Edgar Filing: Jefferies Group LLC

Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q



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

For the quarterly period ended May 31, 2018



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

For the transition period from to

Commission file number 1-14947

JEFFERIES GROUP LLC

(Exact name of registrant as specified in its charter)



Delaware	95-4719745
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

520 Madison Avenue, New York, New York	10022
(Address of principal executive offices)	(Zip Code)

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

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 ☒ No ☐

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

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



Large accelerated filer ☐	Accelerated filer ☐
Non-accelerated filer ☒	Smaller reporting company ☐
	Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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 ☐ No ☒

The Registrant is a wholly-owned subsidiary of Jefferies Financial Group Inc. and meets the conditions set forth in General Instructions H(1)(a) and (b) of Form 10-Q and is therefore filing this Form 10-Q with a reduced disclosure format as permitted by Instruction H(2).

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JEFFERIES GROUP LLC

INDEX TO QUARTERLY REPORT ON FORM 10-Q

May 31, 2018



PART I. FINANCIAL INFORMATION
	Page
Item 1. Financial Statements	2
Consolidated Statements of Financial Condition (Unaudited)	2
Consolidated Statements of Earnings (Unaudited)	3
Consolidated Statements of Comprehensive Income (Unaudited)	4
Consolidated Statements of Changes in Equity (Unaudited)	5
Consolidated Statements of Cash Flows (Unaudited)	6
Notes to Consolidated Financial Statements (Unaudited)	8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	60
Item 3. Quantitative and Qualitative Disclosures About Market Risk	92
Item 4. Controls and Procedures	92

PART II. OTHER INFORMATION

Item 1. Legal Proceedings	93
Item 1A. Risk Factors	93
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	93
Item 6. Exhibits	93

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

JEFFERIES GROUP LLC AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED)

(In thousands)



	May 31, 2018			November 30, 2017
ASSETS
Cash and cash equivalents ($5,172 and $7,514 at May 31, 2018 and November 30, 2017, respectively, related to consolidated VIEs)	$	4,579,931		$	5,164,492
Cash and securities segregated and on deposit for regulatory purposes or deposited with clearing and depository organizations	709,646			578,014
Financial instruments owned, at fair value, (including securities pledged of $11,079,600 and $10,842,051 at May 31, 2018 and November 30, 2017, respectively; and $1,296 and $38,044 at May 31, 2018 and November 30, 2017, respectively, related to consolidated VIEs)	15,705,657			14,193,352
Loans to and investments in related parties	740,804			682,790
Securities borrowed	7,599,043			7,721,803
Securities purchased under agreements to resell	3,822,232			3,689,559
Securities received as collateral	—			103
Receivables:
Brokers, dealers and clearing organizations	2,488,632			2,514,838
Customers	1,977,251			1,563,758
Fees, interest and other ($4 and $197 at May 31, 2018 and November 30, 2017, respectively, related to consolidated VIEs)	365,285			381,231
Premises and equipment	304,859			297,750
Goodwill	1,645,541			1,647,089
Other assets ($2 at both May 31, 2018 and November 30, 2017, related to consolidated VIEs)	1,184,590			1,270,912
Total assets	$	41,123,471		$	39,705,691
LIABILITIES AND EQUITY
Short-term borrowings (includes $68,818 and $23,324 at fair value at May 31, 2018 and November 30, 2017, respectively)	$	506,218		$	436,215
Financial instruments sold, not yet purchased, at fair value	8,914,893			8,171,929
Collateralized financings:
Securities loaned	2,555,701			2,843,911
Securities sold under agreements to repurchase	8,773,506			8,660,511
Other secured financings (includes $968,822 and $722,108 at May 31, 2018 and November 30, 2017, respectively, related to consolidated VIEs)	968,822			722,108
Obligation to return securities received as collateral	—			103
Payables:
Brokers, dealers and clearing organizations	2,729,207			2,226,768
Customers	3,153,047			2,664,023
Accrued expenses and other liabilities ($757 and $1,391 at May 31, 2018 and November 30, 2017, respectively, related to consolidated VIEs)	1,386,546			1,803,720
Long-term debt (includes $708,256 and $606,956 at fair value at May 31, 2018 and November 30, 2017, respectively)	6,591,900			6,416,844
Total liabilities	35,579,840			33,946,132
EQUITY
Member’s paid-in capital	5,715,628			5,895,601
Accumulated other comprehensive loss:
Currency translation adjustments	(148,576		)	(98,909		)
Changes in instrument specific credit risk	(19,984		)	(27,888		)
Cash flow hedges	361			(936		)
Additional minimum pension liability	(4,548		)	(9,046		)
Total accumulated other comprehensive loss	(172,747		)	(136,779		)
Total Jefferies Group LLC member’s equity	5,542,881			5,758,822
Noncontrolling interests	750			737
Total equity	5,543,631			5,759,559
Total liabilities and equity	$	41,123,471		$	39,705,691

See accompanying notes to consolidated financial statements.

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JEFFERIES GROUP LLC AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)

(In thousands)



	Three Months Ended May 31,				Six Months Ended May 31,
	2018		2017		2018		2017
Revenues:
Commissions and other fees	$	158,104	$	152,643	$	306,006	$	298,465
Principal transactions	137,802		280,258		355,275		502,160
Investment banking	500,297		351,863		940,288		759,884
Asset management fees	6,016		4,115		10,946		12,096
Interest	307,327		227,804		565,143		429,827
Other	47,263		22,272		65,746		46,320
Total revenues	1,156,809		1,038,955		2,243,404		2,048,752
Interest expense	334,252		259,661		599,601		473,945
Net revenues	822,557		779,294		1,643,803		1,574,807
Non-interest expenses:
Compensation and benefits	444,094		450,522		899,727		910,694
Non-compensation expenses:
Floor brokerage and clearing fees	46,244		47,494		90,063		93,352
Underwriting costs	13,029		—		27,304		—
Technology and communications	76,381		67,478		145,458		132,985
Occupancy and equipment rental	24,993		23,594		49,584		49,409
Business development	42,393		26,466		84,500		49,098
Professional services	35,991		26,413		66,399		58,537
Other	17,567		21,146		36,165		40,352
Total non-compensation expenses	256,598		212,591		499,473		423,733
Total non-interest expenses	700,692		663,113		1,399,200		1,334,427
Earnings before income taxes	121,865		116,181		244,603		240,380
Income tax expense	23,857		46,391		207,414		56,570
Net earnings	98,008		69,790		37,189		183,810
Net earnings attributable to noncontrolling interests	4		39		3		40
Net earnings attributable to Jefferies Group LLC	$	98,004	$	69,751	$	37,186	$	183,770

See accompanying notes to consolidated financial statements.

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JEFFERIES GROUP LLC AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

(In thousands)



	Three Months Ended May 31,						Six Months Ended May 31,
	2018			2017			2018			2017
Net earnings	$	98,008		$	69,790		$	37,189		$	183,810
Other comprehensive income (loss), net of tax:
Currency translation and other adjustments (1)	(61,188		)	25,882			(45,169		)	23,352
Changes in instrument specific credit risk (2)	26,017			(2,683		)	7,904			(12,378		)
Cash flow hedges (3)	251			—			1,297			—
Total other comprehensive income (loss), net of tax (4)	(34,920		)	23,199			(35,968		)	10,974
Comprehensive income	63,088			92,989			1,221			194,784
Net earnings attributable to noncontrolling interests	4			39			3			40
Comprehensive income attributable to Jefferies Group LLC	$	63,084		$	92,950		$	1,218		$	194,744

(1)

The amount during the six months ended May 31, 2018 includes $5.3 million related to the transfer of the German Pension Plan, which was reclassified to Compensation and benefits expenses within the Consolidated Statements of Earnings and ($0.8) million related to the Tax Cuts and Jobs Act (the “Tax Act”), which was reclassified to Member’s paid-in capital. Refer to Note 3, Accounting Developments for further information. The amounts during the three and six months ended May 31, 2018 include a gain of $20.5 million related to foreign currency gains, which was reclassified to Other income within the Consolidated Statements of Earnings.

(2)

The amount includes income tax expense of approximately $8.8 million and $10.7 million for the three and six months ended May 31, 2018 and income tax benefit of approximately $1.1 million and $7.4 million for the three and six months ended May 31, 2017. The amounts during the three and six months ended May 31, 2018 also include a gain of $0.3 million related to changes in instrument specific credit risk, which was reclassified to Principal transaction revenues within the Consolidated Statements of Earnings. The amount during the six months ended May 31, 2018 includes ($6.5) million related to the Tax Act, which was reclassified to Member’s paid-in capital. Refer to Note 3, Accounting Developments for further information.


(3)	The amount during the six months ended May 31, 2018 includes ($0.2) million related to the Tax Act, which was reclassified to Member’s paid-in capital. Refer to Note 3, Accounting Developments for further information.


(4)	None of the components of other comprehensive income (loss) are attributable to noncontrolling interests.

See accompanying notes to consolidated financial statements.

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JEFFERIES GROUP LLC AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (UNAUDITED)

(In thousands)



	Six Months Ended May 31, 2018			Year Ended November 30, 2017
Member’s paid-in capital:
Balance, beginning of period	$	5,895,601		$	5,538,103
Cumulative effect of the adoption of the new revenue standard, net of tax	(6,121		)	—
Net earnings attributable to Jefferies Group LLC	37,186			357,498
Distribution to Jefferies Financial Group Inc.	(218,593		)	—
Tax Cuts and Jobs Act adjustment	7,555			—
Balance, end of period	$	5,715,628		$	5,895,601
Accumulated other comprehensive income (loss), net of tax (1) (2):
Balance, beginning of period	$	(136,779	)	$	(168,157	)
Currency adjustments (3)	(49,667		)	53,396
Changes in instrument specific credit risk (4)	7,904			(21,394		)
Cash flow hedges (5)	1,297			(936		)
Pension adjustments (6)	4,498			312
Balance, end of period	$	(172,747	)	$	(136,779	)
Total Jefferies Group LLC member’s equity	$	5,542,881		$	5,758,822
Noncontrolling interests:
Balance, beginning of period	$	737		$	651
Net earnings attributable to noncontrolling interests	3			86
Contributions	10			—
Balance, end of period	$	750		$	737
Total equity	$	5,543,631		$	5,759,559


(1)	The components of other comprehensive income (loss) are attributable to Jefferies Group LLC. None of the components of other comprehensive income (loss) are attributable to noncontrolling interests.


(2)	There were no material reclassifications out of Accumulated other comprehensive income (loss) during the year ended November 30, 2017.


(3)	The amount during the six months ended May 31, 2018 includes a gain of $20.5 million related to foreign currency gains, which was reclassified to earnings.


(4)	The amount during the six months ended May 31, 2018 includes a gain of $0.3 million related to changes in instrument specific credit risk, which was reclassified to earnings, and ($6.5) million related to the Tax Act, which was reclassified to Member’s paid-in capital. Refer to Note 3, Accounting Developments for further information.


(5)	The amount during the six months ended May 31, 2018 includes ($0.2) million related to the Tax Act, which was reclassified to Member’s paid-in capital. Refer to Note 3, Accounting Developments for further information.


(6)	The amount during the six months ended May 31, 2018 includes $5.3 million related to the transfer of the German Pension Plan, which was reclassified to earnings, and ($0.8) million related to the Tax Act, which was reclassified to Member’s paid-in capital. Refer to Note 3, Accounting Developments for further information.

See accompanying notes to consolidated financial statements.

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JEFFERIES GROUP LLC AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In thousands)



	Six Months Ended May 31,
	2018			2017
Cash flows from operating activities:
Net earnings	$	37,189		$	183,810
Adjustments to reconcile net earnings to net cash provided by (used in) operating activities:
Depreciation and amortization	5,743			752
Income on loans to and investments in related parties	(24,834		)	(54,495		)
Distributions received on investments in related parties	1,910			6,189
Other adjustments	(94,524		)	40,160
Net change in assets and liabilities:
Securities deposited with clearing and depository organizations	64,880			108
Receivables:
Brokers, dealers and clearing organizations	10,499			(832,729		)
Customers	(413,508		)	(372,368		)
Fees, interest and other	9,390			(87,192		)
Securities borrowed	97,924			(143,554		)
Financial instruments owned	(1,594,717		)	(8,909		)
Securities purchased under agreements to resell	(176,922		)	(452,154		)
Other assets	76,192			(109,591		)
Payables:
Brokers, dealers and clearing organizations	520,766			(969,230		)
Customers	489,060			300,774
Securities loaned	(266,028		)	616,701
Financial instruments sold, not yet purchased	812,496			598,801
Securities sold under agreements to repurchase	139,287			1,818,042
Accrued expenses and other liabilities	(422,224		)	116,605
Net cash provided by (used in) operating activities	(727,421		)	651,720
Cash flows from investing activities:
Contributions to loans to and investments in related parties	(1,906,071		)	(2,642,607		)
Distributions from loans to and investments in related parties	1,873,000			2,579,746
Net payments on premises and equipment	(36,061		)	(39,918		)
Cash received from contingent consideration	—			1,250
Net cash used in investing activities	(69,132		)	(101,529		)

Continued on next page.

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JEFFERIES GROUP LLC AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS – CONTINUED (UNAUDITED)

(In thousands)



	Six Months Ended May 31,
	2018			2017
Cash flows from financing activities:
Proceeds from short-term borrowings	372,481			133,928
Payments on short-term borrowings	(297,708		)	(219,086		)
Proceeds from issuance of long-term debt, net of issuance costs	1,321,714			866,600
Repayment of long-term debt	(1,022,615		)	(75,730		)
Dividend distribution	(200,000		)	—
Net proceeds from (payments on) other secured financings	246,714			(369,626		)
Net change in bank overdrafts	(2,722		)	(1,544		)
Proceeds from noncontrolling interests	10			—
Net cash provided by financing activities	417,874			334,542
Effect of exchange rate changes on cash, cash equivalents and restricted cash	(9,370		)	4,773
Net increase (decrease) in cash, cash equivalents and restricted cash	(388,049		)	889,506
Cash, cash equivalents and restricted cash at beginning of period	5,642,776			4,286,513
Cash, cash equivalents and restricted cash at end of period	$	5,254,727		$	5,176,019

Supplemental disclosures of cash flow information:
Cash paid during the period for
Interest	$	608,178		$	488,705
Income taxes, net	115,748			3,576

The following presents our cash, cash equivalents and restricted cash by category within the Consolidated Statements of Financial Condition (in thousands):



	May 31, 2018		November 30, 2017
Cash and cash equivalents	$	4,579,931	$	5,164,492
Cash and securities segregated and on deposit for regulatory purposes with clearing and depository organizations	674,796		478,284
Total cash, cash equivalents and restricted cash	$	5,254,727	$	5,642,776

See accompanying notes to consolidated financial statements.

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JEFFERIES GROUP LLC AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Index



Note	Page
Note 1. Organization and Basis of Presentation	9
Note 2. Summary of Significant Accounting Policies	10
Note 3. Accounting Developments	11
Note 4. Fair Value Disclosures	14
Note 5. Derivative Financial Instruments	29
Note 6. Collateralized Transactions	35
Note 7. Securitization Activities	37
Note 8. Variable Interest Entities	39
Note 9. Investments	42
Note 10. Goodwill and Intangible Assets	45
Note 11. Short-Term Borrowings	46
Note 12. Long-Term Debt	47
Note 13. Revenues from Contracts with Customers	48
Note 14. Compensation Plans	51
Note 15. Income Taxes	52
Note 16. Commitments, Contingencies and Guarantees	54
Note 17. Net Capital Requirements	55
Note 18. Segment Reporting	56
Note 19. Related Party Transactions	57

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JEFFERIES GROUP LLC AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

(Unaudited)

Note 1. Organization and Basis of Presentation

Organization

Jefferies Group LLC is the largest independent U.S-headquartered global full service, integrated securities and investment banking firm. The accompanying Consolidated Financial Statements represent the accounts of Jefferies Group LLC and all our subsidiaries (together “we” or “us”). The subsidiaries of Jefferies Group LLC include Jefferies LLC, Jefferies International Limited, Jefferies Hong Kong Limited, Jefferies Financial Services, Inc., Jefferies Funding LLC, Jefferies Leveraged Credit Products, LLC and all other entities in which we have a controlling financial interest or are the primary beneficiary.

Jefferies Group LLC is a direct wholly owned subsidiary of publicly traded Jefferies Financial Group Inc. (“Jefferies”), formerly known as Leucadia National Corporation. Jefferies does not guarantee any of our outstanding debt securities. Our 3.875% Convertible Senior Debentures due 2029 (principal amount of $345.0 million) (the “debentures”) were convertible into Jefferies common shares. At November 22, 2017, all of the remaining convertible debentures were called for optional redemption and were redeemed on January 5, 2018 (see Note 12, Long-Term Debt, for further details). Jefferies Group LLC is a Securities and Exchange Commission (“SEC”) reporting company, filing annual, quarterly and periodic financial reports. Richard Handler, our Chief Executive Officer and Chairman, is the Chief Executive Officer of Jefferies, as well as a Director of Jefferies. Brian P. Friedman, our Chairman of the Executive Committee, is Jefferies’ President and a Director of Jefferies.

In connection with the acquisition of Jefferies Bache from Prudential on July 1, 2011, we acquired a defined benefits pension plan located in Germany (the “German Pension Plan”) for the benefit of eligible employees of Jefferies Bache in that territory. On December 28, 2017, a Liquidation Insurance Contract was entered into with Generali Lebensversicherung AG (“Generali”) to transfer the defined benefit pension obligations and insurance contracts to Generali, for approximately €6.5 million, which was paid in January 2018 and released us from any and all obligations under the German Pension Plan. In addition, on December 28, 2017, we entered into an agreement with Prudential under which we received $3.25 million as consideration for the release of Prudential by us from their indemnity relating to the German Pension Plan defined benefit pension obligations.

We operate in two reportable business segments, Capital Markets and Asset Management. For further information on our reportable business segments, refer to Note 18, Segment Reporting.

Basis of Presentation

The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) and should be read in conjunction with our consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended November 30, 2017. Certain footnote disclosures included in our Annual Report on Form 10-K for the year ended November 30, 2017 have been condensed or omitted from the consolidated financial statements as they are not required for interim reporting under U.S. GAAP. The Consolidated Financial Statements reflect all adjustments of a normal, recurring nature that are, in the opinion of management, necessary for the fair presentation of the results for the interim period. The results presented in the Consolidated Financial Statements for interim periods are not necessarily indicative of the results for the entire year.

We have made a number of estimates and assumptions relating to the reporting of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses during the reporting period to prepare these consolidated financial statements in conformity with U.S. GAAP. The most important of these estimates and assumptions relate to fair value measurements, compensation and benefits, goodwill and intangible assets, the ability to realize certain deferred tax assets and the recognition and measurement of uncertain tax positions. Although these and other estimates and assumptions are based on the best available information, actual results could be materially different from these estimates.

Consolidation

Our policy is to consolidate all entities that we control by ownership of a majority of the outstanding voting stock. In addition, we consolidate entities that meet the definition of a variable interest entity (“VIE”) for which we are the primary beneficiary. The primary beneficiary is the party who has the power to direct the activities of a VIE that most significantly impact the entity’s economic performance and who has an obligation to absorb losses of the entity or a right to receive benefits from the entity that could potentially be significant to the entity. For consolidated entities that are less than wholly owned, the third-party’s holding of equity interest is presented as Noncontrolling interests in our Consolidated Statements of Financial Condition and Consolidated Statements of Changes in Equity. The portion of net earnings attributable to the noncontrolling interests is presented as Net earnings (loss) to noncontrolling interests in our Consolidated Statements of Earnings.

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JEFFERIES GROUP LLC AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

(Unaudited)

In situations in which we have significant influence, but not control, of an entity that does not qualify as a VIE, we apply either the equity method of accounting or fair value accounting pursuant to the fair value option election under U.S. GAAP, with our portion of net earnings or gains and losses recorded in Other revenues or Principal transaction revenues, respectively. We also have formed nonconsolidated investment vehicles with third-party investors that are typically organized as partnerships or limited liability companies and are carried at fair value. We act as general partner or managing member for these investment vehicles and have generally provided the third-party investors with termination or “kick-out” rights.

Intercompany accounts and transactions are eliminated in consolidation.

Changes to the Consolidated Statements of Operations

We have reorganized the presentation of our gains and losses generated from our capital invested in asset management funds managed by us and related parties in the first quarter of 2018. This was previously presented as Asset management: Investment income (loss) from investments in managed funds and is now presented within Principal transactions revenues.

Changes to the Consolidated Statements of Cash Flows

In the first quarter of 2018, we made certain changes to the presentation of our Consolidated Statements of Cash Flows in order to net certain Short-term borrowings, primarily related to revolving intraday credit advances. Refer to Note 11, Short-Term Borrowings, for further information. The changes had the impact of reducing Proceeds from short-term borrowings by $16,753.5 million and increasing Payments on short-term borrowings by $16,753.5 million for the six month periods ended May 31, 2017. There was no change to the total Net cash provided by financing activities. We do not believe these changes are material to our Consolidated Statements of Cash Flows.

Note 2. Summary of Significant Accounting Policies

For a detailed discussion about the Company’s significant accounting policies, see Note 2, Summary of Significant Accounting Policies, in our consolidated financial statements included in Part II, Item 8 of our Annual Report on Form 10-K for the year ended November 30, 2017.

During the six months ended May 31, 2018, other than the following, there were no significant changes made to the Company’s significant accounting policies. The accounting policy changes are attributable to the adoption of the Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (the “new revenue standard” or Accounting Standards Codification 606, (“ASC 606”)) on December 1, 2017. These revenue recognition policy updates are applied prospectively in our financial statements from December 1, 2017 forward. Reported financial information for the historical comparable period was not revised and continues to be reported under the accounting standards in effect during the historical periods.

Investment Banking Revenues:


•	Advisory fees from mergers and acquisitions engagements are recognized at a point in time when the related transaction is completed.


•	Expenses associated with investment banking advisory engagements are deferred only to the extent they are explicitly reimbursable by the client and the related revenue is recognized at a point in time. All other investment banking advisory related expenses, including expenses incurred related to restructuring advisory engagements, are expensed as incurred.


•	All investment banking expenses are recognized within their respective expense category on the Consolidated Statements of Earnings and any expenses reimbursed by clients are recognized as Investment banking revenues.

Asset Management Fees:


•	Performance fee revenue is generally recognized only at the end of the performance period to the extent that the benchmark return has been met.

Refer to Note 3, Accounting Developments, and Note 13, Revenues From Contracts With Customers, for further information.

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JEFFERIES GROUP LLC AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

(Unaudited)

Note 3. Accounting Developments

Accounting Standards to be Adopted in Future Periods

Derivatives and Hedging. In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities. The objective of the guidance is to improve the financial reporting of hedging relationships to better portray the economic results of an entity’s risk management activities in its financial statements. The guidance is effective in the first quarter of fiscal 2019. We do not believe the new guidance will have a material impact on our consolidated financial statements.

Stock Compensation. In May 2017, the FASB issued ASU No. 2017-09, Compensation—Stock Compensation: Scope of Modification Accounting. The guidance provides clarity and reduces diversity in practice and cost and complexity when accounting for a change to the terms or conditions of a share-based payment award. The guidance is effective in the first quarter of fiscal 2019 and early adoption is permitted. We do not believe the new guidance will have a material impact on our consolidated financial statements.

Goodwill. In January 2017, the FASB issued ASU No. 2017-04, Simplifying the Test for Goodwill Impairment, which simplifies goodwill impairment testing. The guidance is effective in the first quarter of fiscal 2021. We do not believe the new guidance will have a material impact on our consolidated financial statements.

Financial Instruments—Credit Losses. In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments. The guidance provides for estimating credit losses on certain types of financial instruments by introducing an approach based on expected losses. The guidance is effective in the first quarter of fiscal 2021. We are currently evaluating the impact of the new guidance on our consolidated financial statements.

Leases. In February 2016, the FASB issued ASU No. 2016-02, Leases. The guidance affects the accounting for leases and provides for a lessee model that brings substantially all leases that are longer than one year onto the balance sheet, which will result in the recognition of a right of use asset and a corresponding lease liability. The right of use asset and lease liability will be measured initially using the present value of the remaining rental payments. This guidance change for leases where we are the lessee will require modifications to our current lease accounting systems and the determination of the present value of the remaining rental payments. A significant portion of the population of contracts that will be subject to recognition on our Consolidated Statements of Financial Condition have been identified; however, their initial measurement still remains under evaluation. We plan on adopting the guidance as of our first quarter of fiscal 2019 and are currently evaluating the impact of the new guidance on our consolidated financial statements.

Adopted Accounting Standards

Comprehensive Income. In February 2018, the FASB issued ASU No. 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The guidance allows companies the option to reclassify stranded taxes from Accumulated other comprehensive income to retained earnings due to the decrease in the Federal Statutory tax rate from 35% to 21% resulting from the Tax Act. The amount of the reclassification is the difference between the historical corporate income tax rate and the newly enacted corporate income tax rate. We early adopted this guidance as of February 28, 2018, resulting in a reclassification adjustment of $7.6 million related to unamortized pension liabilities, cash flow hedges and instrument specific credit risk in our consolidated financial statements.

Retirement Benefits. In March 2017, the FASB issued ASU No. 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. The guidance impacts the presentation of net periodic pension costs in the statement of income. We early adopted this guidance in the first quarter of fiscal 2018 and the adoption did not have a material impact on our Consolidated Statements of Earnings.

Statement of Cash Flows. In August 2016, the FASB issued ASU No. 2016-15, Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”). The guidance adds or clarifies guidance on the classification of certain cash receipts and payments in the statement of cash flows. In November 2016, the FASB issued ASU No. 2016-18, Restricted Cash (“ASU 2016-18”), which requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents and amounts generally described as restricted cash or restricted cash equivalents. We adopted both ASUs in the first quarter of fiscal 2018. Prior periods were retrospectively adjusted to conform to the current period’s presentation. The adoption of ASU 2016-15 did not have a material impact on our Consolidated Statements of Cash Flows. Upon adoption of ASU 2016-18, we recorded an increase of $61.2 million in Net cash used for operating activities for the six months ended May 31, 2017 related to reclassifying the changes in our restricted cash balance from operating activities to the cash and cash equivalent balances within the Consolidated Statements of Cash Flows.

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Financial Instruments. In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments—Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. The guidance affects the accounting for equity investments, financial liabilities under the fair value option and the presentation and disclosure requirements of financial instruments. We adopted the guidance on financial liabilities under the fair value option in the first quarter of fiscal 2016 and we adopted the remaining guidance in the first quarter of fiscal 2018. The adoption of this accounting guidance did not have a material effect on our consolidated financial statements.

Revenue Recognition. We adopted the new revenue standard on December 1, 2017 and recognized a reduction of $6.1 million after-tax to beginning Member’s paid-in capital as the cumulative effect of adoption of this accounting change. The impact of adoption is primarily related to investment banking expenses that were deferred as of November 30, 2017 under the previously existing accounting guidance, which would have been expensed in prior periods under the new revenue standard, and investment banking revenues that were previously recognized in prior periods, which would have been deferred as of November 30, 2017 under the new revenue standard. We elected to adopt the new guidance using a modified retrospective approach applied to contracts that were not completed as of December 1, 2017. Accordingly, the new revenue standard is applied prospectively in our financial statements from December 1, 2017 forward and reported financial information for historical comparable periods is not revised and continues to be reported under the accounting standards in effect during those historical periods.

The new revenue guidance does not apply to revenue associated with financial instruments, including loans and securities that are accounted for under other U.S. GAAP, and as a result, did not have an impact on the elements of our Consolidated Statements of Earnings most closely associated with financial instruments, including Principal transaction revenues, Interest income and Interest expense. The new revenue standard primarily impacts the following of our revenue recognition and presentation accounting policies:


•	Investment Banking Revenues. Advisory fees from mergers and acquisitions engagements are recognized at a point in time when the related transaction is completed, as the performance obligation is to successfully broker a specific transaction.


•	Certain Capital Markets Revenues. Revenues associated with price stabilization activities as part of a securities underwriting were historically recognized as part of Investment banking revenues. Under the new revenue standard, revenue from these activities is recognized within Principal transaction revenues, as these revenues are not considered to be within the scope of the new standard.

•

Investment Banking Advisory Expenses. Historically, expenses associated with investment banking advisory assignments were deferred until reimbursed by the client, the related fee revenue is recognized or the engagement is otherwise concluded. Under the new revenue standard, expenses are deferred only to the extent they are explicitly reimbursable by the client and the related revenue is recognized at a point in time. All other investment banking advisory related expenses, including expenses incurred related to restructuring assignments, are expensed as incurred.

•

Investment Banking Underwriting and Advisory Expenses. Expenses have historically been recorded net of client reimbursements and/or netted against revenues. Under the new revenue standard, all investment banking expenses will be recognized within their respective expense category on the Consolidated Statements of Earnings and any expense reimbursements will be recognized as Investment banking revenues (i.e., expenses are no longer recorded net of client reimbursements and are not netted against revenues).

•

Asset Management Fees. In certain asset management fee arrangements, we receive performance-based fees, which vary with performance or, in certain cases, are earned when the return on assets under management exceed certain benchmark returns or other performance targets. Historically, performance fees have been accrued (or reversed) quarterly based on measuring performance to date versus any relevant benchmark return hurdles stated in the investment management agreement. Under the new revenue standard, performance fees are considered variable as they are subject to fluctuation (e.g., based on market performance) and/or are contingent on a future event during the measurement period (e.g., exceeding a specified benchmark index) and are recognized only to the extent it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty is resolved. Accordingly, performance fee revenue will generally be recognized only at the end of the performance period to the extent that the benchmark return has been met.

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There was no significant impact as a result of applying the new revenue standard to our consolidated financial statements for the three and six months ended May 31, 2018, except as it relates to the presentation of investment banking expenses. The table below presents the impact to revenues and expenses as a result of the change in presentation of investment banking expenses (in thousands):



	Three Months Ended May 31, 2018						Six Months Ended May 31, 2018
	As Reported		ASC 606 Impact		Adjusted (1)		As Reported		ASC 606 Impact		Adjusted (1)
Revenues:
Investment banking	$	500,297	$	32,342	$	467,955	$	940,288	$	64,827	$	875,461
Total revenues	1,156,809		32,342		1,124,467		2,243,404		64,827		2,178,577
Net revenues	822,557		32,342		790,215		1,643,803		64,827		1,578,976
Non-interest expenses:
Underwriting costs	13,029		13,029		—		27,304		27,304		—
Technology and communications	76,381		111		76,270		145,458		214		145,244
Business development	42,393		17,998		24,395		84,500		35,241		49,259
Professional services	35,991		856		35,135		66,399		1,567		64,832
Other expenses	17,567		348		17,219		36,165		501		35,664
Total non-compensation expenses	256,598		32,342		224,256		499,473		64,827		434,646
Total non-interest expenses	700,692		32,342		668,350		1,399,200		64,827		1,334,373


(1)	The amounts reflect each affected financial statement line item as they would have been reported under U.S. GAAP, prior to the adoption of the new revenue standard.

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Note 4. Fair Value Disclosures

The following is a summary of our financial assets and liabilities that are accounted for at fair value on a recurring basis, excluding Investments at fair value based on net asset value (“NAV”) of $333.2 million and $215.4 million at May 31, 2018 and November 30, 2017, respectively, by level within the fair value hierarchy (in thousands):



	May 31, 2018
	Level 1		Level 2		Level 3		Counterparty and Cash Collateral Netting (1)			Total
Assets:
Financial instruments owned:
Corporate equity securities	$	1,567,962	$	70,011	$	42,901	$	—		$	1,680,874
Corporate debt securities	821		2,710,178		28,066		—			2,739,065
Collateralized debt obligations and collateralized loan obligations	—		82,399		30,603		—			113,002
U.S. government and federal agency securities	1,971,180		40,450		—		—			2,011,630
Municipal securities	—		827,478		—		—			827,478
Sovereign obligations	1,332,770		1,129,682		—		—			2,462,452
Residential mortgage-backed securities	—		2,037,431		3,655		—			2,041,086
Commercial mortgage-backed securities	—		941,432		27,239		—			968,671
Other asset-backed securities	—		281,821		55,535		—			337,356
Loans and other receivables	—		1,771,853		64,036		—			1,835,889
Derivatives (2)	10,298		3,354,899		5,743		(3,095,476		)	275,464
Investments at fair value	—		—		79,488		—			79,488
Total financial instruments owned, excluding Investments at fair value based on NAV	$	4,883,031	$	13,247,634	$	337,266	$	(3,095,476	)	$	15,372,455

Liabilities:
Financial instruments sold, not yet purchased:
Corporate equity securities	$	1,412,707	$	4,313	$	87	$	—		$	1,417,107
Corporate debt securities	—		1,627,990		522		—			1,628,512
U.S. government and federal agency securities	1,704,473		—		—		—			1,704,473
Sovereign obligations	1,518,030		1,079,417		—		—			2,597,447
Loans	—		1,106,907		12,881		—			1,119,788
Derivatives	10,818		3,657,065		11,617		(3,231,934		)	447,566
Total financial instruments sold, not yet purchased	$	4,646,028	$	7,475,692	$	25,107	$	(3,231,934	)	$	8,914,893
Short-term borrowings	$	—	$	68,818	$	—	$	—		$	68,818
Long-term debt	$	—	$	547,630	$	160,626	$	—		$	708,256


(1)	Represents counterparty and cash collateral netting across the levels of the fair value hierarchy for positions with the same counterparty.

(2)

During the six months ended May 31, 2018, we transferred from Level 1 to Level 2 $20.8 million of listed options included in Financial instruments owned—Derivatives, which are measured based on broker quotes or mid-market valuations. There were no other material transfers of our financial assets and liabilities between Level 1 and Level 2 for the three and six months ended May 31, 2018 and 2017.

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	November 30, 2017
	Level 1		Level 2		Level 3		Counterparty and Cash Collateral Netting (1)			Total
Assets:
Financial instruments owned:
Corporate equity securities	$	1,801,453	$	57,091	$	22,009	$	—		$	1,880,553
Corporate debt securities	—		3,261,300		26,036		—			3,287,336
Collateralized debt obligations and collateralized loan obligations	—		139,166		30,004		—			169,170
U.S. government and federal agency securities	1,269,230		39,443		—		—			1,308,673
Municipal securities	—		710,513		—		—			710,513
Sovereign obligations	1,381,552		1,035,907		—		—			2,417,459
Residential mortgage-backed securities	—		1,453,294		26,077		—			1,479,371
Commercial mortgage-backed securities	—		508,115		12,419		—			520,534
Other asset-backed securities	—		217,111		61,129		—			278,240
Loans and other receivables	—		1,620,581		47,304		—			1,667,885
Derivatives	160,168		3,248,586		9,295		(3,254,216		)	163,833
Investments at fair value	—		946		93,454		—			94,400
Total financial instruments owned, excluding Investments at fair value based on NAV	$	4,612,403	$	12,292,053	$	327,727	$	(3,254,216	)	$	13,977,967
Securities received as collateral	$	103	$	—	$	—	$	—		$	103

Liabilities:
Financial instruments sold, not yet purchased:
Corporate equity securities	$	1,456,675	$	32,122	$	48	$	—		$	1,488,845
Corporate debt securities	—		1,688,825		522		—			1,689,347
U.S. government and federal agency securities	1,430,737		—		—		—			1,430,737
Sovereign obligations	1,216,643		956,992		—		—			2,173,635
Commercial mortgage-backed securities	—		—		105		—			105
Loans	—		1,148,824		3,486		—			1,152,310
Derivatives	247,919		3,399,239		16,041		(3,426,249		)	236,950
Total financial instruments sold, not yet purchased	$	4,351,974	$	7,226,002	$	20,202	$	(3,426,249	)	$	8,171,929
Short-term borrowings	$	—	$	23,324	$	—	$	—		$	23,324
Long-term debt	$	—	$	606,956	$	—	$	—		$	606,956
Obligation to return securities received as collateral	$	103	$	—	$	—	$	—		$	103


(1)	Represents counterparty and cash collateral netting across the levels of the fair value hierarchy for positions with the same counterparty.

The following is a description of the valuation basis, including valuation techniques and inputs, used in measuring our financial assets and liabilities that are accounted for at fair value on a recurring basis:

Corporate Equity Securities

•

Exchange-Traded Equity Securities: Exchange-traded equity securities are measured based on quoted closing exchange prices, which are generally obtained from external pricing services, and are categorized within Level 1 of the fair value hierarchy, otherwise they are categorized within Level 2 of the fair value hierarchy. To the extent these securities are actively traded, valuation adjustments are not applied.

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•

Non-Exchange-Traded Equity Securities: Non-exchange-traded equity securities are measured primarily using broker quotations, pricing data from external pricing services and prices observed from recently executed market transactions and are categorized within Level 2 of the fair value hierarchy. Where such information is not available, non-exchange-traded equity securities are categorized within Level 3 of the fair value hierarchy and measured using valuation techniques involving quoted prices of or market data for comparable companies, similar company ratios and multiples (e.g., price/Earnings before interest, taxes, depreciation and amortization (“EBITDA”), price/book value), discounted cash flow analyses and transaction prices observed from subsequent financing or capital issuance by the company. When using pricing data of comparable companies, judgment must be applied to adjust the pricing data to account for differences between the measured security and the comparable security (e.g., issuer market capitalization, yield, dividend rate, geographical concentration).

•

Equity Warrants: Non-exchange-traded equity warrants are measured primarily using pricing data from external pricing services, prices observed from recently executed market transactions and broker quotations are categorized within Level 2 of the fair value hierarchy. Where such information is not available, non-exchange-traded equity warrants are generally categorized within Level 3 of the fair value hierarchy and are measured using the Black-Scholes model with key inputs impacting the valuation including the underlying security price, implied volatility, dividend yield, interest rate curve, strike price and maturity date.

Corporate Debt Securities

•

Corporate Bonds: Corporate bonds are measured primarily using pricing data from external pricing services and broker quotations, where available, prices observed from recently executed market transactions and bond spreads or credit default swap spreads of the issuer adjusted for basis differences between the swap curve and the bond curve. Corporate bonds measured using these valuation methods are categorized within Level 2 of the fair value hierarchy. If broker quotes, pricing data or spread data is not available, alternative valuation techniques are used including cash flow models incorporating interest rate curves, single name or index credit default swap curves for comparable issuers and recovery rate assumptions. Corporate bonds measured using alternative valuation techniques are categorized within Level 3 of the fair value hierarchy and are a limited portion of our corporate bonds.

•

High Yield Corporate and Convertible Bonds: A significant portion of our high yield corporate and convertible bonds are categorized within Level 2 of the fair value hierarchy and are measured primarily using broker quotations and pricing data from external pricing services, where available, and prices observed from recently executed market transactions of institutional size. Where pricing data is less observable, valuations are categorized within Level 3 and are based on pending transactions involving the issuer or comparable issuers, prices implied from an issuer’s subsequent financing or recapitalization, models incorporating financial ratios and projected cash flows of the issuer and market prices for comparable issuers.

Collateralized Debt Obligations and Collateralized Loan Obligations

Collateralized debt obligations (“CDOs”) and collateralized loan obligations (“CLOs”) are measured based on prices observed from recently executed market transactions of the same or similar security or based on valuations received from third party brokers or data providers and are categorized within Level 2 or Level 3 of the fair value hierarchy depending on the observability and significance of the pricing inputs. Valuation that is based on recently executed market transactions of similar securities incorporates additional review and analysis of pricing inputs and comparability criteria, including, but not limited to, collateral type, tranche type, rating, origination year, prepayment rates, default rates and loss severity.

U.S. Government and Federal Agency Securities


•	U.S. Treasury Securities: U.S. Treasury securities are measured based on quoted market prices and categorized within Level 1 of the fair value hierarchy.


•	U.S. Agency Debt Securities: Callable and non-callable U.S. agency debt securities are measured primarily based on quoted market prices obtained from external pricing services and are generally categorized within Level 1 or Level 2 of the fair value hierarchy.

Municipal Securities

Municipal securities are measured based on quoted prices obtained from external pricing services and are generally categorized within Level 2 of the fair value hierarchy.

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Sovereign Obligations

Sovereign government obligations are measured based on quoted market prices obtained from external pricing services, where available, or recently executed independent transactions of comparable size. To the extent external price quotations are not available or recent transactions have not been observed, valuation techniques incorporating interest rate yield curves and country spreads for bonds of similar issuers, seniority and maturity are used to determine fair value of sovereign bonds or obligations. Sovereign government obligations are classified in Level 1 or Level 2 of the fair value hierarchy, primarily based on the country of issuance.

Residential Mortgage-Backed Securities


•	Agency Residential Mortgage-Backed Securities (“RMBS”): Agency RMBS include mortgage pass-through securities (fixed and adjustable rate), collateralized mortgage obligations and principal-only securities and are generally measured using market price quotations from external pricing services and categorized within Level 2 of the fair value hierarchy.

•

Agency Residential Interest-Only and Inverse Interest-Only Securities: The fair value is estimated using expected future cash flow techniques that incorporate prepayment models and other prepayment assumptions to amortize the underlying mortgage loan collateral. We use prices observed from recently executed transactions to develop market-clearing spread and yield curve assumptions. Valuation inputs with regard to the underlying collateral incorporate weighted average coupon, loan-to-value, credit scores, geographic location, maximum and average loan size, originator, servicer and weighted average loan age. Agency Residential Interest-Only and Inverse Interest-Only Securities are categorized within Level 2 of the fair value hierarchy. We also use vendor data in developing our assumptions, as appropriate.

•

Non-Agency RMBS: The fair value of non-agency RMBS is determined primarily using discounted cash flow methodologies and securities are categorized within Level 2 or Level 3 of the fair value hierarchy based on the observability and significance of the pricing inputs used. Performance attributes of the underlying mortgage loans are evaluated to estimate pricing inputs, such as prepayment rates, default rates and the severity of credit losses. Attributes of the underlying mortgage loans that affect the pricing inputs include, but are not limited to, weighted average coupon; average and maximum loan size; loan-to-value; credit scores; documentation type; geographic location; weighted average loan age; originator; servicer; historical prepayment, default and loss severity experience of the mortgage loan pool; and delinquency rate. Yield curves used in the discounted cash flow models are based on observed market prices for comparable securities and published interest rate data to estimate market yields. In addition, broker quotes, where available, are also referenced to compare prices primarily on interest-only securities.

Commercial Mortgage-Backed Securities

•

Agency Commercial Mortgage-Backed Securities (“CMBS”): Government National Mortgage Association (“GNMA”) project loan bonds are measured based on inputs corroborated from and benchmarked to observed prices of recent securitization transactions of similar securities with adjustments incorporating an evaluation of various factors, including prepayment speeds, default rates and cash flow structures, as well as the likelihood of pricing levels in the current market environment. Federal National Mortgage Association (“FNMA”) Delegated Underwriting and Servicing (“DUS”) mortgage-backed securities are generally measured by using prices observed from recently executed market transactions to estimate market-clearing spread levels for purposes of estimating fair value. GNMA project loan bonds and FNMA DUS mortgage-backed securities are categorized within Level 2 of the fair value hierarchy.


•	Non-Agency CMBS: Non-agency CMBS are measured using pricing data obtained from external pricing services and prices observed from recently executed market transactions and are categorized within Level 2 and Level 3 of the fair value hierarchy.

Other Asset-Backed Securities

Other asset-backed securities (“ABS”) include, but are not limited to, securities backed by auto loans, credit card receivables, student loans and other consumer loans and are categorized within Level 2 and Level 3 of the fair value hierarchy. Valuations are primarily determined using pricing data obtained from external pricing services and broker quotes and prices observed from recently executed market transactions.

Loans and Other Receivables

•

Corporate Loans: Corporate loans categorized within Level 2 of the fair value hierarchy are measured based on market price quotations where market price quotations from external pricing services are supported by transaction data. Corporate loans categorized within Level 3 of the fair value hierarchy are measured based on price quotations that are considered to be less transparent, market prices for debt securities of the same creditor and estimates of future cash flow incorporating assumptions regarding creditor default and recovery rates and consideration of the issuer’s capital structure.

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•

Participation Certificates in Agency Residential Loans: Valuations of participation certificates in agency residential loans are based on observed market prices of recently executed purchases and sales of similar loans and data provider pricing. The loan participation certificates are categorized within Level 2 of the fair value hierarchy given the observability and volume of recently executed transactions and availability of data provider pricing.

•

Project Loans and Participation Certificates in GNMA Project and Construction Loans: Valuations of participation certificates in GNMA project and construction loans are based on inputs corroborated from and benchmarked to observed prices of recent securitizations with similar underlying loan collateral to derive an implied spread. Securitization prices are adjusted to estimate the fair value of the loans to account for the arbitrage that is realized at the time of securitization. The measurements are categorized within Level 2 of the fair value hierarchy given the observability and volume of recently executed transactions.

•

Consumer Loans and Funding Facilities: Consumer and small business whole loans and related funding facilities are valued based on observed market transactions and incorporating valuation inputs including, but not limited to, delinquency and default rates, prepayment rates, borrower characteristics, loan risk grades and loan age. These assets are categorized within Level 2 or Level 3 of the fair value hierarchy.

•

Escrow and Trade Claim Receivables: Escrow and trade claim receivables are categorized within Level 3 of the fair value hierarchy where fair value is estimated based on reference to market prices and implied yields of debt securities of the same or similar issuers. Escrow and trade claim receivables are categorized within Level 2 of the fair value hierarchy where fair value is based on recent trade activity in the same receivable.

Derivatives

•

Listed Derivative Contracts: Listed derivative contracts that are actively traded are measured based on quoted exchange prices, broker quotes or vanilla option valuation models, such as Black-Scholes, using observable valuation inputs from the principal market. Exchange quotes and/or valuation inputs are generally obtained from external vendors and pricing services. Broker quotes are validated directly through observable and tradeable quotes. Listed derivative contracts that use unadjusted exchange close prices are generally categorized within Level 1 of the fair value hierarchy. All other listed derivative contracts are generally categorized within Level 2 of the fair value hierarchy.

•

Over-the-Counter (“OTC”) Derivative Contracts: OTC derivative contracts are generally valued using models, whose inputs reflect assumptions that we believe market participants would use in valuing the derivative in a current transaction. Inputs to valuation models are appropriately calibrated to market data. For many OTC derivative contracts, the valuation models do not involve material subjectivity as the methodologies do not entail significant judgment and the inputs to valuation models do not involve a high degree of subjectivity as the valuation model inputs are readily observable or can be derived from actively quoted markets. OTC derivative contracts are primarily categorized within Level 2 of the fair value hierarchy given the observability and significance of the inputs to the valuation models. Where significant inputs to the valuation are unobservable, derivative instruments are categorized within Level 3 of the fair value hierarchy.

OTC options include OTC equity, foreign exchange, interest rate and commodity options measured using various valuation models, such as the Black-Scholes, with key inputs including the underlying security price, foreign exchange spot rate, commodity price, implied volatility, dividend yield, interest rate curve, strike price and maturity date. Discounted cash flow models are utilized to measure certain OTC derivative contracts including the valuations of our interest rate swaps, which incorporate observable inputs related to interest rate curves, valuations of our foreign exchange forwards and swaps, which incorporate observable inputs related to foreign currency spot rates and forward curves and valuations of our commodity swaps and forwards, which incorporate observable inputs related to commodity spot prices and forward curves. Discounted cash flow models are also utilized to measure certain variable funding note swaps, which are backed by CLOs and incorporates constant prepayment rate, constant default rate and loss severity assumptions. Credit default swaps include both index and single-name credit default swaps. External prices are available as inputs in measuring index credit default swaps and single-name credit default swaps. For commodity and equity total return swaps, market prices are generally observable for the underlying asset and used as the basis for measuring the fair value of the derivative contracts. Total return swaps executed on other underlyings are measured based on valuations received from external pricing services.

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Investments at Fair Value

Investments at fair value based on NAV includes investments in hedge funds, fund of funds and private equity funds, which are measured at the NAV of the funds, provided by the fund managers and are excluded from the fair value hierarchy. Investments at fair value also include direct equity investments in private companies, which are measured at fair value using valuation techniques involving quoted prices of or market data for comparable companies, similar company ratios and multiples (e.g., price/EBITDA, price/book value), discounted cash flow analyses and transaction prices observed for subsequent financing or capital issuance by the company. Direct equity investments in private companies are categorized within Level 2 or Level 3 of the fair value hierarchy. Additionally, investments at fair value include investments in insurance contracts relating to our defined benefit plan in Germany. Fair value for the insurance contracts is determined using a third party and is categorized within Level 3 of the fair value hierarchy.

The following tables present information about our investments in entities that have the characteristics of an investment company (in thousands):



	May 31, 2018
	Fair Value (1)		Unfunded Commitments		Redemption Frequency (if currently eligible)
Equity Long/Short Hedge Funds (2)	$	35,559	$	—	Monthly, Quarterly
Fixed Income and High Yield Hedge Funds (3)	342		—		—
Fund of Funds (4)	176		—		—
Equity Funds (5)	35,991		20,696		—
Multi-asset Funds (6)	261,134		—		—
Total	$	333,202	$	20,696



	November 30, 2017
	Fair Value (1)		Unfunded Commitments		Redemption Frequency (if currently eligible)
Equity Long/Short Hedge Funds (2)	$	33,176	$	—	Monthly, Quarterly
Fixed Income and High Yield Hedge Funds (3)	417		—		—
Fund of Funds (4)	189		—		—
Equity Funds (5)	26,798		19,084		—
Multi-asset Funds (6)	154,805		—		—
Total	$	215,385	$	19,084


(1)	Where fair value is calculated based on NAV, fair value has been derived from each of the funds’ capital statements.


(2)	This category includes investments in hedge funds that invest, long and short, primarily in equity securities in domestic and international markets in both the public and private sectors. At both May 31, 2018 and November 30, 2017, approximately 1% of the fair value of investments in this category are classified as being in liquidation.


(3)	This category includes investments in funds that invest in loans secured by a first trust deed on property, domestic and international public high yield debt, private high yield investments, senior bank loans, public leveraged equities, distressed debt and private equity investments. There are no redemption provisions.


(4)	This category includes investments in fund of funds that invest in various private equity funds. The investments in this category are managed by us and have no redemption provisions. These investments are gradually being liquidated or we have requested redemption, however, we are unable to estimate when these funds will be received.

(5)

At May 31, 2018 and November 30, 2017, the investments in this category include investments in equity funds that invest in the equity of various U.S. and foreign private companies in the energy, technology, internet service and telecommunication service industries. These investments cannot be redeemed; instead, distributions are received through the liquidation of the underlying assets of the funds which are expected to be liquidated in one to ten years.


(6)	This category includes investments in hedge funds that invest, long and short, primarily in multi-asset securities in domestic and international markets in both the public and private sectors. At May 31, 2018 and November 30, 2017, investments representing approximately 17% and 12%, respectively, of the fair value of investments in this category are redeemable with 30 days prior written notice.

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Other Secured Financings

Other secured financings that are accounted for at fair value include notes issued by consolidated VIEs, which are classified as Level 2 or Level 3 within the fair value hierarchy. Fair value is based on recent transaction prices for similar assets.

Short-term Borrowings / Long-term Debt

Short-term borrowings that are accounted for at fair value include equity-linked notes, which are generally categorized as Level 2 within the fair value hierarchy, as the fair value is based on the price of the underlying equity security. Long-term debt includes variable rate, fixed-to-floating rate, CMS (constant maturity swap), digital and Bermudan structured notes. These are valued using various valuation models that incorporate our own credit spread, market price quotations from external pricing sources referencing the appropriate interest rate curves, volatilities and other inputs as well as prices for transactions in a given note during the period. Long-term debt notes are generally categorized within Level 2 of the fair value hierarchy where market trades have been observed during the quarter, otherwise categorized as Level 3.

Level 3 Rollforwards

The following is a summary of changes in fair value of our financial assets and liabilities that have been categorized within Level 3 of the fair value hierarchy for the three months ended May 31, 2018 (in thousands):



	Three Months Ended May 31, 2018
	Balance at February 28, 2018		Total gains/losses (realized and unrealized) (1)			Purchases			Sales			Settlements			Issuances		Net transfers into/ (out of) Level 3			Balance at May 31, 2018		Change in unrealized gains/ (losses) relating to instruments still held at May 31, 2018 (1)
Assets:
Financial instruments owned:
Corporate equity securities	$	35,412	$	1,322		$	1,485		$	(75	)	$	(110	)	$	—	$	4,867		$	42,901	$	1,612
Corporate debt securities	26,103		923			17,058			(13,481		)	—			—		(2,537		)	28,066		543
CDOs and CLOs	26,433		(2,350		)	251			(1,905		)	(431		)	—		8,605			30,603		(2,422		)
RMBS	21,762		(5,416		)	112			(13,113		)	(35		)	—		345			3,655		423
CMBS	15,103		(2,213		)	—			—			(1,924		)	—		16,273			27,239		(2,706		)
Other ABS	51,288		(4,001		)	59,057			(62,905		)	(3,846		)	—		15,942			55,535		(2,670		)
Loans and other receivables	62,043		(6,051		)	19,029			(16,237		)	(1,940		)	—		7,192			64,036		(5,185		)
Investments at fair value	79,879		(82		)	2,001			(2,310		)	—			—		—			79,488		(82		)
Liabilities:
Financial instruments sold, not yet purchased:
Corporate equity securities	$	61	$	26		$	—		$	—		$	—		$	—	$	—		$	87	$	(26	)
Corporate debt securities	522		—			—			—			—			—		—			522		—
CMBS	35		(35		)	—			—			—			—		—			—		—
Loans	10,323		(3,416		)	(10,543		)	8,685			(29		)	—		7,861			12,881		3,231
Net derivatives (2)	6,882		(1,580		)	—			—			569			—		3			5,874		(115		)
Long-term debt	—		(20,838		)	—			—			—			23,362		158,102			160,626		20,838


(1)	Realized and unrealized gains/losses are reported in Principal transaction revenues in our Consolidated Statements of Earnings.


(2)	Net derivatives represent Financial instruments owned—Derivatives and Financial instruments sold, not yet purchased—Derivatives.

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Analysis of Level 3 Assets and Liabilities for the Three Months Ended May 31, 2018

During the three months ended May 31, 2018, transfers of assets of $78.7 million from Level 2 to Level 3 of the fair value hierarchy are primarily attributed to:


•	CDOs and CLOs of $20.3 million, CMBS of $17.1 million, loans and other receivables of $16.4 million and other ABS of $15.9 million due to reduced pricing transparency.

During the three months ended May 31, 2018, transfers of assets of $28.0 million from Level 3 to Level 2 are primarily attributed to:


•	CDOs and CLOs of $11.7 million and loans and other receivables of $9.2 million due to greater pricing transparency supporting classification into Level 2.

During the three months ended May 31, 2018, there were transfers of long-term debt of $158.1 million from Level 2 to Level 3 due to a decrease in market observability.

Net losses on Level 3 assets were $17.9 million and net gains on Level 3 liabilities were $25.8 million for the three months ended May 31, 2018. Net losses on Level 3 assets were primarily due to decreased market values across certain loans and other receivables, RMBS and other ABS. Net gains on Level 3 liabilities were primarily due to decreased valuations of certain long-term debt.

The following is a summary of changes in fair value of our financial assets and liabilities that have been categorized within Level 3 of the fair value hierarchy for the six months ended May 31, 2018 (in thousands):



	Six Months Ended May 31, 2018
	Balance at November 30, 2017		Total gains/losses (realized and unrealized) (1)			Purchases			Sales			Settlements			Issuances		Net transfers into/ (out of) Level 3			Balance at May 31, 2018		Change in unrealized gains/ (losses) relating to instruments still held at May 31, 2018 (1)
Assets:
Financial instruments owned:
Corporate equity securities	$	22,009	$	13,343		$	5,383		$	(520	)	$	(1,779	)	$	—	$	4,465		$	42,901	$	12,710
Corporate debt securities	26,036		434			19,304			(15,704		)	(2,049		)	—		45			28,066		(1,048		)
CDOs and CLOs	30,004		(2,961		)	568			(2,374		)	(3,765		)	—		9,131			30,603		(5,375		)
RMBS	26,077		(4,193		)	112			(10,959		)	(88		)	—		(7,294		)	3,655		419
CMBS	12,419		(2,292		)	1,208			(487		)	(3,209		)	—		19,600			27,239		(3,176		)
Other ABS	61,129		(5,476		)	132,291			(124,787		)	(7,622		)	—		—			55,535		(2,498		)
Loans and other receivables	47,304		(201		)	46,682			(25,456		)	(11,648		)	—		7,355			64,036		(1,756		)
Investments at fair value	93,454		418			2,240			(17,570		)	—			—		946			79,488		(176		)
Liabilities:
Financial instruments sold, not yet purchased:
Corporate equity securities	$	48	$	39		$	—		$	—		$	—		$	—	$	—		$	87	$	(39	)
Corporate debt securities	522		—			—			—			—			—		—			522		—
CMBS	105		(105		)	—			—			—			—		—			—		—
Loans	3,486		1,226			(5,100		)	12,092			—			—		1,177			12,881		106
Net derivatives (2)	6,746		(668		)	(6		)	—			(494		)	296		—			5,874		535
Long-term debt	—		(28,082		)	—			—			—			81,284		107,424			160,626		20,082


(1)	Realized and unrealized gains/losses are reported in Principal transaction revenues in our Consolidated Statements of Earnings.


(2)	Net derivatives represent Financial instruments owned—Derivatives and Financial instruments sold, not yet purchased—Derivatives.

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Analysis of Level 3 Assets and Liabilities for the Six Months Ended May 31, 2018

During the six months ended May 31, 2018, transfers of assets of $49.1 million from Level 2 to Level 3 of the fair value hierarchy are primarily attributed to:


•	CMBS of $19.7 million and CDOs and CLOs of $12.7 million due to reduced pricing transparency.

During the six months ended May 31, 2018, transfers of assets of $14.9 million from Level 3 to Level 2 are primarily attributed to:


•	RMBS of $9.0 million due to greater pricing transparency supporting classification into Level 2.

During the six months ended May 31, 2018, there were transfers of long-term debt of $107.4 million from Level 2 to Level 3 due to a decrease in market observability.

Net losses on Level 3 assets were $0.9 million and net gains on Level 3 liabilities were $27.6 million for the six months ended May 31, 2018. Net losses on Level 3 assets were primarily due to decreased market values across other ABS, RMBS, CDOs and CLOs and CMBS, partially offset by increased market values across corporate equity securities. Net gains on Level 3 liabilities were primarily due to decreased valuations of certain long-term debt.



	Three Months Ended May 31, 2017
	Balance at February 28, 2017		Total gains/losses (realized and unrealized) (1)			Purchases		Sales			Settlements			Issuances		Net transfers into/ (out of) Level 3			Balance at May 31, 2017		Change in unrealized gains/ (losses) relating to instruments still held at May 31, 2017 (1)
Assets:
Financial instruments owned:
Corporate equity securities	$	20,580	$	(1,198	)	$	490	$	(1,263	)	$	(281	)	$	—	$	2,220		$	20,548	$	(1,428	)
Corporate debt securities	33,467		(1,420		)	8,789		(9,181		)	(6,986		)	—		58			24,727		(1,983		)
CDOs and CLOs	45,354		(2,721		)	16,334		(33,546		)	—			—		1,834			27,255		(131		)
Municipal securities	26,554		(70		)	—		(26,484		)	—			—		—			—		—
RMBS	39,259		(2,188		)	3,176		(6,636		)	(4		)	—		(575		)	33,032		(1,024		)
CMBS	20,653		98			534		(4,111		)	(1		)	—		(910		)	16,263		(546		)
Other ABS	37,702		(3,663		)	13,476		—			(2,241		)	—		(1,925		)	43,349		(3,642		)
Loans and other receivables	53,172		3,226			20,054		(19,378		)	(7,181		)	—		(528		)	49,365		1,687
Investments at fair value	83,785		5,194			300		—			(273		)	—		—			89,006		5,194
Liabilities:
Financial instruments sold, not yet purchased:
Corporate equity securities	$	324	$	30		$	—	$	—		$	—		$	—	$	—		$	354	$	(30	)
Corporate debt securities	523