JEFFERIES BACHE, LLC (formerly Prudential Bache Commodities, LLC) NFA I.D. No. 0330387 Statement of Financial Condition and Supplementary Schedules And Independent Auditor s Report And Supplemental Report on Internal Control This report is deemed PUBLIC in accordance with Regulation1.10(g) under the Commodity Exchange Act.
Table of Contents This Report Contains: Page Report of Independent Auditors 1 Financial Statement as of November 30, 2011 Statement of Financial Condition 2 Notes to Financial Statement 3-16 Supplemental Information as of November 30, 2011 Supplementary Schedule I Computation of Net Capital Pursuant to Regulation 1.17 of the Commodity Exchange Act Supplementary Schedule II Reconciliation of the Statement of Financial Condition to the Computation of Net Capital Requirements Pursuant to Regulation 1.10(d)(3) Under the Commodity Exchange Act Supplementary Schedule III Schedule of Segregation Requirements and Funds in Segregation for Customers Trading on U.S. Commodity Exchanges Pursuant to Section 4d(2) under the Commodity Exchange Act Supplementary Schedule IV Schedule of Secured Amounts and Funds Held in Separate Accounts for Foreign Futures and Foreign Options Customers Pursuant to Regulation 30.7 Under the Commodity Exchange Act SCH-I SCH-II SCH-III SCH-IV Supplemental Report on Internal Control
Deloitte & Touche LLP 2 World Financial Center New York, NY 10281 USA Tel: +1 212-436-2000 Fax: +1 212-436-5000 www.deloitte.com INDEPENDENT AUDITORS REPORT To the Board of Directors of Jefferies Bache, LLC New York, New York We have audited the accompanying statement of financial condition of Jefferies Bache, LLC (the "Company") as of November 30, 2011, that you are filing pursuant to Regulation 1.16 under the Commodity Exchange Act. This financial statement is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statement is free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statement, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. As discussed in Note 1 to the financial statements, the Company changed its fiscal year from December 31 to November 30. In our opinion, such statement of financial condition presents fairly, in all material respects, the financial position of Jefferies Bache, LLC at November 30, 2011, in conformity with accounting principles generally accepted in the United States of America. February 28, 2012 Member of Deloitte Touche Tohmatsu
Statement of Financial Condition November 30, 2011 (In thousands) ASSETS Cash and cash equivalents $ 29,919 Cash and securities segregated under federal and other regulations 2,049,165 Receivables: Brokers, dealers and clearing organizations 186,271 Affiliated brokers and dealers 165,547 Customers 71,732 Due from affiliates 415 Exchange memberships, at cost (market value $8,871) 10,499 Shares in exchanges, at cost (market value $3,376) 3,893 Premises and equipment, net 5,292 Prepaid and other assets 6,301 Total assets $ 2,529,034 LIABILITIES AND MEMBER S EQUITY LIABILITIES: Payables: Brokers, dealers and clearing organizations $ 22,223 Affiliated brokers and dealers 521,618 Customers 1,623,121 Due to affiliates 5,478 Taxes payable 4,499 Compensation and benefits 9,383 Accrued expenses and other liabilities 15,656 Total liabilities 2,201,978 MEMBER S EQUITY: Contributed capital 309,518 Retained earnings 17,538 Total member's equity 327,056 Total liabilities and member's equity $ 2,529,034 The accompanying notes are an integral part of this Statement of Financial Condition. 2
Notes to Statement of Financial Condition 1. ORGANIZATION AND BASIS OF PRESENTATION Organization and Business Jefferies Bache, LLC (formerly Prudential Bache Commodities, LLC) (the Company ), is a Limited Liability Company formed under the laws of Delaware. The Company is a wholly owned subsidiary of Jefferies Bache Holdings, LLC (the Parent ), which in turn is a wholly owned subsidiary of Jefferies Group, Inc. (the Ultimate Parent ). Until July 1, 2011, Prudential Bache Commodities, LLC ( PBC ) was an indirect wholly owned subsidiary of Prudential Financial, Inc. ( Prudential ). The Company is registered as a futures commission merchant ( FCM ) with, and is subject to regulatory requirements of, the Commodity Futures Trading Commission ( CFTC ) under the Commodity Exchange Act. The Company is also a member of the National Futures Association ("NFA") and is a clearing member of all principal commodities exchanges in the United States. The Company primarily executes and/or clears customer and principal transactions in exchange traded futures and options contracts, as well as a limited amount of over-the-counter foreign exchange and precious metals trading contracts. The Company also has certain trading and revenue sharing arrangements with affiliates. Acquisition by Jefferies Group, Inc. On July 1, 2011, the Ultimate Parent acquired the Global Commodities Group from Prudential. The Global Commodities Group included 100% of the equity interest in the Company. In accordance with the purchase method of accounting, the Ultimate Parent established a new basis for the Company s assets and liabilities in the Ultimate Parent s consolidated financial statements based on the fair market values of the Company s assets and liabilities at the time of the acquisition. The following table summarizes the new basis for the Company s assets and liabilities at the acquisition date, which have been reflected in this financial statement: 3
Prior to Acquisition Subsequent to acquisition adjustments acquisition ASSETS Cash and cash equivalents $ 63,768 $ - $ 63,768 Cash and securities segregated under federal and other regulations 2,681,852-2,681,852 Financial instruments owned, at fair value 144,998-144,998 Receivables: Brokers, dealers, and clearing organizations 282,878-282,878 Customers 51,086-51,086 Due from affiliates 1,358-1,358 Exchange memberships, at cost 3,796 6,703 10,499 Shares in exchanges, at cost - 3,893 3,893 Premises and equipment 1,423 2,943 4,366 Other assets 935-935 Total assets $ 3,232,094 $ 13,539 $ 3,245,633 LIABILITIES AND MEMBER S EQUITY LIABILITIES: Payables: Brokers, dealers and clearing organizations $ 737,306 $ - $ 737,306 Customers 2,193,525-2,193,525 Due to affiliates 9,552-9,552 Accrued expenses and other liabilities 21,129 6,515 27,644 MEMBER S EQUITY: Contributed capital 300,076 (40,558) 259,518 Accumulated deficit (29,494) 29,494 - Bargain purchase gain - 18,088 18,088 Total liabilities and member's equity $ 3,232,094 $ 13,539 $ 3,245,633 Acquisition adjustments recognized on July 1, 2011 include: (a) attributing fair value to the Company s exchange memberships and shares in exchanges held, $6,703 and $3,893, respectively; (b) attributing fair value and capitalizing certain internally developed computer software of $2,943; (c) recognizing a deferred tax liability of $4,891 on the acquisition adjustments; and (d) recognizing additional compensation liabilities, primarily relating to issuance of stock compensation, of $1,624. In addition to the new accounting basis established for certain assets and liabilities, purchase accounting re-establishes equity of the entity based on the consideration paid in the acquisition. Accordingly, any retained earnings, accumulated deficit or contributed capital from periods prior to the acquisition no longer exists and consideration paid for the entity is reflected as additional paid-in-capital. As the consideration transferred in the acquisition was less than the acquisition-date amounts of the identifiable assets acquired and liabilities assumed a bargain purchase gain was recognized. Retained earnings at November 30, 2011 represents only the results of operations subsequent to July 1, 2011 (the date of acquisition of the Company by the Ultimate Parent). Change of Fiscal Year End On July 25, 2011, the Board of Managers of the Company approved a change to the fiscal year end from a calendar year basis to a fiscal year ending on November 30 to be consistent with the fiscal year of 4
the Ultimate Parent. The change in the fiscal year end was approved on August 11, 2011 by the CME Group, the Company s Designated Self-Regulatory Organization. Basis of Presentation The accompanying Statement of Financial Condition has been prepared in accordance with generally accepted accounting principles in the U.S. These principles require management to make estimates and assumptions that may affect the amounts reported in financial statements and accompanying notes. The most significant of these estimates and assumptions relate to fair value measurements, compensation and benefits, legal reserves and income tax liabilities. Although these and other estimates and assumptions are based on the best available information, actual results could be materially different from these estimates. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Cash Equivalents Cash equivalents consist of money market funds not held for resale with original maturities of three months or less. The Company maintains its cash accounts with several large banks. At November 30, 2011, approximately $27,000 was on deposit at two banks. Cash and Securities Segregated under Federal and Other Regulations As a FCM, the Company is obligated by rules mandated by the CFTC under the Commodities Exchange Act, to segregate or set aside cash or qualified securities to satisfy such regulations, which have been promulgated to protect customer assets. In addition, certain exchanges require cash or securities deposited to conduct day to day clearing activities. Financial Instruments Financial instruments owned and financial instruments sold, not yet purchased are recorded at fair value on a trade date basis. The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (the exit price). Fair Value Hierarchy. In determining fair value, the Company maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability based on market data obtained from independent sources. Unobservable inputs reflect our assumptions that market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The Company applies a hierarchy to categorize fair value measurements broken down into three levels based on the transparency of inputs as follows: Level 1: Quoted prices are available in active markets for identical assets or liabilities as of the reported date. Level 2: Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these financial instruments include cash instruments for which quoted prices are available but traded less frequently, derivative instruments whose fair value have been derived using a model where inputs to the model are directly observable in the market, or can be derived principally from or corroborated by observable market data, and instruments that are fair valued using other financial instruments, the parameters of which can be directly observed. Level 3: Instruments that have little to no pricing observability as of the reported date. These financial instruments are measured using management s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation. The availability of observable inputs can vary and is affected by a wide variety of factors, including, for example, the type of financial instrument and market conditions. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised in determining fair value is greatest for instruments categorized in Level 3. The Company uses prices and inputs that are current as of the measurement date. As the observability of prices and inputs may change for a financial instrument from period to period, this condition may cause a transfer of an instrument 5
among the fair value hierarchy levels. Transfers among the levels are recognized at the beginning of each period. At November 30, 2011, the Company did not have any financial instruments owned or financial instruments securities sold, not yet purchased. Valuation Process for Financial Instruments Financial instruments are valued at quoted market prices, if available. Certain financial instruments have bid and ask prices that can be observed in the marketplace. For financial instruments whose inputs are based on bid-ask prices, the Company allows for mid-market pricing and adjust to the point within the bid-ask range that meets the Company s best estimate of fair value. For offsetting positions in the same financial instrument, the same price within the bid-ask spread is used to measure both the long and short positions. For financial instruments that do not have readily determinable fair values using quoted market prices, the determination of fair value is based upon consideration of available information, including types of financial instruments, current financial information, restrictions on dispositions, fair values of underlying financial instruments and quotations for similar instruments. The valuation process for financial instruments may include the use of valuation models and other techniques. Adjustments to valuations (such as counterparty, credit, concentration or liquidity) derived from valuation models may be made when, in management s judgment, either the size of the position in the financial instrument in a nonactive market or other features of the financial instrument such as its complexity, or the market in which the financial instrument is traded require that an adjustment be made to the value derived from the models. An adjustment may be made if a financial instrument is subject to sales restrictions that would result in a price less than the quoted market price. Adjustments from the price derived from a valuation model reflect management s judgment that other participants in the market for the financial instrument being measured at fair value would also consider in valuing that same financial instrument and are adjusted for assumptions about risk uncertainties and market conditions. Results from valuation models and valuation techniques in one period may not be indicative of future period fair value measurements. See Note 4, Financial Instruments, for a description of valuation techniques applied to the classes of financial instruments at fair value. Receivable from Brokers, Dealers and Clearing Organizations Receivables from brokers, dealers and clearing organizations include deposits of cash and/or securities with exchange clearing organizations to meet margin requirement, amounts due from clearing organizations for daily variation settlements and fees receivable from correspondent brokers. The balance as of November 30, 2011 includes $150,000 of money market funds pledged with the commodities exchanges and clearing organizations to meet margin requirements. Payable to Brokers, Dealers and Clearing Organizations Payables to broker, dealers and clearing organizations represent amounts owed for daily variation settlements and clearing fees due to clearing organizations. Receivable from and Payable to Customers Receivables from and payables to customers represent balances arising in connection with customers commodities transactions, including variation gains and losses on open commodity futures contracts. Securities owned by customers and held as collateral for these receivables are not reflected on the Statement of Financial Condition. Exchange memberships, at cost Memberships in commodity exchanges and clearing organizations are recorded at cost and are evaluated annually for impairment, or more frequently if warranted. Shares in exchanges, at cost Equity interests in commodity exchanges required by an exchange to be held for membership privileges are valued at cost and are evaluated annually for impairment, or more frequently if warranted. Premises and Equipment Premises are carried at cost less accumulated depreciation. Included within Premises and equipment are computer software costs developed for internal use of $2,943 that resulted from the purchase accounting adjustment as noted in Note 1., furniture, fixtures, equipment and software amounted to $5,833 and leasehold improvements amounted to $1,741. The related accumulated depreciation and amortization was $2,282 as of November 30, 2011. 6
Foreign Currency Translation Assets and liabilities denominated in foreign currencies are translated at fiscal yearend exchange rates. Share-based Compensation The Ultimate Parent issues restricted stock and restricted stock units ( RSU ) to certain employees of the Company under its Incentive Compensation Plan (the Incentive Plan ), primarily in connection with year end compensation. Delivery of the underlying shares of common stock is conditioned on the grantees satisfying requirements outlined in the award agreements. In addition to year end compensation awards, the Ultimate Parent grants restricted stock and RSUs to new employees as "sign-on" awards, to existing employees as "retention" awards and to certain senior executives as awards for multiple years. Sign-on and retention awards are generally subject to annual ratable vesting upon a four year service requirement and are amortized as compensation expense on a straight line basis over the related four years. Further, RSUs are granted to certain senior executives with both performance and service conditions. The Ultimate Parent amortizes these awards granted to senior executives over the service period as we have determined it is probable that the performance condition will be achieved. The subsequent expense of the cost of the restricted stock and RSUs is allocated to the Company by the Ultimate Parent and is included in Compensation and benefits on the Statement of Operations. Income Taxes The Company is a single-member LLC which is disregarded for federal and most income tax purposes. However, a federal and state income tax provision is being provided because the Company is treated as a division of the Ultimate Parent. For periods prior to July 1, 2011, the results of operations and associated tax liability were included in the appropriate consolidated tax returns of Prudential. For periods beginning after July 1, 2011, the results of operations of the Company are included in the consolidated Federal and state income tax returns filed by the Ultimate Parent. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The realization of deferred tax assets is assessed and a valuation allowance is recorded to the extent that it is more likely than not that any portion of the deferred tax asset will not be realized. The Company recognizes tax positions in the financial statement only when it is more likely than not, based on the technical merits the position will be sustained upon examination by the relevant taxing authority. A tax position that meets the more likely than not recognition threshold is measured at the largest amount of tax benefit that is greater than fifty percent likely of being realized upon settlement. Legal Reserves In the normal course of business, the Company has been named, from time to time, as a defendant in various legal and regulatory proceedings. The Company is also involved, from time to time, in other reviews, investigations and proceedings, both formal and informal, by governmental and self-regulatory agencies regarding its businesses, certain of which may result in judgments, settlements, fines, penalties or other injunctions. The Company recognizes a liability for a contingency in Accrued expenses and other liabilities when it is probable that a liability has been incurred and when the amount of loss can be reasonably estimated. When a range of probable loss can be estimated, an accrual for the most likely amount of such loss, and if such amount is not determinable, then the Company accrues the minimum of the range of probable loss. The determination of the outcome and loss estimates requires significant judgment on the part of management. In many instances, it is not possible to determine whether any loss is probable or even possible, or to estimate the amount of any loss or the size of any range of loss. Management believes that, in the aggregate, the pending legal actions or regulatory proceedings and other exams, investigations or similar reviews (both formal and informal) should not have a material adverse effect on its results of operations, cash flows or financial condition. In addition, Management believes that any amount that could be reasonably estimated of potential loss or range of potential loss in excess of what has been provided in the financial statement is not material. 7
New Accounting Developments Balance Sheet Offsetting Disclosures In December 2011, the Financial Accounting Standards Board ( FASB ) issued an Accounting Standards Update ( ASU ), Disclosures about Offsetting Assets and Liabilities ( ASU 2011-11 ) to Topic 210, Balance Sheet. The update requires new disclosures about balance sheet offsetting and related arrangements. For derivatives and financial assets and liabilities, the amendments require disclosure of gross asset and liability amounts, amounts offset on the balance sheet, and amounts subject to the offsetting requirements but not offset on the balance sheet. The guidance is effective December 1, 2013 and is to be applied retrospectively. This guidance does not amend the existing guidance on when it is appropriate to offset; as a result, the Company does not expect this guidance to affect its financial condition. Fair Value Measurements and Disclosures In May 2011, the FASB issued accounting updates to ASC 820, Fair Value Measurements Topic Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS, which provide clarifying guidance on how to measure fair value and additional disclosure requirements. The amendments prohibit the use of blockage factors at all levels of the fair value hierarchy and provide guidance on measuring financial instruments that are managed on a net portfolio basis. Additional disclosure requirements include transfers between Levels 1 and 2; and for Level 3 fair value measurements, a description of our valuation processes and additional information about unobservable inputs impacting Level 3 measurements. The updates are effective March 1, 2012 and will be applied prospectively. The adoption of this guidance will not have an impact on the Company s financial condition. 3. CASH AND SECURITIES SEGREGATED UNDER FEDERAL AND OTHER REGULATIONS The Company has segregated assets in cash or other qualified securities owned totaling $2,049,165 at November 30, 2011 under the Commodity Exchange Act and other regulatory requirements representing funds deposited by customers and funds accruing to customers as a result of trades or contracts. Included within this balance is $115,000 of U.S. Treasury bills and $1,555,000 of money market funds purchased from various commodities exchanges and clearing organizations to satisfy customer margin requirements. 8
4. FINANCIAL INSTRUMENTS The following table presents information about the Company s assets and liabilities measured at fair value on a recurring basis as of November 30, 2011 by level within the fair value hierarchy: Counterparty Cash Collateral Level 1 Level 2 Netting Netting Total Assets: Financial instruments owned: Derivatives $ - $ 241,214 $ (239,719) $ (1,495) $ - Derivatives with affiliate - 254,461 (241,214) (13,247) - Cash and securities segregated under federal and other regulations: U.S. Treasury bills 115,000 - - - 115,000 $ 115,000 $ 495,675 $ (480,933) $ (14,742) $ 115,000 Liabilities: Financial instruments sold, not yet purchased: Derivatives $ - $ 254,461 $ (239,719) $ (14,742) $ - Derivatives with affiliate - 241,214 (241,214) - - $ - $ 495,675 $ (480,933) $ (14,742) $ - Pricing information obtained from external data providers may incorporate a range of market quotes from dealers, recent market transactions and benchmarking model-derived prices to quoted market prices and trade data for comparable securities. External pricing data is subject to evaluation for reasonableness using a variety of means including comparisons of prices to those of similar product types, quality and maturities, consideration of the narrowness or wideness of the range of prices obtained, knowledge of recent market transactions and an assessment of the similarity in prices to comparable dealer offerings in a recent time period. The Company has a formalized process whereby it challenges the appropriateness of pricing information obtained from data providers and pricing services in order to validate the data for consistency with the definition of a fair value exit price. The Company s process includes understanding and evaluating the service providers valuation methodologies. The Company considers pricing data from multiple service providers as available as well as compares pricing data to prices the Company has observed for recent transactions, if any, in order to corroborate our valuation inputs. The following is a description of the valuation basis, including valuation techniques and inputs, used in measuring the Company s financial assets and liabilities that are accounted for at fair value on a recurring basis: U.S. Government and Federal Agency Securities U.S. Treasury Securities: U.S. Treasury securities are measured based on quoted market prices and categorized in Level 1 of the fair value hierarchy. Derivatives Listed Derivative Contracts: Listed derivative contracts are measured based on quoted exchange prices, which are generally obtained from pricing services, and are categorized as Level 1 in the fair value hierarchy. OTC Derivative Contracts: OTC derivative contracts are generally valued using a model, whose inputs reflect assumptions that the Company believes market participants would use in valuing the derivative in a current period transaction. Inputs to valuation models are appropriately calibrated to market data. For many OTC 9
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 in Level 2 of the fair value hierarchy given the observability of the inputs to the valuation models. OTC options include options measured using a Black-Scholes model with key inputs impacting the valuation including the underlying commodity price, implied volatility, dividend yield, interest rate curve, credit spreads, strike price and maturity date. Discounted cash flow models are utilized to measure certain OTC derivative contracts which incorporate observable inputs related to interest rate curves, and valuations of the Company s foreign exchange forwards, which incorporate observable inputs related to foreign currency spot rates and forward curves. The Company did not have any assets or liabilities categorized as level 3 during the eleven months ended November 30, 2011 nor were there transfers into or out of Levels 1 and 2. Cash and cash equivalents, Receivables Brokers, dealers and clearing organizations, Receivables Affiliated brokers and dealers, Receivables Customers, Payables - Brokers, dealers and clearing organizations, Payables Affiliated brokers and dealers, Payables Customers, are not accounted for at fair value; however, the recorded amounts approximate fair value due to their liquid or short-term nature. 5. DERIVATIVE FINANCIAL INSTRUMENTS The Company enters into various transactions involving derivatives including futures, forward contracts and other overthe-counter derivative contracts/instruments. These derivative instruments are held for trading purposes, which include meeting the needs of clients and hedging proprietary trading activities, and are subject to varying degrees of market and credit risk. In addition to the Company s role of clearing futures and exchange traded option contracts for customers, the Company facilitates over-the-counter ( OTC ) commodity and foreign exchange transactions for customer accounts. Customers of the Company trade in OTC transactions by executing OTC derivative contracts with the Company. In order to eliminate market risk, the Company enters into offsetting OTC derivative contracts with an affiliate. Futures and forward contracts represent an agreement to receive or deliver a commodity at a specified future date and price. Included in derivative contracts/instruments are option contracts which provide the option purchaser with the right but not the obligation to buy or sell the underlying commodity. The option writer is obligated to sell or buy the underlying commodity if the option purchaser chooses to exercise. The Company s derivative positions are valued daily. Derivative activities are recorded at fair value in the Statement of Financial Condition, net of cash paid or received under credit support agreements and on a net counterparty basis when a legal right to offset exists under a master netting agreement. Fair value is determined based upon quoted market prices when available, while OTC derivative financial instruments, principally forwards and options, are valued based on the present value of estimated future cash flows that would be received from or paid to a third party in settlement of these derivative contracts. Values are affected by changes in interest rates, currency exchange rates and credit spreads, market volatility and liquidity. The Company s risk of loss in the event of counterparty default is limited to the current fair value or replacement cost on contracts in which the Company has recorded an unrealized gain. 10
The following table presents the fair value and related number of derivative contracts at November 30, 2011, categorized by predominant risk exposure. The fair value of assets and liabilities related to derivative contracts represents the Company s receivable/payable for derivative financial instruments, gross of counterparty netting and cash collateral received and pledged: Assets Liabilities Fair Number of Fair Number of Value Contracts Value Contracts Foreign exchange contracts $ 495,410 1,094 $ 495,410 1,094 Commodity contracts 265 10 265 10 Total 495,675 495,675 Counterparty/cash-collateral netting (495,675) (495,675) Total $ - $ - The following table sets forth the remaining contract maturity of the fair value of OTC derivative assets and liabilities, on a net by counterparty basis, as of November 30, 2011 (gross of collateral received): OTC derivative assets 0 12 1 5 Cross-Maturity Months Years netting Total Commodity options $ 109 $ - $ - $ 109 Foreign exchange forwards and options 14,633 - - 14,633 $ 14,742 $ - $ - $ 14,742 OTC derivative liabilities 0 12 1 5 Cross-Maturity Months Years netting Total Commodity options $ 109 $ - $ - $ 109 Foreign exchange forwards and options 14,633 - - 14,633 $ 14,742 $ - $ - $ 14,742 At November 30, 2011, the counterparty credit quality with respect to the fair value of the Company s OTC derivative assets was as follows: Counterparty credit quality(1): A or higher $ - B to BBB 14,741 Lower than B 1 Unrated - $ 14,742 (1) The Company utilizes the credit ratings of external rating agencies when available. When external credit ratings are not available, the Company may utilize internal credit ratings determined by the Ultimate Parent s credit risk management. Credit ratings determined by credit risk management use methodologies that produce ratings generally consistent with those produced by external rating agencies 11
6. SHORT-TERM DEBT In connection with the Ultimate Parent s acquisition of the Company from Prudential on July 1, 2011, the Company together with two affiliates, entered into a $1.0 billion revolving credit facility with Prudential, which expired on September 29, 2011. The borrowings under the facility were to provide working capital to the borrowers under the facility. The credit facility contained financial covenants that significantly restricted the ability of the borrowers to pay dividends and make other payments or advances to the Ultimate Parent or other affiliates. The Company did not have any borrowings under this facility. 7. CREDIT FACILITY On August 26, 2011 the Company together with two affiliates entered into a committed senior secured revolving credit facility ( Credit Facility ) with a group of commercial banks in Dollars, Euros and Sterling, in aggregate totaling $950.0 million, of which $250.0 million can be borrowed unsecured. The Credit Facility is guaranteed by the Ultimate Parent and contains financial covenants that, among other things, imposes restrictions on future indebtedness of certain subsidiaries of the Ultimate Parent, requires the Ultimate Parent to maintain specified level of tangible net worth and liquidity amounts, and requires certain subsidiaries of the Ultimate Parent to maintain specified levels of regulated capital. The Credit Facility terminates on August 26, 2014. Interest is based on the Federal funds rate or, in the case of Euro and Sterling borrowings, the Euro Interbank Offered Rate and the London Interbank Offered Rate, respectively. The Company did not have any borrowings under this facility during the period from August 26, 2011 to November 30, 2011. The Company was in compliance with debt covenants under the Credit Facility at November 30, 2011. 8. INCOME TAXES On July 1, 2011, the Company was acquired from Prudential by the Ultimate Parent. Since the Company is a disregarded entity the acquisition was treated as an asset purchase. Accordingly, deferred taxes attributable to periods prior to July 1, 2011 were settled at acquisition such that there were no differences between financial statement carrying amounts of assets and liabilities and their respective tax bases and therefore no deferred tax assets or liabilities were recorded. Subsequent to acquisition, deferred tax assets and liabilities were provided for based on temporary differences created by acquisition adjustments. Prior to July 1, 2011, the Company was included in the consolidated Federal income tax return of Prudential. Additionally, as Prudential was an insurance company which paid state premium tax in lieu of state income tax, the Company was generally not subject to state income taxes. Beginning July 1, 2011, the Company is treated as division of the Ultimate Parent and is included within the Ultimate Parent s consolidated U.S. Federal and state combined or unitary income tax returns. In states that neither accept nor require combined or unitary tax returns, the Company files separate state income tax returns. The Company accounts for income taxes on a separate company basis, with benefit for losses and combined state tax rates, as applicable. At November 30, 2011, the Company had a current income tax payable of $83 to the Parent, which is included in Taxes Payable on the Statement of Financial Condition. At November 30, 2011, a net deferred tax liability of $4,399 is recorded on the Statement of Financial Condition and is comprised, primarily of a deferred tax liability of $4,319 related to exchange membership interests. 12
, the Company accrued interest related to unrecognized tax benefits of approximately $559. No material penalties were accrued. The Company does not expect the total amount of the unrecognized tax benefits to materially increase or decrease in the next twelve months. At November 30, 2011, the amount of unrecognized tax benefit was $1,334. The earliest tax year which is subject to examination by the Internal Revenue Service is 2007. Prudential has agreed to certain indemnifications for income taxes that may relate to periods prior to the acquisition date, in accordance with the Stock and Purchase Agreement. 9. EMPLOYEE BENEFIT PLANS Pension and Other Postretirement Employee Benefits Six months from January 1 to June 30, 2011 For the period January 1, 2011 to June 30, 2011, substantially all employees of the Company were eligible to participate in a defined benefit pension plan sponsored by Prudential. Prudential provided for certain healthcare and life insurance benefits for eligible retired employees of the Company. Prudential also sponsored a voluntary savings plan for employees (401(k) plan) that provided for salary reduction contributions by employees and matching contributions by Prudential of up to 4% of annual salary. Pension and Other Postretirement Employee Benefits Five months from July 1 to November 30, 2011 The Company s employees are eligible to participate in various benefit plans of the Ultimate Parent, including an Employee Stock Ownership Plan, an Employee Stock Purchase Plan ( ESPP ) designed to qualify under Section 423 of the Internal Revenue Code ( IRC ) and a profit sharing plan, which includes a salary reduction feature designed to qualify under Section 401(k) of the IRC. There are no separate plans solely for the employees of the Company and therefore benefit plan expenses are determined based upon participation and are effected through an allocation from the Ultimate Parent. 10. SHARE-BASED COMPENSATION Share-Based Compensation Six months from January 1 to June 30, 2011 Share-based compensation awarded to employees of the Company by Prudential included stock options, restricted stock units, restricted stock awards, and performance shares, under a plan authorized by Prudential s Board of Directors. On July 1, 2011 share-based compensation awarded to employees of the Company by Prudential in prior periods that had not met their vesting conditions were converted to equivalent share awards of the Ultimate Parent. All Prudential restricted awards that had met their vesting conditions were exercised and the liability released prior to the acquisition. Share-Based Compensation Five months from July 1 to November 30, 2011 The Company s employees participate in the share-based compensation plans of the Ultimate Parent. 11. RISK MANAGEMENT Transactions involving derivative and non-derivative financial instruments involve varying degrees of both market and credit risk. The Company monitors its exposure to market and credit risk on a daily basis through a variety of reporting and control procedures. Market Risk Market risk is the exposure to an adverse change in the market value caused by a change in market prices or rates. Market risk is identified, measured, monitored and controlled by the Ultimate Parent s Risk Management group through 13
a series of limits which reflect the Company s risk appetite in the context of the market environment and business strategy. Substantially all of the Company s principal trading is done on a back-to-back basis with an affiliate, Jefferies Bache Financial Services, Inc. ( JBFSI, formerly known as PB Financial Services Inc., a wholly owned subsidiary of the Ultimate Parent). Credit Risk in Proprietary Transactions Counterparties to the Company s proprietary transactions are primarily institutional clients. Credit losses could arise should counterparties fail to perform under the terms of the contracts and the value of collateral, to the extent there is any, proves inadequate. The Company manages credit risk by dealing with creditworthy counterparties, monitoring net exposure to individual counterparties, monitoring compliance with established credit limits on a daily basis, and obtaining collateral where appropriate. Credit Risk in Client and Broker Activities In the normal course of business, the Company s activities include execution and settlement of institutional client exchange-traded transactions. These activities may expose the Company to risk arising from price volatility which can reduce the clients or brokers ability to meet their obligations. In the event a client or broker is unable to meet their commitments to the Company and margin deposits are insufficient to cover the clients outstanding liabilities, the Company may be required to purchase or sell financial instruments at prevailing market prices in order to fulfill the client s obligations. The Company monitors required margin levels daily and pursuant to such guidelines, requires customers to deposit additional collateral or reduce positions, when necessary. The Company accepts securities and certain other assets as margin deposits from customers that the Company is permitted by contract or custom to sell or repledge. At November 30, 2011 the fair value of securities and other assets received as collateral was $559,828 of which none were pledged at the commodities exchanges. Concentrations of Credit Risk Concentrations of credit risk exist for groups of counterparties when they have similar economic characteristics that would cause their ability to meet obligations to be similarly affected by economic, industry or geographic factors. In its trade facilitation activities, the Company is actively involved in commodities brokerage and trading with a broad range of institutional clients. The Company s exposure to credit risk associated with the nonperformance of these counterparties in fulfilling their contractual obligations can be directly impacted by volatile trading markets which may impair the counterparties abilities to satisfy their obligations to the Company. From time to time the Company may have significant exposure to specific counterparties, but the Company monitors and manages its exposure and seeks to control its concentration of credit risk through a variety of reporting and control procedures described in preceding discussions of market and credit risk. 12. GUARANTEES Derivative and other transactions In the normal course of its business, the Company may enter into various types of guarantees with counterparties in connection with certain derivative and other transactions. Such guarantees include contracts that contingently require a guarantor to make payments to the guaranteed party based on changes in an underlying agreement that is related to an asset, a liability or an equity security of the guaranteed party, contracts that contingently require the guarantor to make payments to the guaranteed party based on another entity s failure to perform under an agreement, and indirect guarantees of the indebtedness of others, even though the payment to the guaranteed party may not be based on changes related to an asset, a liability or an equity security of the guaranteed party. The Company has not recorded any liabilities in the Statement of Financial Condition as of November 30, 2011 related to these guarantees as management believes that it is unlikely that it will have to make material payments under such guarantees. Exchange and clearing houses The Company is a member of various U.S. exchanges and clearing houses that trade and clear futures and options on futures contracts. Associated with its memberships, the Company may be required to pay a proportionate share of the financial obligations of another member that may default on its obligations to the exchanges or clearing corporations. While the rules governing different exchange memberships vary, in general, the 14
Company s obligations would arise only if the exchange had previously exhausted its resources. To mitigate these performance risks, the exchanges and clearinghouses often require members to post collateral. In addition, any such obligation would be apportioned among the other non-defaulting members of the exchange. Any potential contingent liability under these membership agreements cannot be estimated and may exceed the collateral amounts posted. Management believes that any potential requirement to make payments under these agreements is remote. Accordingly, no contingent liability has been recorded in the Company s financial statement at November 30, 2011 for these agreements. 13. NET CAPITAL REQUIREMENTS The Company is subject to the net capital requirements of CFTC Regulation 1.17 minimum financial requirements for futures commission merchants and introducing brokers. Under this rule, an FCM is required to maintain an adjusted net capital equal to, or in excess of, the greater of: (A) $1,000 or (B) the FCM s risk-based capital requirement, being the sum of (1) eight percent of the total risk margin requirement for positions carried by the FCM in customer accounts, plus (2) eight percent of the total risk margin requirement for positions carried by the FCM in non-customer accounts. At November 30, 2011, the Company determined that it had adjusted net capital of $264,392 which is $112,350 in excess of the minimum required net capital of $152,042. The minimum capital requirement may effectively restrict the withdrawal of shareholder s equity. The Company s ability to make capital and certain other distributions is subject to the rules and regulations of various exchanges, clearing organizations and other regulatory agencies of which it is a member, and which may have capital requirements that are greater than the CFTC s. 14. RELATED PARTY TRANSACTIONS The Company s customer trades in over-the-counter transactions are offset by entering into back-to-back trades with an affiliate, JBFSI, in order to hedge the Company s exposure to market risk. In addition, JBFSI s commodities trading accounts are carried by the Company. Included within Payables Affiliated brokers and dealers are balances of $80,736 as of November 30, 2011 pertaining to JBFSI s commodity trading accounts and open OTC transactions, net of cash collateral and counterparty netting. Under an informal services agreement with JBFSI, the Company provides management and administrative support to JBFSI. Under a Support Services, Space Sharing and Expense Agreement ( the Agreement ) between the Company and its affiliate Jefferies Bache Securities, LLC ( JBS, formerly known as Prudential Bache Securities, LLC), the employees of JBS provided services to the Company. The services provided by the majority of JBS s employees are principally for the benefit of the Company. JBS accrued for and paid directly certain expenses related to its business activities, such as all sales commissions payable to registered personnel, all registration and examination fees, and all legal fees. The Company advances on behalf of JBS certain other expenses of JBS, such as salaries and employee benefits of support personnel, for which JBS pays the Company a monthly management service. On November 23, 2011 JBS was dissolved and merged with Jefferies & Company, Inc. ( JefCo, a wholly owned subsidiary of the Ultimate Parent). No new Agreement has been executed with JefCo. The Company and two of its affiliates are engaged in the business of trading in metals and providing trading and advisory services to customers who wish to trade in metals. This business is conducted principally through the facilities of the London Metal Exchange, of which one of the affiliates is a member. In connection with this business, the Company and these affiliates have entered into an agreement whereby profits/(losses) from this business are allocated based upon the level of services and assistance provided by each company. The Company and an affiliate are engaged in brokering in a global sugar trading business including sugar options contracts. In connection with this business, the Company and this affiliate have entered into an agreement whereby profits/(losses) from this business are allocated based upon the level of services and assistance provided by each company. 15
The Company is the clearing broker for trades on certain U.S. commodities exchanges introduced by an affiliated broker-dealer, Jefferies Bache Ltd. ( JBL, formerly known as Bache Commodities Ltd.). The Company also introduces to JBL trades on certain non-u.s. commodities exchanges. In connection with this activity the Company has as of November 30, 2011 a trading account receivable balance with JBL of $165,547 which is included in Receivables Affiliated brokers and dealers, and a payable to JBL of $422,375 which is included in Payables - Affiliated brokers and dealers in the Statement of Financial Condition. Two other affiliates have commodities trading accounts with the Company, including a trading account opened by JefCo as part of a clearing arrangement executed by JefCo with the Company in 2011. Under the arrangement, the Company executes and clears futures trades for JefCo. At November 30, 2011, the Company has payables totaling $18,507 included within Payables - Affiliated brokers and dealers in connection with these accounts, including for deposits related to initial and variation margin on futures trades. 15. SUBSEQUENT EVENTS Management has evaluated events and transactions that occurred after November 30, 2011 through the date that this financial statement was issued. In January 2012, the Company returned capital of $25,000 to its Parent. 16