

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

Issuer Purchases of Equity Securities

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

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

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

Critical Accounting Policies

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

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

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

Fair Value of Financial Instruments

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

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

Fair Value of Derivatives

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

Compensation and Benefits

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

Subsequent Events

Debt Issuance — 30 Year Senior Debentures

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

Massachusetts Mutual Life Insurance Company

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

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

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

Business Segments

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

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

2005 Compared to 2004

Overview

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

Equity Revenue

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

Equity Product Revenue

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

Convertible Product Revenue

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

Execution Product Revenue

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

Fixed Income & Commodities Revenue

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

High Yield Product Revenue

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

Investment Grade Fixed Income Product Revenue

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

Commodities Revenue

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

Investment Banking Product Revenue

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

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

Asset Management Revenue

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

Changes in Assets Under Management

Net Interest Revenue

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

Compensation and Benefits

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

Issuance of Stock-Based Compensation to Employees

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

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

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

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

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

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

Non-Personnel Expenses

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

Earnings before Income Taxes and Minority Interest

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

Minority Interest

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

Earnings per Share

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

2004 Compared to 2003

Overview

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

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

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

Equity Revenue

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

Equity Product Revenue

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

Convertible Product Revenue

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

Execution Product Revenue

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

Fixed Income & Commodities Revenue

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

High Yield Revenue

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

Investment Grade Fixed Income Revenue

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

Commodities Revenue

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

Investment Banking Product Revenue

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

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

Asset Management Revenue

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

Changes in Assets Under Management

Interest Income and Expense

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

Compensation and Benefits

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

Issuance of Stock-Based Compensation to Employees

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

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

Non-Personnel Expenses

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

Earnings before Income Taxes and Minority Interest

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

Minority Interest

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

Earnings per Share

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

Liquidity, Financial Condition and Capital Resources

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

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

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):

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

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

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

Excess Liquidity

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

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

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

Analysis of Financial Condition and Capital Resources

Financial Condition

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

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

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

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):

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

Capital Resources

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

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

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

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

Our long term debt ratings are as follows:

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.

Net Capital

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

Guarantees

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

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

Leverage Ratios

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

Stock Repurchases

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

Commitments

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

Off Balance Sheet Arrangements

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

Effects of Changes in Foreign Currency Rates

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

Effects of Inflation

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

Risk Management

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

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

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

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

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

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

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

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

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

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

Recent Accounting Developments

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

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

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

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

Value-at-Risk

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

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

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

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

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

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

VaR Back-Testing

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

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

Daily Trading Net Revenue
($ in millions)

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

Maturity Data

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

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

INDEX TO FINANCIAL STATEMENTS

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

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

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

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

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

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

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

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

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

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

/s/  KPMG LLP

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

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

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

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

/s/  KPMG LLP