Jefferies Group, Inc. History

Company Perspectives:

Jefferies Group, Inc. is a fully-integrated investment bank, finding innovative ways to meet the needs of its clients. Gaining momentum in the area of corporate finance, high yield bonds, and research has added greater dimension to our demonstrated equity capabilities, broadening the way in which we serve our clients.

Company History:

Jefferies Group, Inc. is a holding company for Jefferies & Company, Inc., a global investment bank focused on capital raising, research, mergers and acquisitions, and advisory and restructuring services for medium-sized companies. The company's reputation is built on successful trading in equity and taxable fixed income securities, convertible bonds, options, futures, and international securities for institutional clients. Situated in "Wall Street West," the company is based in Los Angeles, California, with 19 international offices.

Starting in a Phone Booth, 1962

The company was started in 1962 in a telephone booth at the Pacific Coast Stock Exchange by Boyd Jefferies. Jefferies, who had been a partner at Noble, Tulk, Marsh & Jefferies, borrowed $30,000 to launch his own operation. Jefferies had one employee, whom he directed as floor broker. The year 1962 was not an easy one in which to start a company: the stock market collapsed in June and fell again in August after the Cuban Missile Crisis, with an annual loss of over 79 points (the worst since 1931). Despite this difficult environment, Jefferies' first year was successful, and the company expanded its staff and opened a real office, using a closed-circuit television and speaker box to link Boyd Jefferies with his office staff.

Jefferies' Niche: Third Market Trading

In the early years, Jefferies was extremely successful in its manipulation of the emerging "third market," which involved trading listed stocks in an over-the-counter style, providing an attractive anonymity to buyers who preferred to keep their interests from becoming public. For these clients, the stock exchange was too public and fixed commission rates were too high. Jefferies' third market offerings, on the other hand, provided privacy and negotiated commissions to banks, mutual funds, and other financial institutions.

In addition to the third market niche, Jefferies pioneered use of the split commission, or "give up," in 1964. The split commission meant that Jefferies could act on behalf of a client, charge full commission, and then share that commission with other brokerage firms that had worked with the client. This commission sharing helped Jefferies build and expand its market. Jefferies joined the Detroit, Midwest, Boston, and Philadelphia stock exchanges by 1965. In 1967, the company joined the New York stock exchange (NYSE), opening a five-person office in New York. From 1967 to 1968, the third market surged 40 percent in volume. The growing third market helped Jefferies become the seventh largest firm in size and trading on the NYSE.

Members of the NYSE were dismayed by the burgeoning third market, and campaigned to eliminate it. Exchange members felt that negotiated commission rates were destructive to free competition, that the third market was irresponsible, and that the market was fragmented. In 1969, a study of the structure of securities markets was conducted by former Federal Reserve Board Chairman William McChesney Martin, who recommended the elimination of the third market and the barring of institutions trading in the market from Big Board membership. The study was followed by SEC hearings on the issue.

The IDS Acquisition, 1969

Meanwhile, Jefferies & Company was acquired in 1969 by the Minneapolis-based Investors Diversified Services, Inc. (IDS), the second largest financial services company in the country at the time. Jefferies saw the acquisition as a means to bypass the restrictions of the NYSE and increase the size of its institutional business through sizeable capital outlay. The details of the acquisition called for an earnout, which meant that Jefferies & Company would receive shares of IDS preferred stock upon the condition that earnings met expectations for four years. If earnings achieved as planned, the deal would be valued at $45 million. Because IDS did not derive at least 50 percent of its gross income from broker-dealer operations, Jefferies had to quit the New York exchange under Exchange Rule 318. Unhampered by the concerns of NYSE members, Jefferies concentrated on third market business.

The economy entered a downturn in the 1970s. While other Wall Street companies made cutbacks, Jefferies actually increased its staff commission rates to 30 percent (the industry standard was 10-20 percent). The result was the attraction and retention of highly qualified staff in a difficult period. Jefferies returned to the regional exchanges, with the exception of New York. Texas became a new site of expansion in 1971, with an office opened in Dallas.

In 1971, the company reapplied for membership in the Big Board of the NYSE. Upon rejection (based on Rule 318), IDS and Jefferies filed an antitrust lawsuit against the exchange, seeking $6 million in damages. Jefferies and its parent company claimed that the NYSE Big Board was an illegal monopoly, and that exclusion had placed the company at a competitive disadvantage. In 1973, the presiding judge informed the NYSE that he planned to rule in Jefferies favor. Membership was opened to brokerage firms owned by other kinds of companies, so long as 80 percent of brokerage was conducted with the public. Jefferies rejoined the exchange in March 1973.

Jefferies had met financial expectations according to its ownership agreement with IDS for the first three years. However, an internal conflict of interest caused an earnings dip in 1973. Almost a third of Jefferies' previous clients were lost due to competition with IDS, which always competed with investment brokerages for the best price. For its part, IDS did not yield the expected capital to Jefferies, nor did it conduct any trades with the firm. In August 1973 Boyd Jefferies bought back his company over dinner for $2.5 million. The story of the Jefferies acquisition was the subject of a later case study at Harvard Business School.

Later that year, Jefferies & Company resigned from the Big Board, only to rejoin the following spring. The NYSE raised its commission rates, and Jefferies reentered the third market in full force. Management salaries and other expenses were cut back, and Jefferies began anew without IDS's parentage.

Rebuilding in the 1970s and 1980s

The mid-1970s marketplace continued to slump, and Congress moved to ease industry restrictions with the Exchange Act of 1975, finally signaling the end of fixed commission rates. As the third market became more attractive to many institutions, Jefferies was poised with familiarity and experience. By the late 1970s, many of Jefferies' clients who had left during the IDS period returned to the firm. In 1977, Jefferies had expanded with offices in Los Angeles, New York, Chicago, Dallas, Boston and Atlanta. The company was a top broker for regional banks including St. Louis Union Trust, Hartford National Bank & Trust, and First National Bank of Minneapolis, and for big volume companies including Citibank, Morgan Guaranty, and Bank of America.

Seeking to expand into the high-net-worth market, Jefferies Group, Inc. (the holding company for Jefferies & Company) took over and reorganized Wagenseller & Durst, a Los Angeles-based retail brokerage. The new company, W&D Securities, first offered secondary stocks and new issues, then became a clearing business for research, and ultimately served as a soft dollar firm, exchanging research activities for commissions.

In 1981, Jefferies achieved its largest transaction ever, a buyback called "the Mighty Mouse of block trading" by Fortune magazine. Jefferies assisted drug, food, and liquor conglomerate Foremost-McKesson in a $65 million buyback from industrialist Victor Posner. The company purchased its first computer in 1982, and became accessible 24 hours a day. In December 1982, the company began to take advantage of trading halts. When Warner Communications' Atari division announced losses, Warner trades were closed on the exchange, and Jefferies was the only company moving the stock. In two days, Jefferies traded about six million shares, generating business and new international clients. Later, Jefferies took advantage of similar halts in PepsiCo, Inc. and Alleghany Corporation.

The company went public on October 13, 1983, with an initial offering of 1.75 million shares at $13 per share. By 1984, according to Business Week, Jefferies was among the ten most profitable publicly held brokerages. International expansion during trade halts led the company to develop a new overseas office in London, headed by Frank Baxter. In 1986, Baxter became president and chief operating officer, returning to New York to manage the company. Later that year, Jefferies managed the first public trade transfer of ownership, trading 25.8 million shares of Allied Stores for Robert Campeau.

Managing a Crisis, 1987

After 25 years in business, the company reached a potentially disastrous turning point in 1987. Boyd Jefferies, founder and CEO, was charged by the government and the SEC with two securities violations: "parking" stock for customer Ivan Boesky and a customer margin violation. Jefferies pleaded guilty, receiving a fine and a probation barring him from the securities industry for five years. The company itself was not charged, but its brokerage unit was censured by the SEC. Jefferies resigned from the company. To make matters worse, the stock market crashed on October 19, 1987. Plummeting prices led to a $6.5 million loss on the company's principal holdings. As the new CEO, Frank Baxter had quite a job on his hands.

Baxter's unique leadership style was peppered with personal idiosyncrasy. A disciple of New Age guru Deepak Chopra and an avid practitioner of transcendental meditation, Baxter installed a meditation room in Jefferies' headquarters (which was later closed for lack of use). On his desk sat framed photos of Mahatma Gandhi and Martin Luther King, Jr. Nicknamed "the smiling assassin," Baxter had a New Age demeanor covering a hard-edged business sense.

Baxter's first action was geared toward building staff morale in a time of crisis: he retained the company's name and implemented 20 percent bonuses for the company's 180 traders. The generosity worked: not one trader left the company. To compensate for a dip in business, Baxter cut costs by 15 percent through back office automation, and he limited capital use to $50 million (from $300 million in 1985). What could have been an institutional nightmare was salvaged by Baxter's shrewd managerial techniques. The company earned net income of $6.1 million in 1987, increasing that figure to $16 million (on sales of $145 million) in 1988. Shares rose from $7.50 in 1987 to $14.50 in mid-1989. By 1990, the company traded its highest-ever volume: 3.5 percent of the consolidated NYSE tape.

Rebirth and Diversification, Late 1980s-90s

In its second life, under Baxter's leadership, the company focused on diversification, delving beyond its third market niche. Baxter's expansion plans included global expansion in electronic trading, corporate finance, international convertible sales, and derivative sales (all of which were quick money-makers). Jefferies moved quickly into the fourth market: off-exchange, computer-based (electronic) trading. In the fourth market, the broker's position was eliminated by the Portfolio System for Institutional Trading (POSIT), which traded portfolios and matched buyers and sellers automatically. POSIT was supplemented with the Quantitative Executive System (QUANTEX), which allowed traders to access buy and sell recommendations throughout the day. The company added a wholly owned subsidiary (Investment Technology Group) in 1987 to run POSIT. Jefferies' fourth market activities resulted in a new role for the firm's account executives, who were now referred to as JeffCAT, or Jefferies Computer Assisted Traders.

The high yield bond trading business was another new area for Jefferies' expansion, made possible by the collapse of Drexel Burnham Lambert. Jefferies hired 18 former Drexel employees and became one of the top three junk bond trading companies. Taxable fixed income (TFI) and corporate finance departments made Jefferies capable of handling bank debt capabilities and products. By 1992, junk bonds became the company's second most profitable sector. That year, the company made plans to open a Hong Kong office. In 1993, the company landed its first public equity-related deal, and 14 employees of Howard Weil Labouisse Friederichs (including the firm's entire corporate finance department) were recruited. With 125 sales traders--the largest institutional equity sales force in the country--Jefferies was well equipped to secure equity deals. In 1992, equity trading comprised almost two-thirds of revenues ($108.2 million). The company that year earned a stunning net of $18.7 million or $3.08 a share.

At this time, the company was the biggest U.S. third market trader, as well as the largest in computer-based trading. Rapid expansion under Baxter's helm, an efficient new accounting method, and the larger boom in securities spelled success for Jefferies in the 1990s. The company's stock price jumped from $11 at the beginning of 1992 to $35 in September 1993--more than a 200 percent gain in less than two years. Since 1989, Jefferies had bought back almost three million shares of its own stock, including Boyd Jefferies' remaining 800,000 shares.

Integration: A Global Investment Bank

In the 1990s, the company positioned itself to entrepreneurial companies as a "custom shop" full investment bank, offering better pricing and financing options than Wall Street.

Beginning in 1993, Baxter sought to maximize earnings per share by integrating the different departments of the firm's diversification effort (business lines, fixed income, and electronic trading). Baxter also continued to explore new industries. In 1993, Jefferies formed a new subsidiary group to compete in the public energy equity market. By 1993, the company had 38 equity analysts, and revenue from investment banking for mid-sized companies had jumped 127 percent over the previous year. In 1994, the company built a new analytical trading division to trade equities and futures. In 1998, Jefferies launched a series of intranet-based data marts to support its transition to investment banking and entry into the corporate, finance, and research markets.

By 1997, it was clear that Baxter had truly saved the company from its potential demise at the time of Boyd Jefferies' indictment. The company had not had a losing year since Baxter took over, and 1997 revenues approached $800 million (a 47 percent increase over 1996), with earnings of $63.6 million. Rumors of a takeover more than doubled 1997 stock prices, which reached an all-time high of $89.63 a share in December. With high employee ownership of stock and an even higher level of personal investment in the newly focused company, Baxter gave no indications of selling. After almost four decades in business, Jefferies Group, Inc. was quite a different company than the one started in a telephone booth in 1962. Resilience, expansion, careful niche market development, and wise leadership allowed the company to weather its storms and remain a leader in the industry.

Principal Subsidiaries: Jefferies & Company, Inc.; Investment Technology Group, Inc.; Jefferies International Limited (U.K.); Jefferies (Japan) Limited; Jefferies Pacific Limited (Hong Kong); Jefferies (Switzerland) Ltd.

Further Reading:

• "A Brief History of Jefferies," Jefferies & Company, Inc., http://www. jefo.com, 1998.
• Hoffman, Thomas, "Intranet Helps Market Shift; Web Data Mart Expands Bank Investment Service," Computerworld Magazine, May 25, 1998.
• "Making a Difference for 30 Years--1962-1992," Jefferies & Company, Inc., http://www.jefo.com, 1998.
• "Overview," Jefferies & Company, Inc., http://www.jefo.com, 1998.
• Pratt, Tom, "Jefferies' Equity Effort Expands into New Issues," Investment Dealers Digest, April 19, 1993, p. 14.
• Schwimmer, Anne, "Something to Cheer About," Investment Dealers Digest, September 27, 1993, pp. 16-21.
• Sommar, Jessica, "Jefferies Recruits Kipnis to Build Equity Derivatives," Investment Dealers Digest, February 4, 1994, p. 6.
• Toal, Brian A., "New Jefferies Energy Group Gets Off to Fast 1993 Deal Pace," Oil & Gas Investor, October 1993, pp. 16-22.
• Vrana, Deborah, "Jefferies' New Age: When Frank Baxter Took Over in the '80s," Los Angeles Times, March 22, 1998, p. D-1.

Source: International Directory of Company Histories, Vol. 25. St. James Press, 1999.

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