| JEFFERIES GROUP INC /DE/ Item 1A Risk Factors Factors Affecting Our Business The following factors describe some of the assumptions, risks, uncertainties and other factors that could adversely affect our business or that could otherwise result in changes that differ materially from our expectations |
| In addition to the factors mentioned in this report, we are also affected by changes in general economic and business conditions, acts of war, terrorism and natural disasters |
| Changing conditions in financial markets and the economy could result in decreased revenues |
| As an investment banking and securities firm, changes in the financial markets or economic conditions in the United States and elsewhere in the world could adversely affect our business in many ways, including the following: • A market downturn could lead to a decline in the volume of transactions executed for customers and, therefore, to a decline in the revenues we receive from commissions and spreads |
| • Unfavorable financial or economic conditions could likely reduce the number and size of transactions in which we provide underwriting, financial advisory and other services |
| Our investment banking revenues, in the form of financial advisory and underwriting or placement fees, are directly related to the number and size 9 _________________________________________________________________ [61]Table of Contents of the transactions in which we participate and could therefore be adversely affected by unfavorable financial or economic conditions |
| • Adverse changes in the market could lead to a reduction in revenues from principal transactions and commissions |
| • Adverse changes in the market could also lead to a reduction in revenues from asset management fees and investment income from managed funds and losses from managed funds |
| Continued increases in our asset management business, especially increases in the amount of our investments in managed funds, would make us more susceptible to adverse changes in the market |
| Our principal trading and investments expose us to risk of loss |
| A significant portion of our revenues is derived from trading in which we act as principal |
| Although the majority of our principal trading is “riskless principal” in nature, we may incur trading losses relating to the purchase, sale or short sale of high yield, international, convertible, and equity securities and futures and commodities for our own account and from other program or principal trading |
| Additionally, we have made substantial investments of our capital in debt securities, equity securities and commodities, including investments managed by us and investments managed by third parties |
| In any period, we may experience losses as a result of price declines, lack of trading volume, and illiquidity |
| From time to time, we may engage in a large block trade in a single security or maintain large position concentrations in a single security, securities of a single issuer, or securities of issuers engaged in a specific industry |
| In general, because our inventory is marked to market on a daily basis, any downward price movement in these securities could result in a reduction of our revenues and profits |
| In addition, we may engage in hedging transactions that if not successful, could result in losses |
| Increased competition may adversely affect our revenues and profitability |
| All aspects of our business are intensely competitive |
| We compete directly with numerous other brokers and dealers, investment banking firms and banks |
| In addition to competition from firms currently in the securities business, there has been increasing competition from others offering financial services, including automated trading and other services based on technological innovations |
| We believe that the principal factors affecting competition involve market focus, reputation, the abilities of professional personnel, the ability to execute the transaction, relative price of the service and products being offered and the quality of service |
| Increased competition or an adverse change in our competitive position could lead to a reduction of business and therefore a reduction of revenues and profits |
| Competition also extends to the hiring and retention of highly skilled employees |
| A competitor may be successful in hiring away an employee or group of employees, which may result in our losing business formerly serviced by such employee or employees |
| Competition can also raise our costs of hiring and retaining the key employees we need to effectively execute our business plan |
| Operational risks may disrupt our business, result in regulatory action against us or limit our growth |
| Our businesses are highly dependent on our ability to process, on a daily basis, a large number of transactions across numerous and diverse markets in many currencies, and the transactions we process have become increasingly complex |
| If any of our financial, accounting or other data processing systems do not operate properly or are disabled or if there are other shortcomings or failures in our internal processes, people or systems, we could suffer an impairment to our liquidity, financial loss, a disruption of our businesses, liability to clients, regulatory intervention or reputational damage |
| These systems may fail to operate properly or become disabled as a result of events that are wholly or partially beyond our control, including a disruption of electrical or communications services or our inability to occupy one or more of our buildings |
| The inability of our systems to accommodate an increasing volume of transactions could also constrain our ability to expand our businesses |
| We also face the risk of operational failure or termination of any of the clearing agents, exchanges, clearing houses or other financial intermediaries we use to facilitate our securities transactions |
| Any such failure or termination could adversely affect our ability to effect transactions and manage our exposure to risk |
| 10 _________________________________________________________________ [62]Table of Contents 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 |
| 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 11 _________________________________________________________________ [63]Table of Contents actively involved in the regulation of broker-dealers |
| Securities firms are also subject to regulation by regulatory bodies, state securities commissions and state attorneys general in those foreign jurisdictions and states in which they do business |
| Broker-dealers are subject to regulations which cover all aspects of the securities business, including sales methods, trade practices among broker-dealers, use and safekeeping of customers’ funds and securities, capital structure of securities firms, anti-money laundering, record-keeping and the conduct of directors, officers and employees |
| Broker-dealers that engage in commodities and futures transactions are also subject to regulation by the Commodity Futures Trading Commission (“CFTC”) and the National Futures Association (“NFA”) |
| The Commission, self-regulatory organizations, state securities commissions, state attorneys general, the CFTC and the NFA may conduct administrative proceedings which can result in censure, fine, suspension, expulsion of a broker-dealer or its officers or employees, or revocation of broker-dealer licenses |
| Additional legislation, changes in rules or changes in the interpretation or enforcement of existing laws and rules, may directly affect our mode of operation and our profitability |
| Continued efforts by market regulators to increase transparency and reduce the transaction costs for investors, such as decimalization and NASD’s Trade Reporting and Compliance Engine, or TRACE, has affected and could continue to affect our trading revenue |
| Our business is substantially dependent on our Chief Executive Officer |
| Our future success depends to a significant degree on the skills, experience and efforts of Richard Handler, our Chief Executive Officer |
| We do not have an employment agreement with Mr |
| Handler which provides for his continued employment |
| The loss of his services could compromise our ability to effectively operate our business |
| 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 |
| 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 |