**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**Form 10-K**

 

| **(Mark One)**                                                                                                                                                                                                         |                                                                                          |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                   |                                                                                          |
| **ý**                                                                                                                                                                                                             | **Annual Report Pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934**     |
|                                                                                                                                                                                                                   |                                                                                          |
| **For the fiscal year ended November 30, 2002**                                                                                                                                                                   |
|                                                                                                                                                                                                                   |                                                                                          |
| **OR**                                                                                                                                                                                                                 |
|                                                                                                                                                                                                                   |                                                                                          |
| **o**                                                                                                                                                                                                                  | **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-**6817

** **

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**Lehman Brothers Inc.**

(Exact Name of Registrantas Specified in its Charter)

 

| **Delaware**                                                                      |   | **13-2518466**                        |
|-----------------------------------------------------------------------------------|--------|---------------------------------------|
| (State  or other jurisdiction of incorporation or organization)                   |   | (I.R.S.  Employer Identification No.) |
|                                                                              |   |                                  |
| **745 Seventh Avenue****New York, New York**                                      |   | **10019**                             |
| (Address  of principal executive offices)                                         |   | (Zip  Code)                           |
|                                                                              |   |                                  |
| Registrant’s telephone  number, including area code: **(212) 526-7000** |

 

Securities registered pursuant to Section 12(b)of the Act:

 

| **Title of each class**                    |   | **Name of each exchange**  **on which registered** |
|--------------------------------------------|--------|---------------------------------------------------------|
| 7  5/8% Senior Subordinated Notes Due 2006 |   | New York Stock Exchange                                 |

 

Securities registered pursuant toSection 12(g) of the Act:

** **

**None**

** **

Indicate by check mark whether the Registrant: (1) has filed allreports required to be filed by Section 13 or 15 (d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the Registrant was required to file such reports), and(2) has been subject to such filing requirements for the past90 days. Yes ý  No o

 

Indicate by check mark if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K (Section 229.405 of this chapter) is notcontained herein, and will not be contained, to the best of Registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to thisForm 10-K. ý

 

Indicate by check mark whether the registrantis an accelerated filer (as defined in Rule 12b-2 of the Act).  Yes ý  No o

 

Asthe Registrant is a wholly–owned subsidiary of Lehman BrothersHoldings Inc., none of the Registrant’s outstanding common equity is heldby non-affiliates of the Registrant.  Asof February 28, 2003, 1,006 shares of the Registrant’s Common Stock, parvalue $0.10 per share, were issued and outstanding.

 

**THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERALINSTRUCTION I(1)(a) AND (b) OF FORM 10-K AND THEREFORE IS FILING THIS FORMWITH THE REDUCED DISCLOSURE PERMITTED THEREBY**.

 

**DOCUMENTSINCORPORATED BY REFERENCE:**

**None**

 

 

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**TABLE OFCONTENTS**

 
| **AVAILABLE INFORMATION**                       | 3        |
|-------------------------------------------------|----------|
|                                            |     |   |
| **PART I**                                      |     |
|                                            | ITEM 1.  | BUSINESS | 4 |
|                                            | ITEM 2.  | PROPERTIES | 12 |
|                                            | ITEM 3.  | LEGAL PROCEEDINGS | 13 |
|                                            | ITEM 4.  | SUBMISSION OF MATTERS TO  A VOTE OF SECURITY HOLDERS | 19 |
|                                            |     |   |   |
| **PART  II**                                    |     |
|                                            | ITEM 5.  | MARKET FOR REGISTRANT’S  COMMON EQUITY AND RELATED STOCKHOLDER  MATTERS | 20 |
|                                            | ITEM 6.  | SELECTED FINANCIAL DATA | 20 |
|                                            | ITEM 7.  | MANAGEMENT’S ANALYSIS OF  RESULTS OF OPERATIONS | 20 |
|                                            | ITEM 7A. | QUANTITATIVE AND  QUALITATIVE DISCLOSURES ABOUT MARKET RISK | 40 |
|                                            | ITEM 8.  | FINANCIAL STATEMENTS AND  SUPPLEMENTARY DATA | 40 |
|                                            | ITEM 9.  | CHANGES IN AND  DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE | 40 |
|                                            |     |   |
| **PART  III**                                   |     |
|                                            | ITEM 10. | DIRECTORS AND EXECUTIVE  OFFICERS OF THE REGISTRANT | 41 |
|                                            | ITEM 11. | EXECUTIVE COMPENSATION | 41 |
|                                            | ITEM 12. | SECURITY OWNERSHIP OF  CERTAIN BENEFICIAL OWNERS AND MANAGEMENT | 41 |
|                                            | ITEM 13. | CERTAIN RELATIONSHIPS  AND RELATED TRANSACTIONS | 41 |
|                                            | ITEM 14. | CONTROLS AND PROCEDURES | 41 |
|                                            |     |   |
| **PART  IV**                                    |     |
|                                            | ITEM 15. | EXHIBITS, FINANCIAL  STATEMENT SCHEDULES AND REPORTS ON FORM 8-K | 42 |
|                                            |     |   |
|                                            |
| **SIGNATURES**                                  |     | 44 |
|                                            |     |   |
| **CERTIFICATIONS**                              | 45       |
|                                            |     |   |
| **INDEX TO  CONSOLIDATED FINANCIAL STATEMENTS** | F-1      |
|                                            |     |   |
| **EXHIBIT INDEX**                               |
|                                            |     |   |
| **EXHIBITS**                                    |
|                                                 |          |  |  |  |

 

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**AVAILABLE INFORMATION**

 

Lehman Brothers Inc. (“LBI”) files annual, quarterly andcurrent reports and other information with the Securities and ExchangeCommission (“SEC”).  You may read andcopy any document LBI files with the SEC at the SEC’s Public ReferenceRoom at 450 Fifth Street, NW, Washington, DC 20549.  You may obtain information on the operation of the PublicReference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site that contains annual, quarterly and current reports,proxy and information statements and other information regarding issuers thatfile electronically with the SEC.  LBI’s electronic SEC filings are availableto the public at http://www.sec.gov.

 

LBI’s publicinternet site is http://www.lehman.com. LBI makes available free of charge through its internet site, via a linkto the SEC’s internet site at http://www.sec.gov, its annual reports onForm 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K andamendments to those reports filed or furnished pursuant to Section 13(a) or15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonablypracticable after it electronically files such material with, or furnishes itto, the SEC.

 

In addition, LBIcurrently makes available on http://www.lehman.com its most recent annual report on Form10-K and its quarterly reports on Form 10-Q for the current fiscal year,although in some cases these documents are not available on that site as soonas they are available on the SEC’s site.You will need to have on your computer the Adobe Acrobat Reader software toview these documents, which are in the .PDF format.   If you do not have Adobe Acrobat, a link to Adobe Systems Incorporated’s internet site, from which you can downloadthe software, is provided.

 

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**PART I**

 

**ITEM 1****.  BUSINESS**

 

As used herein, “LBI” or the “Registrant” means Lehman Brothers Inc., aDelaware corporation, incorporated on January 21,1965. LBI and its subsidiaries arecollectively referred to as the “Company” or “Lehman Brothers.”  LBI is awholly–owned subsidiary of Lehman Brothers Holdings Inc., a Delawarecorporation, which (together with its subsidiaries, as appropriate) is referredto herein as “Holdings.”

 

The Company, together with its affiliates, is one of the leading globalinvestment banks, serving institutional, corporate, government andhigh-net-worth individual clients and customers. Its executive offices arelocated at 745 Seventh Avenue, New York, New York 10019, and its telephonenumber is (212) 526-7000.

 

##### **Forward–Looking Statements**

##### ** **

Some of the statements contained in this Report, including those relatingto the Company’s strategy and other statements that are predictive in nature,that depend upon or refer to future events or conditions, or that include wordssuch as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates”and similar expressions, are forward–looking statements within themeaning of Section 21E of the Securities Exchange Act of 1934.  These statements are not historical factsbut instead represent only the Company’s expectations, estimates and projectionsregarding future events. These statements are not guarantees of futureperformance and involve certain risks and uncertainties that are difficult topredict, which may include market, credit or counterparty, liquidity, legal andoperational risks.  Those risks anduncertainties include, but are not limited to:

 

•                                          *Market Fluctuations**and Volatility*.  Changesin interest and foreign exchange rates, securities and commodities valuationsand increases in volatility can increase risk, and may also impact customerflow related revenues in the Company’s Capital Markets and Client Servicesbusinesses, as well as impact the volume of debt and equity underwritings andmerger and acquisition transactions.

 

•                                          *Industry Competition andChanges in Competitive Environment.*  Increased competition from both banking institutions and non-traditionalfinancial services providers and from industry consolidation could impact feesearned from the Company’s investment banking and capital markets businesses.

 

•                                          *Investor Sentiment.*  This past year has seen a record number ofaccounting and corporate governance scandals, which have had a significantimpact on investor confidence in the marketplace.  In addition, geopolitical concerns about possible military actionand terrorist activities can have an effect on the global financial markets.

 

•                                          *Liquidity.*  Liquidityrisk management is of critical importance to the Company.  Liquidity could be impacted by the inabilityto access the long-term or short-term debt markets or the repurchase andsecurities lending markets. However, the Company’s liquidity and fundingpolicies have been designed with the goal of providing sufficient liquidityresources to continually fund its balance sheet and to meet all obligations inall market environments.

 

•                                          *Credit Ratings. *The Company’s access to theunsecured funding markets is dependent upon the Company’s credit ratings.  A reduction in the Company’s credit ratingscould adversely affect the Company’s access to liquidity alternatives and itscompetitive position, and could increase the cost of funding, or triggeradditional collateral requirements.

 

•                                          *Credit Exposure.*  Credit risk represents the possibility that acounterparty will be unable to honor its contractual obligations to theCompany.  Although the Company actively managesdaily credit risk exposure as part of its risk management framework,counterparty default risk may arise from unforeseen events orcircumstances.

 

•                                          *Legal/Regulatory. *Legalrisks include litigation (see “Item 3—Legal Proceedings” herein) and legislativeand regulatory developments in the United States and other jurisdictions, whichcould have unforeseeable impacts on the Company’s businesses and results.

 

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The Company’sactual results and financial condition may differ, perhaps materially, from theanticipated results and financial condition in any forward–lookingstatements, and, accordingly, readers are cautioned not to place undue relianceon such statements. For more information concerning the risks and other factorsthat could affect the Company’s future results and financial condition, see“Management’s Analysis of Results of Operations” in Item 7 of this Report. TheCompany undertakes no obligation to update any forward–lookingstatements, whether as a result of new information, future events or otherwise.

 

**LEHMAN BROTHERS**

 

Lehman Brothers, together with its affiliates, is one of the leadingglobal investment banks, serving institutional, corporate, government andhigh-net-worth individual clients and customers. The Company’s worldwideheadquarters in New York are complemented by offices in additional locations inthe United States, Europe, the Middle East, Latin America and the Asia Pacificregion. Affiliates of LBI provideinvestment banking and capital markets services in Europe and Asia.  TheCompany is engaged primarily in providing financial services.  Other businesses in which the Company isengaged represent less than 10 percent of consolidated assets, revenues orpre-tax income.

 

The Company’s business includes capital raising for clients throughsecurities underwriting and direct placements, corporate finance and strategicadvisory services, private equity investments, securities sales and trading,research, and the trading of foreign exchange and derivative products andcertain commodities. The Company and its affiliates act as market–makersin all major equity and fixed income products in both the U.S. andinternational markets. Lehman Brothers is a member of all principal securitiesand commodities exchanges in the United States, as well as the NationalAssociation of Securities Dealers, Inc. (“NASD”).  Affiliates of LBI hold memberships orassociate memberships on several principal international securities andcommodities exchanges, including the London, Tokyo, Hong Kong, Frankfurt, Parisand Milan stock exchanges.

 

Lehman Brothers and its affiliates provide a full array of capitalmarket products and advisory services worldwide. Through the Company’sinvestment banking, trading, research, structuring and distributioncapabilities in equity and fixed income products, the Company continues itsfocus of building its client/customer business model. These “customer flow”activities represent a majority of the Company’s revenues. In addition to itscustomer flow activities, the Company also takes proprietary positions, thesuccess of which is dependent on its ability to anticipate economic and markettrends. The Company believes its customer flow orientation mitigates itsoverall revenue volatility.

 

The Company operates in three business segments (each of which isdescribed below): Investment Banking, Capital Markets and Client Services.Financial information concerning the Company for the fiscal years endedNovember 30, 2002, November 30, 2001, and November 30, 2000,including the amount of net revenue contributed by each segment in suchperiods, is set forth in the Consolidated Financial Statements and the Notesthereto beginning on page F-1 of this Report and is incorporated herein byreference. Information with respect to the Company’s operations by segment andnet revenues by geographic area is set forth in Note 18 of the Notes toConsolidated Financial Statements beginning on page F-8 of this Report and isincorporated herein by reference.

 

**Investment Banking**

 

Lehman Brothers’ Investment Banking professionals are responsible fordeveloping and maintaining relationships with issuer clients, gaining athorough understanding of their specific needs and bringing together the fullresources of Lehman Brothers and its affiliates to accomplish their financial and strategic objectives. Investment Banking is organized intoindustry, geographic and product coverage groups, enabling individual bankersto develop specific expertise in particular industries and markets. Industrycoverage groups include Communications & Media, Consumer/Retailing,Financial Institutions, FinancialSponsors, Healthcare, Industrial,Natural Resources, Power, Real Estate and Technology. Where appropriate,specialized product groups are partnered with the global industry andgeographic groups to provide tailor-made solutions for Lehman Brothers’clients. These product groups include Equity Capital Markets, which consists ofequity and equity–related securities and derivatives, Debt CapitalMarkets, which incorporates expertise in syndicate, liability management,derivatives and bank loan syndication, Private Placements, Leveraged Financeand Mergers & Acquisitions/Strategic Advisory Services. Geographically,Lehman Brothers and its

 

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affiliatesmaintain investment banking offices in seven cities in the U.S. and in****sixteen****citiesin Europe, the Middle East, Asia and Latin America.  The high degree of integration among the industry, product andgeographic groups has allowed Lehman Brothers to become a leading source of one–stopfinancial solutions for its global clients.

 

*Mergers &Acquisitions/Strategic Advisory.*  Lehman Brothers has a longhistory of providing strategic advisory services to corporate, institutionaland government clients around the world on a wide range of financial matters,including mergers and acquisitions, restructurings and spin-offs, targetedstock transactions, share repurchase strategies, government privatizationprograms, takeover defenses and other strategic advice.

 

*Underwriting.*  TheCompany is a leading underwriter of initial and other public and privateofferings of equity and fixed income securities, including listed andover-the-counter securities, government and agency securities and mortgage–and asset–backed securities.

 

**Capital Markets**

 

Lehman Brothers combines the skills from the sales, trading and researchareas of its Equities and Fixed Income Divisions to serve the financial needsof the Company’s clients and customers. This integrated approach enables LehmanBrothers to structure and execute global transactions for clients and toprovide worldwide liquidity in marketable securities.

 

##### **Equities**

##### ** **

The Equities group is responsible for the Company’s equity operationsand all dollar and non-dollar equity and equity–related productsworldwide. These products include listed and over-the-counter securities,American Depositary Receipts, convertibles, options, warrants and derivatives.

 

*Equity CashProducts.*  Lehman Brothers makes markets in equity andequity–related securities, and executes block trades on behalf of clientsand customers. The Company and its affiliates participate in the global equityand equity–related markets in all major currencies through theirworldwide presence and membership in major stock exchanges, including, amongothers, those in New York, London, Tokyo, Hong Kong, Frankfurt, Paris andMilan.

 

*EquityDerivatives.*  Lehman Brothers offers equity derivativecapabilities across a wide spectrum of products and currencies, includingdomestic and international portfolio trading, listed options and futures andover-the-counter derivatives. The Company’s equity derivatives business isorganized into two major product areas: a global volatility business,encompassing options–related products, and a global portfolio tradingbusiness that specializes in agency/risk baskets and other structured products.

 

*Equity Finance.*  LehmanBrothers maintains an integrated Equity Financing and Prime Broker business toprovide liquidity to its clients and customers and supply a source of securedfinancing for the Company. Equity Financing provides financing in all marketson a margin basis for customer purchases of equities and other capital marketsproducts as well as securities lending and short–selling facilitation.The Prime Broker business also engages in full operations, clearing andprocessing services for that unit’s customers.

 

*Arbitrage.*  LehmanBrothers engages in a variety of arbitrage activities including “riskless”arbitrage, where the Company seeks to benefit from temporary pricediscrepancies that occur when a security is traded in two or more markets, and“risk” arbitrage activities, which involve the purchase of securities atdiscounts from the expected values that would be realized if certain proposedor anticipated corporate transactions (such as mergers, acquisitions,recapitalizations, exchange offers, reorganizations, bankruptcies, liquidationsor spin-offs) were to occur. Lehman Brothers’ arbitrage activities benefit fromthe Company’s presence in the global capital markets, access to advancedinformation technology, in-depth market research, proprietary risk managementtools and general experience in assessing rapidly changing market conditions.

 

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**Fixed Income**

 

Lehman Brothers and its affiliates actively participate in all key fixedincome markets worldwide and maintain a 24-hour trading presence in globalfixed income securities. The Company is a preeminent market–maker in newissue and other fixed income securities.

 

Fixed Income businesses include the following:

 

*Government andAgency Obligations.*  Lehman Brothers is one of the leadingprimary dealers in U.S. government securities, as designated by the FederalReserve Bank of New York, participating in the underwriting and market–makingof U.S. Treasury bills, notes and bonds, and securities of federal agencies.The Company and its affiliates are also market–makers in the governmentsecurities of all G7 countries, and participate in other major European andAsian government bond markets.

 

*Corporate DebtSecurities and Loans.*  Lehman Brothers makes markets in fixed andfloating rate investment grade debt worldwide. The Company is also a majorparticipant in the preferred stock market, managing numerous offerings oflong-term and perpetual preferreds and auction rate securities.

 

*High YieldSecurities and Leveraged Bank Loans.*  The Company also makes marketsin non-investment grade debt securities and bank loans. Lehman Brothersprovides “one-stop” leveraged financing solutions for corporate and financialacquirers and high yield issuers, including multi–tranche, multi–productacquisition financing. The Company remains one of the leading investment banksin the syndication of leveraged loans.

 

*Money MarketProducts.*  Lehman Brothers holds leading marketpositions in the origination and distribution of medium-term notes andcommercial paper. The Company is an appointed dealer or agent for numerousactive commercial paper and medium-term note programs on behalf of companiesand government agencies worldwide.

 

*Mortgage andAsset-Backed Securities.*  The Company is a leading underwriter of andmarket-maker in residential and commercial mortgage- and asset-backedsecurities and is active in all areas of secured lending, structured financeand securitized products. Lehman Brothers underwrites and makes markets in thefull range of U.S. agency–backed mortgage products, mortgage-backedsecurities, asset–backed securities and whole loan products. It is also aleader in the global market for residential and commercial mortgages (includingmulti–family financing) and leases.

 

*Municipal andTax-Exempt Securities.*  Lehman Brothers is a major dealer in municipaland tax-exempt securities, including general obligation and revenue bonds,notes issued by states, counties, cities, and state and local governmentalagencies, municipal leases, tax-exempt commercial paper and put bonds.

 

*Financing.*  TheCompany’s Financing Unit engages in three primary functions: managing theCompany’s matched book activities, supplying secured financing to customers,and providing funding for the Company’s activities. Matched book fundinginvolves borrowing and lending cash on a short-term basis to institutionalcustomers collateralized by marketable securities, typically government orgovernment agency securities. The Company enters into these agreements invarious currencies and seeks to generate profits from the difference between interestearned and interest paid. The Financing Unit works with the Company’sinstitutional sales force to identify customers that have cash to invest and/orsecurities to pledge to meet the financing and investment objectives of theCompany and its customers. Financing also coordinates with the Company’sTreasury area to provide collateralized financing for a large portion of theCompany’s securities and other financial instruments owned. In addition to itsactivities on behalf of its U.S. clients and customers, the Company and itsaffiliates are major participants in the European and Asian repurchaseagreement markets, providing secured financing for the Company’s customers inthose regions.

 

*Fixed IncomeDerivatives.*  The Company and its affiliates offer a broadrange of derivative, interest rate and credit products and services.Derivatives professionals are integrated into all of the Company’s fixed incomeareas in response to the worldwide convergence of the cash and derivativemarkets.

 

*ForeignExchange.*  The global foreign exchange operations ofLehman Brothers and its affiliates provide market

 

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accessand liquidity in all currencies for spot, forward and over-the-counter optionsmarkets around the clock. Lehman Brothers offers its customers superiorexecution, market intelligence, analysis and hedging capabilities, utilizingforeign exchange as well as foreign exchange options and derivatives. LehmanBrothers and its affiliates also provide advisory services to central banks,corporations and investors worldwide, structuring innovative products to fittheir specific needs. The Company makes extensive use of its globalmacroeconomics research to advise clients on the appropriate strategies tominimize interest rate and currency risk.

 

**GlobalDistribution**

 

Lehman Brothers’ institutional sales organizations encompass distinctglobal sales forces that have been integrated into the Fixed Income andEquities Capital Markets businesses to provide investors with the full array ofproducts and research offered by the Company.

 

*Equity Sales.*  LehmanBrothers’ institutional Equity sales force provides an extensive range ofservices to institutional investors. The Equity sales organization focuses ondeveloping long-term relationships though a comprehensive understanding ofcustomers’ investment objectives, while providing proficient execution andconsistent liquidity in a wide range of global equity securities andderivatives.

 

*Fixed IncomeSales.* Lehman Brothers’ FixedIncome sales force is one of the most productive in the industry, serving theinvesting and liquidity needs of major institutional investors. Employing arelationship management approach that provides superior information flow andproduct opportunities for the Company’s customers, the Fixed Income salesorganization covers the major share of the buying power in the global fixedincome markets.

 

**Research**

 

Research at Lehman Brothers encompasses the full range of researchdisciplines, including quantitative, economic, strategic, credit, relativevalue and market–specific analysis.

 

*Equity Research*.  Toensure in-depth expertise within various markets, Equity Research hasestablished regional teams on a worldwide basis that are staffed with industryand strategy specialists.

 

*Fixed IncomeResearch.* Fixed IncomeResearch specialists provide expertise in U.S., European and Asian governmentand agency securities, derivatives, sovereign issues, corporate securities,high yield, asset– and mortgage–backed securities, indices,emerging market debt and municipal securities.

 

**Client Services**

 

ClientServices includes the Company’s Private Client Services group, a retail–basedorganization that primarily serves the investment needs of wealthy individuals,and its Private Equity Division, which manages assets through a series ofprivate equity funds and investments.

 

**Private ClientServices**

 

The Company’s Private Client Services group’s investment representativesserve the investment needs of private investors with substantial assets as wellas thousands of mid-sized institutional accounts worldwide. The group’sinvestment representatives provide their clients with direct access to banking,fixed income, equity, foreign exchange and derivative products, as well as the Company’sresearch and execution capabilities.

 

Lehman Brothers also provides asset management services, includingInvestment Consulting Services, a wrap-fee series of third party managedproducts, management of multiple manager funds onshore and offshore and amanaged futures advisory business. The Company also has dealer agreements witha large number of mutual fund families.

 

Lehman Brothers is expanding its asset management activities to focus on the strategicdevelopment of a comprehensive asset management platform for the Company,drawing on—and providing both individual and

 

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institutional clients with access to—Lehman Brothers’investment advisory expertise across various asset classes and geographies.Those responsibilities include the Company’s and its affiliates’ recentlyestablished asset management initiatives, such as Lehman Brothers AlternativeInvestment Management (a joint venture with Ehrenkranz & Ehrenkranz) and aninvestment in the United Kingdom’s Edgeworth Capital.  InJanuary 2003, Holdings acquired the fixed income investment management businessof Lincoln Capital Management, which will become the U.S. institutional fixedincome management platform for large institutional investors.

 

**Private Equity**

 

The Company andits affiliates currently have over $4.5 billion in Private Equity assetsunder management, primarily in five asset classes: Merchant Banking, VentureCapital, Real Estate, Fixed Income-related and Third Party Funds. The primary goalof each asset class is to make investments that provide attractiverisk-adjusted returns to investors, including institutions, high-net-worthindividuals, the Company and certain employees of the Company and its affiliates.

 

*MerchantBanking.*  Lehman Brothers’ merchant banking activitiesinclude making principal equity investments, often in partnership with clientsof the Company. Merchant banking seeks to partner with proven operating teamsthat have compelling business strategies and growth plans, with the aim ofcreating long-term value for investors.

 

*VentureCapital.*  Lehman Brothers’ venture capital funds arefocused on making growth-oriented equity investments in technology,communications and healthcare companies. Venture capital investments focus oncompanies capable of turning innovative technology and management solutionsinto successful businesses.

 

*Real Estate.*  LehmanBrothers’ Real Estate Fund is focused on making real estate equity investmentsin North America and Europe in a wide variety of commercial and residentialproperties, real estate companies and related service businesses.

 

*Fixed Income-related.*  Thisasset class is currently comprised of two investing activities:   European mezzanine investments andcollateralized debt obligation (CDO)-related investments.

 

*Third Party Funds.*  This asset class consists ofinvestment activities related to non-affiliated partnerships, including a fund-of-funds forinvestments in other private equity funds, purchasing secondary limitedpartnership interests in existing private equity funds and managingco-investment programs on behalf of large institutional investors.

 

Commitments forall of the Company’s private equity funds are raised in private placements notrequiring registration under the Securities Act of 1933.

 

**Technology and e-Commerce**

 

Lehman Brothers is committed to maintaining a technology platform todeliver a full range of capital markets information and services to itsinstitutional and high–net–worth client base. The Company-wide e-Commerceorganization, which brings together senior management from all of the Company’sglobal business areas, has developed the Company’s overall e-commerce strategy,approves all e-commerce investments and provides a forum to share e-commerceknowledge and new developments across the Company’s businesses and geographies.The Company’s e-commerce strategy focuses on client and markets connectivity,content and strategic ventures. Lehman Brothers has an integrated client andemployee web site, LehmanLive*,*which serves as a complete suite ofservices, including research and analytics, trade and post-trade (clearing andsettlement information, risk management and prime brokerage) information andemployee applications.  LehmanBrothers has made many strategic investments and is a participant in a numberof institutional trading networks. Notable investments include TradeWeb,MarketAxess and SecuritiesHub in Fixed Income, and TheMarkets.com, EquiLend,Redi/Arca and NYFIX Millennium**inEquities. Additionally, Lehman Brothers has supported the global expansion ofNASDAQ with an investment in its U.S. and European ventures.

 

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**Corporate**

 

The Company’s Corporate division provides support to its businessesthrough the processing of certain securities and commodities transactions;receipt, identification and delivery of funds and securities; safeguarding ofcustomers’ securities; risk management; and compliance with regulatory andlegal requirements. In addition, this staff is responsible for technologyinfrastructure and systems development, treasury operations, financial controland analysis, tax planning and compliance, internal audit, expense management,career development and recruiting and other support functions.

 

**Risk Management**

 

As a leadingglobal investment banking company, risk is an inherent part of the Company’sbusinesses. Global markets, by their nature, are prone to uncertainty andsubject participants to a variety of risks. Lehman Brothers has developed policiesand procedures designed to identify, measure and monitor each of the risksinvolved in its trading, brokerage and investment banking activities on aglobal basis. The principal risks of Lehman Brothers are market, credit,liquidity, legal and operational risks. As part of the Company’s customer flowactivities, Lehman Brothers takes proprietary positions in interest rates,foreign exchange and various securities, derivatives and commodities. Althoughthe Company seeks to mitigate risk associated with such positions throughhedging activities, consistent with its expectations of future events, it issubject to the risk that actual market events may differ from the Company’sexpectations, which may result in losses associated with such positions.

 

Lehman Brothers has developed a control infrastructure to monitor andmanage each type of risk on a global basis throughout the Company. A fulldescription of the Company’s Risk Management procedures is contained in“Management’s Analysis of Results of Operations—­Risk Management” in Item 7 ofthis Report, and is incorporated herein by reference.

 

**Competition**

 

All aspects of the Company’s business are highly competitive. TheCompany competes in U.S. and international markets directly with numerous otherbrokers and dealers in securities and commodities, including traditional andonline securities brokerage firms, investment banking firms, investmentadvisors and certain commercial banks and, indirectly for investment funds,with insurance companies and others.

 

The financial services industry has become considerably moreconcentrated as numerous securities firms have been acquired by or merged intoother firms. These developments have increased competition from other firms,many of which have significantly greater equity capital than the Company.  Legislative and regulatory changes in theUnited States allow commercial banks to enter businesses previously limited toinvestment banks, and several combinations between commercial banks andinvestment banks have occurred, which has further increased competition.

 

**Regulation**

 

The securities industry in the United States is subject to extensiveregulation under both federal and state laws. LBI is registered as a broker–dealer,and LBI and certain other subsidiaries of Holdings are registered as investmentadvisors, with the SEC and as such are subject to regulation by the SEC and byself-regulatory organizations, principally the NASD, national securitiesexchanges such as the New York Stock Exchange (which has been designated by theSEC as LBI’s primary regulator) and the Municipal Securities Rulemaking Board.Securities firms are also subject to regulation by state securitiesadministrators in those states in which they conduct business. LBI is aregistered broker–dealer in all 50 states, the District of Columbia andthe Commonwealth of Puerto Rico. The SEC, self-regulatory organizations andstate securities commissions may conduct administrative proceedings, which mayresult in censure, fine, the issuance of cease-and-desist orders or suspensionor expulsion of a broker–dealer or an investment advisor, its officers oremployees.

 

LBI is also registered with the Commodity Futures Trading Commission(the “CFTC”) as a futures commission merchant and is subject to regulation as suchby the CFTC and various domestic boards of trade and other commodity exchanges.The Company’s U.S. commodity futures and options business is also regulated bythe National Futures Association, a not-for-profit membership corporation whichhas been designated as a registered futures association by 

 

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theCFTC.

 

LBI and its subsidiaries are also subject to regulation by securities,banking and finance regulatory authorities, securities exchanges and otherself-regulatory organizations in other countries in which they do business.

 

The Company believes that it is in material compliance with applicableregulations.

 

**Capital Requirements**

 

LBI and certain ofits subsidiaries are subject to various capital adequacy requirementspromulgated by regulatory and exchange authorities of the countries in whichthey operate and/or to capital targets established by various ratingsagencies.  Reference is made toNote 8 of the Notes to Consolidated Financial Statements beginning on pageF-8 of this Report, which is incorporated herein by reference.

 

**Employees**

 

As of November 30, 2002, the Company employed approximately6,000 persons. The Company considers itsrelationship with its employees to be good.

 

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**ITEM 2****.  PROPERTIES**

 

The new 1,000,000square-foot office tower at 745 Seventh Avenue in New York City, which the Company purchased in 2001,is now fully operational as the Company’s world headquarters.  In September 2002, the Company sold its 1.1 million square foot tenancy-in-commoninterest in Three World Financial Center (the location of its former worldheadquarters) in downtown Manhattan.

 

In addition to itsworld headquarters building,  the Company leases approximately437,000 square feet of office space at 399 Park Avenue and 56,000 square feetof data center space at another location in New York City, each with a termextending until 2016. Both locations are now fully operational.

 

The Company also leases approximately 409,000 square feet ofoffice space in Jersey City, New Jersey, with a term extending until 2016.  As of fiscal year end 2002, 153,000 squarefeet were occupied, with the rest sublet to an unaffiliated third party.  TheCompany expects the remaining 256,000 square feet to be occupied by yearend 2003.   Lehman Brothers leasesapproximately 400,000 square feet of additional office space in Jersey City, ofwhich approximately 32,000 square feet have been subleased to a third-partytenant.  This lease expires in2011.  The Company intends to vacate thelatter space as it occupies the remaining space in the other Jersey Citybuilding and will seek to sublease the vacated space.

 

The Company leases and has options to lease a total ofapproximately 715,000 square feet of space at One World Financial Center (inthe same office complex as Three World Financial Center), which had beenoccupied or had been planned to be occupied prior to September 11, 2001. The lease terms expire at various dates fromDecember 2015 through 2025, with the exception of a lease for 148,000 squarefeet, which expires in 2006.  InApril 2002, the Company entered intoa sublease arrangement with an unaffiliated third party for approximately85,000 square feet of the space at One World Financial Center, which expires inDecember 2015.  The remainder of theleased space remains unoccupied, and the Company continues to explore subleasealternatives with respect to this facility.

 

All three of theCompany’s business segments (as described herein and in the ConsolidatedFinancial Statements of the Registrant and its subsidiaries) use the facilitiesdescribed above (or will use them, in the case of facilities to be occupied).

 

Facilities occupied by the Company (or to be occupied as described above)are believed to be adequate for the purposes for which they are (or are to be)used, and the occupied facilities are well maintained.

 

Additional information with respect to facilities, certain chargesrelated thereto and lease commitments is set forth in Notes 2 and 3 and underthe caption “Lease Commitments” in Note 16 of the Notes to ConsolidatedFinancial Statements beginning on page F-8 of this Report and is incorporatedherein by reference.

 

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**ITEM 3****.  LEGAL PROCEEDINGS**

 

The Company isinvolved in a number of judicial, regulatory and arbitration proceedingsconcerning matters arising in connection with the conduct of its business. Suchproceedings include actions brought against the Company and others with respectto transactions in which the Company acted as an underwriter or financialadvisor, actions arising out of the Company’s activities as a broker or dealerin securities and commodities and actions brought on behalf of various classesof claimants against many securities and commodities firms, including theCompany.

 

Although there canbe no assurance as to the ultimate outcome, the Company generally has denied,or believes it has a meritorious defense and will deny, liability in allsignificant cases pending against it including the matters described below, andit intends to defend vigorously each such case.  Based on information currently available and establishedreserves, the Company believes that the eventual outcome of the actions againstit, including the matters described below, will not, in the aggregate, have amaterial adverse effect on the consolidated financial position or cash flows ofthe Company but may be material to the Company’s operating results for anyparticular period, depending on the level of the Company’s income for suchperiod.

 

*ResearchAnalyst Independence Investigations*

 

On December 20, 2002, LBI reached an agreement inprinciple with the SEC, the New York State Attorney General’s Office, the NewYork Stock Exchange (“NYSE”), the NASD and the North American SecuritiesAdministrators Association (on behalf of state securities regulators) toresolve their investigations of the Company relating to allegations of researchanalyst conflicts of interest.  Pursuantto the agreement in principle, LBI agreed, among other things, (i) to pay $50million in retrospective relief, (ii) to contribute $25 million spread overfive years to provide third-party independent research to clients, (iii) tocontribute $5 million towards investor education and (iv) to adopt internalstructural and operational reforms that will further augment the steps it hasalready taken to promote research analyst independence.  The agreement in principle will become finalupon execution of written agreements acceptable to all of the parties and finaljudicial approval of the settlement. In the fourth quarter of fiscal 2002, the Company recorded a pre-taxcharge associated with the agreement in principle; for additional information see Note4 of the Notes to Consolidated Financial Statements beginning on page F-8of this Report, which is incorporated herein by reference.

 

*AIAHolding SA et al. v. Lehman Brothers Inc. and Bear Stearns & Co., Inc.*

 

In July 1997, LBI was served with a complaint in theUnited States District Court for the Southern District of New York (the “NewYork District Court”) in which 277 named plaintiffs asserted 24 causes ofaction against LBI and Bear Stearns & Co., Inc. The amount of damages wasunspecified. The claims arose from the activities of an individual named AhmadDaouk, who was employed by an introducing broker which introduced accounts toLBI between 1988 and 1992. Daouk allegedly perpetrated a fraud upon theclaimants, who are mostly investors of Middle Eastern origin, and the complaintalleged that LBI breached various contractual and common law duties owed to theinvestors.  In March 1998, the DistrictCourt dismissed without prejudice 18 of the 24 counts pleaded in the complaint.In July 1998, the plaintiffs served a First Amended Complaint containing 18causes of action against LBI and/or Bear Stearns.  Prior to the date for the trial, in December 2002 all partiesagreed to a settlement of all claims.

# ** **

### ***Actions Regarding Enron Corporation***

### ** **

In April 2002, aConsolidated Complaint for Violation of the Securities Laws was filed in theUnited States District Court for the Southern District of Texas (the “TexasDistrict Court”) in *In re Enron Corporation Securities Litigation*(the “*Enron Litigation*”), alleging claims for violation ofSections 11 and 15 of the Securities Act of 1933 (the “Securities Act”),Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act’), andRule 10b-5 thereunder, and the Texas Securities Act.  The case is brought purportedly on behalf of purchasers of EnronCorporation’s publicly traded equity and debt securities betweenOctober 19, 1998, and November 27, 2001, against Holdings and eightother commercial or investment banks, 38 current or former Enron officers anddirectors, Enron’s accountants, Arthur Andersen LLP (“Andersen”) (andaffiliated entities and partners) and two law firms.  The complaint seeks unspecified compensatory and injunctiverelief based on the theory that defendants engaged or participated in

 

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manipulative devices toinflate Enron’s reported profits and financial condition, made false ormisleading statements and participated in a scheme or course of business todefraud Enron’s shareholders.  OnDecember 20, 2002, the Court granted Holdings’ motion to dismiss as to theSection 10(b)/Rule 10b-5 claim and dismissed that claim as to Holdings.  The other claims against Holdings remainpending.

 

In May 2002, acomplaint was filed in the District Court of Galveston County, Texas, 56thJudicial Circuit, against LBI and Holdings by American National InsuranceCompany and certain of its affiliates. The complaint is based on the allegations in the*Enron Litigation* and asserts that plaintiffs relied ondefendants’ allegedly false and misleading statements in purchasing andcontinuing to hold Enron debt and equities in their LBI accounts.  The complaint alleges violations of theTexas State Securities Act, fraud, breach of fiduciary duty, negligence andprofessional malpractice, and seeks unspecified compensatory relief andpunitive damages. LBI and Holdings removed this case to the Texas DistrictCourt, and plaintiffs have filed a motion to remand the case back to statecourt.

 

Also in May 2002,a Third Amended Petition was filed in the District Court of Tulsa County,Oklahoma, by Samson Investment Company alleging that Andersen is liable forplaintiffs’ damages, allegedly incurred in connection with certain contractsentered into with Enron.  Plaintiffsallege that Andersen conspired with Enron to misrepresent Enron’s financialcondition in its financial statements. In December 2002, Andersen filed a Third-Party Petition against LBI,Holdings and other commercial and investment banks.  The Third Party Petition seeks contribution from LBI and Holdingsin the event Andersen is held liable to plaintiffs and alleges that LBI,Holdings and other third-party defendants were involved in creating and usingEnron’s special purpose entities (“SPEs”), engaged in transactions with theSPEs, misrepresented or failed to disclose to Andersen information about theSPEs and issued analysts’ reports that enhanced the public’s perception ofEnron’s financial performance and condition.

 

In August 2002, acomplaint was filed in the Court of Common Pleas, Civil Division, FranklinCounty, Ohio, against Holdings, along with four other commercial or investmentbanks, among other defendants, by the Public Employees Retirement System ofOhio and three other state employee retirement plans.  The complaint alleges that defendants engaged or participated inmanipulative devices to inflate Enron’s reported profits and financialcondition, made false or misleading statements and participated in a scheme orcourse of business to defraud Enron’s shareholders, and that plaintiffs reliedon defendants’ false and misleading statements in purchasing and continuing tohold Enron debt and equities in the State’s pension funds.  Against Holdings, the complaint allegesclaims for common law fraud and deceit, aiding and abetting common law fraud,conspiracy to commit fraud, negligent misrepresentation and violation of theTexas Securities Act, and seeks unspecified compensatory relief and punitivedamages.  This action was removed tofederal court, transferred to the Texas District Court and consolidated withthe *EnronLitigation*.

 

Also in August2002, Capital Management, L.P., the former general partner of LJM2Co-Investment, L.P. (“LJM2”), an Enron-related SPE, filed a third-party claimin Delaware Chancery Court alleging that Holdings’ subsidiary LB I GroupInc., an investor in LJM2, together with the other LJM2 limited partnersbreached the Limited Partnership Agreement by rescinding a capital call.  The case has been removed to federal courtand a motion has been made to transfer it to the U.S. Bankruptcy Court inDallas, Texas, where the LJM2 bankruptcy is proceeding.  A motion to remand the case back to statecourt is also pending.

 

InSeptember 2002, the Washington State Investment Board, which is a namedplaintiff in the *Enron Litigation*, filed a new purported class action in theTexas District Court.  This actionmirrors the claims in the *Enron Litigation*, but alleges a classaction period of September 9, 1997, to October 18, 1998.  This action is an attempt to expand the classaction period in the *Enron Litigation* based upon the lengthenedstatute of limitations in the Sarbanes-Oxley Act of 2002.

 

In October 2002,two actions were filed in Iowa state court (Linn and Polk Counties) against LBIand Holdings, along with several other commercial or investment banks, by AUSALife Insurance Co., Principal Global Investors, LLC, and certain otherpurchasers of Enron securities.  Thecomplaints seek rescission and an unspecified amount of compensatory andpunitive damages.  The complaints allegethat defendants participated in the alleged Enron fraudulent scheme byparticipating in Enron’s debt offerings, making disguised loans to Enron andparticipating in transactions involving Enron’s SPEs, which were used to avoidrecognizing losses.  Plaintiffs allegethat through the performance of these services, defendants gained knowledge ofEnron’s inflated values but failed to disclose that information.  The 

 

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complaints allegeviolations of the Iowa Securities Act and claims for fraud and deceit and forcivil conspiracy.  The Polk County action was removed to federalcourt but has been remanded to state court.  The Linn County action has been removed to federal court, andplaintiffs have moved to remand it back to state court, while defendants haverequested that the action be transferred to the Bankruptcy Court for theSouthern District of New York, where the Enron bankruptcy is proceeding.

 

Also in October2002, a complaint was filed in Superior Court for Los Angeles County againstLBI, Holdings, and other commercial or investment banks by two Oaktree CapitalManagement investment funds.  Thecomplaint alleges that Enron systematically falsified its financial statementsusing improper accounting valuations and false hedges that enabled Enron toboost its reported earnings.  Plaintiffsallege that Enron’s bankers, including LBI and Holdings, participated in thefraudulent scheme by obtaining loan proceeds that Enron falsely characterizedas prepaid commodity trades, falsely concealing the true financial condition ofEnron from rating agencies and institutional investors and creating and usingnote offerings by Enron’s SPEs to generate new cash for Enron.  The complaint alleges that defendants knewand acted on inside information about Enron’s true financial condition inconnection with its offerings of Enron securities, while misrepresenting oromitting material facts to the public. The complaint makes claims under California state law for trading oninside information, for making false and misleading statements and for unfaircompetition by material misstatements or omissions in connection with Enronsecurities offerings.  The complaintseeks compensatory damages, an accounting, restitution and disgorgement ofprofits.

 

In December 2002, aSecond Amended Petition was filed against Andersen in the District Court ofWashington County, Texas, 21st Judicial District, by Jane Bullock and otherpurchasers of Enron securities making claims for fraud, negligentmisrepresentation and civil conspiracy in connection with allegedly materiallymisleading public statements concerning Enron’s financial condition.  In January 2003, Andersen filed aThird-Party Petition against LBI, Holdings and other commercial or investmentbanks.  The Third Party Petition seeksassessment of proportionate liability and contribution from LBI and Holdingsand the other third-party defendants. The Third Party Petition alleges that the third-party defendants wereinvolved in creating, structuring, using and managing Enron’s SPEs,misrepresented or failed to disclose information regarding the SPEs, madepublic statements about Enron, financially assisted Enron, assisted Enron inraising money, invested in the SPEs and engaged in transactions involvingEnron’s assets.

 

*First Alliance Mortgage CompanyMatters*

 

During 1999 andthe first quarter of 2000, Lehman Commercial Paper, Inc. (“LCPI”) provided awarehouse line of credit to First Alliance Mortgage Company (“FAMCO”), and LBIunderwrote the securitizations of mortgages originated by FAMCO.  Prior to 1999, LCPI had provided a $25million back-up warehouse line to FAMCO for an 18-month period, and LBI hadco-managed four securitizations, one each quarter, both of which engagements endedat the conclusion of the third quarter of 1997.  In March 2000, FAMCO filed for protection from its creditorsunder Chapter 11 of the United States Bankruptcy Code.  In August 2001, a purported adversary classaction (the “Class Action”) was filed in the United States Bankruptcy Court forthe Central District of California (the “Bankruptcy Court”), allegedly onbehalf of a class of FAMCO borrowers seeking equitable subordination of LPCI’s(among other creditors’) liens and claims in the Bankruptcy Court.  In October 2001, the complaint was amendedto add LBI as a defendant and to add claims for aiding and abetting allegedfraudulent lending activities by FAMCO and for unfair competition under theCalifornia Business and Professions Code*.* In August 2002, a Second Amended Complaint was filed, which added aclaim for punitive damages and extended the class period from May 1, 1996,until FAMCO’s bankruptcy filing.  Thepending complaint seeks actual and punitive damages, the imposition of aconstructive trust on all proceeds paid or being paid by FAMCO to LCPI and LBI,disgorgement of profits, and attorneys’ fees and costs.

 

In November 2001,the Official Joint Borrowers Committee (the “Committee”) initiated an adversaryproceeding, allegedly on behalf of the FAMCO-related debtors, in the BankruptcyCourt by filing a complaint against LCPI, LBI, Holdings and several individualofficers and directors of FAMCO and its affiliates.  As to the Lehman Brothers defendants, the Committee assertedbankruptcy claims for avoidance of lien, recovery of property, equitablesubordination and disallowance of claim, and also asserted claims fordeclaratory relief and aiding and abetting breach of fiduciary duty.  In December 2001, the Committee amended itscomplaint, dropping  Holdings as adefendant and adding claims for equitable indemnification and contribution,which claims have subsequently been dismissed. In 

 

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addition to relief underthe Bankruptcy Code, the Committee seeks unspecified compensatory damages.

 

The United StatesCourt for the Central District of California (the “California District Court”)withdrew the reference to the Bankruptcy Court in both of these cases and inFebruary 2002 consolidated them before the California District Court.  In November 2002, the California DistrictCourt entered an order defining the class in the Class Action as “all personswho acquired mortgage loans from First Alliance from May 1, 1996 through March31, 2000, which were used as collateral for First Alliance’s warehouse creditline with Lehman Commercial Paper Inc. or were securitized in transactionsunderwritten by Lehman Brothers Inc.”

 

In February 2003,the California District Court issued an Order granting Lehman’s motion forsummary judgment on the California Business and Professions Code claims andgranting Lehman’s motion for partial summary judgment on the claims prior to1999 and dismissing those claims. Trial began on February 18, 2003.

 

Separately, LBI has haddiscussions with the Florida Attorney General’s office about that office’sinvestigation of LBI regarding LBI’s role in connection with First Alliance.

 

*ActionsRegarding Frank Gruttadauria*

 

LBI discovered in January2002 that Frank Gruttadauria, the former branch manager of LBI’s Clevelandoffice, which was acquired in October 2000 from SG Cowen Securities Corporation(‘‘SG Cowen’’) as part of the purchase by LBI of certain accounts and relatedassets belonging to SG Cowen’s private client group, had apparently beeninvolved in creating false account statements for clients of that office andmay have caused unauthorized transfers of funds from client accounts. Thisconduct allegedly took place for a number of years and began well prior to theacquisition of this office by LBI. Under the terms of the purchase agreement,SG Cowen retained liability for activities arising out of the conduct oroperation of the business while owned by SG Cowen.

 

To date, the following cases have been filed againstLehman Brothers and SG:  eight cases inthe United States District Court for the Northern District of Ohio, six casesin the United States District Court for the Northern District of Illinois, onecase in the United States District Court for the Southern District of California,and one case in the United States District Court for the Eastern District ofWisconsin.  One of the cases pending inthe United States District Court for the Northern District of Illinois has beenstayed pending arbitration before the NASD by agreement of the parties.  Six arbitrations have been filed includingfour before the NYSE, the previously referenced matter before the NASD, and oneadditional matter before the NASD.  Fourof the foregoing matters, the case pending in United States District Court forthe Southern District of California, two of the cases pending in the UnitedStates District Court for the Northern District of Illinois, and one of thecases filed before the NYSE, have been settled.  Generally speaking, the remaining complaints, amended complaintsand statements of claim allege violations of federal securities laws,violations of state and Blue Sky laws, civil conspiracy, and common law claimsfor fraud, promissory estoppel, negligent and reckless failure to supervise andbreach of fiduciary duty.  On the whole,plaintiffs seek compensatory and punitive damages, pre- and post-judgmentinterest, attorneys’ fees and costs, an accounting, and in some instances,treble damages.  Each case still pendingin federal court is or will be subject to a motion to stay pending arbitrationbased on plaintiffs’ contractual agreement to arbitrate their claims againstdefendants, and eight of the federal court matters are currently subject toappeals to the United States Court of Appeals as a result of the districtcourts’ denial of motions to stay pending arbitration.  One of the NYSE arbitrations is scheduled togo to a hearing in May of 2003, and one of the NASD arbitrations is scheduledto go to a hearing in July of 2003.

 

LBI received and responded torequests for information, documents and/or testimony related to theGruttadauria matter from the NYSE, the SEC, the Division of Securities of theDepartment of Commerce of the State of Ohio (“Ohio Securities Division”) andthe U.S. House of Representatives Committee on Financial Services, Subcommitteeon Oversight and Investigations.  LBI isin discussions with the NYSE, the SEC and the Ohio Securities Division toresolve any regulatory concerns in this matter.

 

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*IPOAllocation Cases*

 

LBI was named as adefendant in approximately 192 purported securities class actions that werefiled between March and December 2001 in the New York District Court. Theactions, which allege improper IPO allocation practices, have been brought bypersons who, either directly or in the aftermarket, purchased IPO securitiesduring the period between March 1997 and December 2000. The plaintiffs allegethat Lehman and other IPO underwriters required persons receiving allocations ofIPO shares to pay excessive commissions on unrelated trades and to purchaseshares in the aftermarket at specified escalating prices. The plaintiffs, whoseek unspecified compensatory damages, claim that these alleged practicesviolated various provisions of the federal securities laws, specifically,sections 11, 12(a)(2) and 15 of the Securities Act, section 10(b) of theExchange Act, Rule 10b-5 thereunder, and section 20(a) of the Exchange Act. The192 actions in which LBI was named a defendant have been consolidated into 83cases, each involving a distinct offering. Those 83 consolidated cases, andapproximately 240 others in which LBI is not named as a defendant, have beencoordinated for pretrial purposes before a single judge.

 

In January 2002, aseparate consolidated class action, entitled *Inre Initial Public Offering Antitrust Litigatio*n, was filed againstLBI, among other underwriters, alleging violations of federal and stateantitrust laws. The complaint alleges that the underwriter defendants conspiredto require customers who wanted IPO allocations to pay back to the underwritersa percentage of their IPO profits in the form of commissions on unrelatedtrades, to purchase other, less attractive securities and to buy shares in theaftermarket at predetermined escalating prices. Originally filed as twelveseparate class actions in three different courts, the consolidated antitrustaction is now pending before a single judge—different from the one hearing thesecurities cases—in the New York District Court. The antitrust plaintiffs seekunspecified treble damages.

 

In April 2002, a suit wasfiled in Delaware Chancery Court by Breakaway Solutions Inc. (“Breakaway”),which names LBI and two other underwriters as defendants.  The complaint purports to be brought onbehalf of a class of issuers who issued securities in initial public offerings(“IPOs”) through at least one of the defendants during the period of January1998 through October 2000 and whose securities increased in value 15% or moreabove the original price within 30 days after the IPO.  It alleges that defendants underpriced IPOsecurities and allocated those underpriced securities to certain favoredcustomers in return for alleged arrangements with the customers for increasedcommissions on other transactions and alleged tie-in arrangements.  The complaint asserts claims for breaches ofcontract, of the implied covenant of good faith and fair dealing and offiduciary duty, and for indemnification or contribution and unjust enrichmentor restitution.  Breakaway seeks, amongother relief, certification of a class, a permanent injunction preventingdefendants from engaging in the alleged practices, an accounting of alldefendants’ commissions, profits and compensation in connection with the IPOs,declarations requiring defendants to indemnify Breakaway in the pendingconsolidated IPO securities class actions and determining that Breakaway has noindemnification obligation to defendants in those actions, and compensatorydamages.

 

*IPOFee Litigation*

 

*HaroldGillet, et al. v. Goldman Sachs & Co., et al.; Yakov Prager, et al. v.Goldman, Sachs & Co., et al.; David Holzman, et al. v. Goldman, Sachs &Co., et al. *Beginningin November 1998, four purported class actions were filed in the New York DistrictCourt against in excess of 25 underwriters of initial public offering (‘‘IPO’’)securities, including LBI. Plaintiffs, alleged purchasers of securities issuedin certain IPOs, seek compensatory and injunctive relief for alleged violationsof the antitrust laws based on the theory that the defendants fixed andmaintained fees for underwriting certain IPO securities at supra-competitivelevels. By memorandum and order in February 2001 (the ‘‘Order’’), the New YorkDistrict Court granted defendants’ motion to dismiss the Consolidated AmendedComplaint, concluding that the purchaser plaintiffs lacked standing under theantitrust laws to assert the claims. On appeal, the U.S. Court of Appeals forthe Second Circuit reversed and remanded the case to the New York DistrictCourt for further proceedings, including potential dismissal of the claimsbased on additional arguments raised in the motion to dismiss.

 

*In ReIssuer Plaintiff Initial Public Offering Fee Antitrust Litigation.* By order dated April 10, 2001, the New YorkDistrict Court consolidated four actions pending before the court brought bybankrupt issuers of IPO securities

 

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against more than 20 underwriter defendants (includingLBI). In July 2001, the plaintiffs filed a consolidated class action complaintseeking unspecified compensatory damages and injunctive relief for allegedviolations of the antitrust laws based on the theory that the defendantunderwriters fixed and maintained fees for underwriting certain IPO securitiesat supra-competitive levels. CHS Electronics and MDCM Holdings, two of the fouroriginal plaintiffs, subsequently withdrew their claims.

 

*IslandVenture Corporation, et al. v. Lehman Brothers Inc. and Lehman BrothersSecurities Asia, Ltd.*

 

On February 9, 2001,Island Venture Corporation, Continental Resources Corporation, RecolaInvestment Corporation, Grand Concord Corporation and Goodwell IndustrialCorporation filed a First Amended Complaint in the United States District Courtfor the District of New Jersey against LBI and Lehman Brothers Securities Asia,Ltd. In July 2001, plaintiffs filed a Second Amended Complaint. The complaintarises in connection with the plaintiffs’ purchase of various promissory notesissued by Indonesian companies in 1997 and upon which the issuers havedefaulted. It also asserts claims relating to an alleged unauthorizedliquidation for $8.5 million of a $10 million Asia Investment Grade DefaultNote (‘‘Basket Note’’) issued by Lehman Brothers Holdings PLC. The complaintseeks rescission and damages under various common law theories of mutualmistake, breach of contract, breach of fiduciary duty, negligence, negligentmisrepresentation and constructive fraud, as well as asserting claims underSection 10(b) of the Securities Exchange Act. The plaintiffs seek to recoverdamages of approximately $60 million on all the notes they purchased and thedifference between the liquidation price and the face value of the Basket Noteplus lost interest payments.

 

### ***In re Metricom Securities Litigation***

### ** **

In August 2002, a FirstAmended Consolidated Class Action Complaint for Violation of the Securities Actof 1933 and the Exchange Act of 1934, Corrected Copy, was filed in the UnitedStates District Court for the Northern District of California captioned *In re Metricom Securities Litigation*.  The action is brought on behalf of apurported class of investors who purchased the common stock of Metricom, Inc.,during the period from June 21, 1999, to July 2, 2001. Plaintiffs name variousofficers, directors and selling shareholders of Metricom, along with LBI andthe four other co-managing underwriters of an offering of Metricom common stockon February 3, 2000. Prior to the commencement of this action, Metricom filedfor protection under the federal bankruptcy code. The February 2000 offeringraised approximately $500 million. Against the underwriters, plaintiffs allege violations of Sections 11and 12(2) of the Securities Act and of Section 10(b) of the Exchange Act. Thecomplaint alleges that the prospectus and registration statement for theoffering failed to disclose material facts concerning, among other things,Metricom’s flawed business plan and marketing strategy. The complaint seeksclass action status, damages and ‘‘statutory compensation,” and attorneys’ feesand other costs.

 

*WorldCom Bondholders Litigation*

# ** **

LBI and otherunderwriters of WorldCom, Inc., bonds issued in several offerings in each of1997, 1998, 2000 and 2001 have been named as defendants in certain lawsuitsalleging that the offering materials were false and misleading.   LBI underwrote $915 million principalamount of bonds in the 1998 offerings and $375 million principal amount ofbonds in the 2000 offerings.  (LBI didnot participate in the 1997 and 2001 offerings.)  With respect to LBI, a purported class action was filed in July2002 in the New York District Court.  OnOctober 11, 2002, the complaint was superceded by the filing of a consolidatedputative class action complaint in the New York District Court, entitled *In re WorldCom, Inc. Securities Litigation*.  This action alleges violations by theunderwriters of the federal securities law, including Sections 11 and 12 of theSecurities Act, in connection with May 2000 and May 2001 bond offerings, and isbrought on behalf of purchasers and acquirers of bonds issued in or traceableto these offerings.  In addition to theabove purported class action, a number of individual actions have been filed inconnection with some or all of these WorldCom bond offerings.

 

A lawsuit wasfiled in October 2002 in the Supreme Court of the State of New York, New YorkCounty, by municipal pension funds that allegedly purchased WorldCom commonstock and $383 million principal amount of WorldCom notes, an unspecified amountof which are alleged to be traceable to the 2000 public offerings.  The complaint alleges violations of Section11 of the Securities Act, along with common law claims, against LBI and

 

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Holdings.  Plaintiffs seek, among other things,unspecified compensatory and punitive damages.

 

A suit was filedin November 2002 in the Washington Superior Court, Kings County, by a statepension fund that allegedly purchased approximately $162 million principalamount of WorldCom notes issued in the 1998, 2000 and 2001 public offerings.The complaint alleges violations of Section 11 of the Securities Act by LBI andHoldings.  Plaintiff seeks unspecifiedcompensatory damages, among other things.

 

Three otherlawsuits were filed in November 2002 and January 2003 in the Superior Court ofCalifornia, Los Angeles County, by county, municipal and private pension andretirement funds that allegedly purchased, respectively, approximately $157million, $102 million and $135 million principal amount of WorldCom notesissued in the 1998, 2000 and 2001 public offerings and a December 2000 privateoffering.  The complaints allegeviolations of Section 11 of the Securities Act by LBI and Holdings.  Plaintiffs seek rescission or unspecifiedcompensatory damages, among other things.

 

Two suits werefiled in December 2002 in the Wisconsin Circuit Court, Dane County, and in theState of Minnesota District Court, Second Judicial District, by state andmunicipal pension funds, which allegedly purchased a total of approximately$133 million and $161 million, respectively, of WorldCom notes issued in the1998, 2000 and 2001 public offerings. The complaint alleges violations ofSection 11 of the Securities Act by LBI and Holdings.  Plaintiffs seek rescission or unspecified compensatory damages,among other things.

 

A lawsuit was filed inJanuary 2003 in the Chancery Court of Davidson County in Tennessee on behalf ofthe Tennessee Consolidated Retirement System, which allegedly purchased $60million principal amount of WorldCom notes issued in the 1998 and 2000offerings (as well as $102 million in the 2001 offerings in which Lehman didnot participate).  The complaint allegesviolations of Section 11 of the Securities Act against LBI and Holdings andseeks unspecified compensatory damages, among other things.

 

In addition,actions have been filed in federal court in Mississippi by a bank and trustcompany and in state courts in Ohio and Montana by a state or union pensionfunds; each, insofar as LBI is concerned, allege violations of disclosurerequirements and assert damages of less than $15 million.

 

Each of these individual actions, with the exceptionof the actions filed in January 2003, has been removed to federal court andeach has been, or is expected to be, transferred by the Judicial Panel onMultidistrict Litigation to the New York District Court for consolidatedpre-trial proceedings with the class action pending in the New York DistrictCourt.  A motion to remand these actionsto state court is pending.

 

Most of theseactions also name as defendants certain of WorldCom’s present or formerofficers and/or directors and/or WorldCom’s outside accounting firm.  On July 21, 2002, WorldCom, Inc. filed forprotection under the U.S. bankruptcy laws.

 

**ITEM 4****.  SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

Pursuantto General Instruction I of Form 10-K, the information required by Item 4is omitted.

 

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**PART II**

 

**ITEM 5****.  MARKET FOR REGISTRANT’S COMMONEQUITY AND RELATED STOCKHOLDER MATTERS**

 

All of the outstanding Common Stock, par value $0.10 per share, of LBIis owned by Holdings.  For informationon payment of dividends by the Company during the two most recent fiscal years,see Note 17 of Notes to Consolidated Financial Statements beginning onpage F-8 hereof, which information is incorporated herein by reference.

 

**ITEM 6****.  SELECTEDFINANCIAL DATA**

 

Pursuant to General Instruction I of Form 10-K, the informationrequired by Item 6 is omitted.

 

**ITEM 7****.  MANAGEMENT’S ANALYSIS OFRESULTS OF OPERATIONS**

 

Pursuant to General Instruction I of Form 10-K, set forth on thefollowing pages is Management’s Analysis of Results of Operations for thetwelve months ended November 30, 2002 and November 30, 2001. Suchinformation should be read in conjunction with the Consolidated FinancialStatements of the Registrant and its Subsidiaries together with the Notesthereto beginning on page F-1 hereof.

 

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** **

**MANAGEMENT’S ANALYSIS OF RESULTS OF OPERATIONS**

** **

**TABLE OF CONTENTS**

** **
| **Forward Looking Statements**          | 22                    |
|-----------------------------------------|-----------------------|
|                                    |
| **Results of Operations**               | 23                    |
|                                    | Net Revenues          | 23 |
|                                    | Non-Interest Expenses | 24 |
|                                    | Income Taxes          | 25 |
|                                    | Segments              | 25 |
|                                    |                  |   |
| **Summary of  Contractual Obligations** | 30                    |
|                                    |                  |   |
| **Off-Balance-Sheet  Arrangements**     | 31                    |
|                                    |                  |   |
| **Risk Management**                     | 34                    |
|                                    | Credit Risk           | 35 |
|                                    | Market Risk           | 35 |
|                                    | Operational Risk      | 36 |
|                                    | Value at Risk         | 36 |
|                                    |                  |   |
| **Critical Accounting  Policies**       | 37                    |
|                                    |                  |
| **New Accounting Developments**         | 39                    |
|                                    |                  |
| **Effects of Inflation**                | 39                    |

 

21

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**ForwardLooking Statements**

 

Some of the statements contained in thisManagement’s Analysis of Results of Operations, including those relating to theCompany’s strategy and other statements that are predictive in nature, thatdepend upon or refer to future events or conditions or that include words suchas “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates” andsimilar expressions, are forward-looking statements within the meaning ofSection 21E of the Securities Exchange Act of 1934. These statements are nothistorical facts but instead represent only the Company’s expectations,estimates and projections regarding future events. These statements are notguarantees of future performance and involve certain risks and uncertaintiesthat are difficult to predict, which may include, but are not limited to,market, credit or counterparty, liquidity, legal and operational risks. Marketand liquidity risks include changes in interest and foreign exchange rates andsecurities and commodities valuations, the availability and cost of capital andcredit, changes in investor sentiment, global economic and political trends,concerns about possible military action and terrorist activity and industrycompetition. Legal risks include legislative and regulatory developments in theU.S. and throughout the world. The Company’s actual results and financialcondition may differ, perhaps materially, from the anticipated results andfinancial condition in any such forward-looking statements and, accordingly,readers are cautioned not to place undue reliance on such statements. TheCompany undertakes no obligation to update any forward-looking statements,whether as a result of new information, future events or otherwise.  For additional factors that may affect resultsof operations, see “Business—Forward-Looking Statements” in Item 1 of thisReport, which is incorporated herein by reference.

 

22

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**Resultsof Operations**

 

The Company reported net income of $740 million in 2002, $855 millionin 2001 and $1,134 million in 2000. Although 2002 results decreased from prior year’s levels, the Companybelieves that these results in an extremely challenging market environment,coupled with market share increases in many products, demonstrate the strength,diversity and resiliency of the Company’s franchise.  The Company has improved its market position in a number of keyareas including: Merger and Acquisition (“M&A”) advisory and debt andcommon stock underwriting. The Company also continued to maintain a strict disciplinewith regard to its core competencies during the year, specifically managingexpenses, risk management and capital deployment.

 

The Company’s results in 2002 include theimpact of two special items:  an $8million pre-tax charge associated with decisions to reconfigure certain realestate and an $80 million pre-tax charge related to the Company’s participationin the proposed settlement regarding allegations of research analyst conflictsof interest.  The net pre-tax effect ofthese two items is a charge of $88 million ($60 million after-tax). (Additionalinformation about these amounts can be found in Notes 3 and 4 to theConsolidated Financial Statements.)

 

The Company’s 2001 results include the impact of a $51 million pretaxspecial charge stemming from the events of September 11th, whichresulted in the displacement and relocation of substantially all of theCompany’s New York based employees. (Additional information about this charge can be found in Note 2 to theConsolidated Financial Statements.)

 

*NetRevenues*

 

The Company recorded net revenues of $3,927 million, $4,094 million and$4,735 million for fiscal years 2002, 2001, and 2000, respectively.  The decrease in net revenues over thisthree-year period principally resulted from the deterioration of marketconditions from the more favorable environment in 2000.  The 4% decrease in net revenues in 2002 wasprincipally the result of lower equity capital markets revenue levels,partially offset by an increase in fixed income capital markets revenues and aslight increase in Client Services revenues.

 

*Principal**Transactions, Commissions and Net Interest Revenues*

 

The Company evaluates the performance of its Capital Markets and ClientServices revenues in the aggregate, including Principal transactions,Commissions and net interest.  Decisionsrelating to these activities are based on an overall review of aggregaterevenues, which includes an assessment of the potential gain or loss associatedwith a transaction, including any associated commissions, and the interestrevenue or expense associated with financing or hedging the Company’spositions.  Therefore, the Company viewsnet revenues from Principal transactions, Commissions and Interest revenue,offset by Interest expense, in the aggregate. Caution should be used when analyzing these revenue categoriesindividually, as they are not always indicative of the performance of theCompany’s overall Capital Markets and Client Services activities.

 

Principal transactions, Commissions and Net interest revenues totaled$2,438 million in 2002 as compared to $2,542 million in 2001 and $3,066 millionin 2000. The 4% decrease in 2002 from 2001 principally reflects the negativeconditions within the U.S. equity markets. Partially offsetting this decline was an increase in fixed incomerevenues, particularly mortgage products, which benefited from low interestrate levels and increased customer flow activities as investors sought moredefensive asset classes.   Principal transactions,Commissions and net interest revenues decreased by $524 million or 17% in 2001from 2000, reflecting the depressed market environment in 2001.

 

Within the above amounts, Principaltransactions revenues were $577 million in 2002 as compared to $903 million in2001 and $1,938 million in 2000. Commissions revenues were $1,073 million in2002 as compared to $848 million in 2001 and $686 million in 2000.  Interest and dividend revenues were $8,985million in 2002 as compared to $14,276 million in 2001 and $16,501 million in2000.  Interest expense was $8,197million in 2002 as compared to $13,485 million in 2001 and $16,059 million in2000.

 

23

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The decrease in Principal transactions revenues in 2002 and 2001principally reflects reduced equity product revenues resulting from poor marketconditions.  In addition, Principaltransactions revenues decreased in 2002 as a result of the transition to acommission-based revenue structure on NASDAQ trades,  whereby these revenues are classified as Commissions in2002.  In prior years, the Company’sNASDAQ trades for substantially all of its institutional customers weretransacted on a spread basis, with related revenues classified within Principaltransactions.

 

Commissions revenues increased in 2002 as compared to the prior year’slevels due to the migration to institutional commission-based pricing in theNASDAQ market, growth in market trading volumes and an increase in theCompany’s market share of listed and NASDAQ trading volumes.  Commission revenues increased in 2001 as aresult of growth in market trading volumes and an increase in the Company’smarket share of listed and NASDAQ trading volumes.

 

Interest and dividends revenues and Interest expense are a function ofthe level and mix of total assets and liabilities, principally financialinstruments owned and secured financing activities, the prevailing level ofinterest rates, as well as the term structure of the Company’s financings.  Interest and dividends revenues and Interestexpense are integral components of the Company’s overall customer flowactivities.  The decline in interestrevenue and interest expense in 2002 and 2001 is principally due to thesubstantial declines in interest rates during those periods.  Net interest income of $788 million in 2002was relatively flat from net interest income of $791 million in 2001. Theincrease in net interest income to $791 million in 2001 from $442 million in2000 was due to a change in inventory mix to higher levels of interest-bearingassets in response to shifts in customer demands and a lower cost of funding.

 

*InvestmentBankin**g*

 

Investment banking revenues were $1,457million in 2002 as compared to $1,508 million in 2001 and $1,614 in 2000.Investment banking revenues result mainly from fees earned by the Company forunderwriting public and private offerings of fixed income and equitysecurities, and advising clients on M&A activities and other services.  In 2002, Investment banking revenuesdecreased 3% from 2001, reflecting lower levels of M&A advisory activities,partially offset by higher equity underwriting revenues that were principallygenerated by a small number of large transactions.  In 2001, Investment banking revenues decreased by 7% primarily asa result of decreases in equity origination and M&A activities due toindustry wide decreases in volume, partially offset by higher fixed incomeunderwriting.

 

*Non-Interest Expenses*

 

*In millions*

 
|                                       |   | **2002** |   | **2001** |   | **2000** |   |
|--------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                                       |   |     |   |     |   |     |   |
| *Twelve months ended November 30,*         |   |     |   |     |   |     |   |
|                                       |   |     |   |     |   |     |   |
| Compensation  and benefits                 |   | $        | 2,002  |     | $      | 2,088    |   | $ | 2,304 |   |
|                                       |   |     |   |     |   |     |   |
| Nonpersonnel                               |   | 891      |   | 826      |   | 814      |   |
|                                       |   |     |   |     |   |     |   |
| Regulatory  settlement                     |   | 80       |   | —   |   | —   |   |
|                                       |   |     |   |     |   |     |   |
| Other  real estate reconfiguration costs   |   | 8        |   | —   |   | —   |   |
|                                       |   |     |   |     |   |     |   |
| September  11th (recoveries)/expenses, net |   | —   |   | 51       |   | —   |   |
|                                       |   |     |   |     |   |     |   |
| Total  non-interest expenses               |   | $        | 2,981  |     | $      | 2,965    |   | $ | 3,118 |   |
|                                       |   |     |   |     |   |     |   |
| Compensation  and benefits/Net revenues    |   | 51.0     | %      | 51.0     | %      | 48.7     | %      |

 

Non-interest expenses were $2,981 million for fiscal 2002, relativelyflat from $2,965 million in fiscal 2001 and down 5% in fiscal 2001 from $3,118million in fiscal 2000.  Totalnon-interest expenses in fiscal 2002 included two special items: a charge of $8million for certain real estate reconfiguration costs and a charge of $80million resulting from the Company’s regulatory settlement associated withallegations of research analyst conflicts of interest.  Fiscal 

 

24

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2001 total non-interest expenses included  a net charge associated with September 11th relatedexpenses.  (Additional information aboutthese charges can be found in Notes 2, 3 and 4 to the Consolidated FinancialStatements).

 

Nonpersonnel expenses were $891 million in 2002 compared to $826million in 2001.  The increase innonpersonnel expenses is principally attributable to increases in netmanagement fees and occupancy costs, partially offset by decreases in  technology and communications and otherdiscretionary spending for business development and professional fees.  Management fee expenses increased in 2002,primarily a result of a net decrease in services provided by the Company toaffiliates.  Occupancy expense increasedto $185 million in 2002 from $115 millions in 2001, principally attributable toadditional space to accommodate the growth in headcount resulting from theCompany’s expansion during the past several years as well as the increased costof our new corporate headquarters. Nonpersonnel expenses remained relatively flat in 2001 from 2000, asincreases in investments in technology and communications, occupancy expensesto accommodate headcount growth and brokerage and clearance expenses wereoffset by reductions in other expense items.

 

Compensation and benefits expenses were $2,002 million in 2002, $2,088million in 2001 and $2,304 million in 2000. Compensation and benefits expenseas a percentage of net revenues in 2002 remained consistent at approximately51%.  Compensation and benefits expenseincludes the cost of salaries, incentive compensation and employee benefitplans as well as the amortization of deferred stock compensation awards.Compensation and benefits expenses decreased 4% from 2001 and 9% in 2001 from2000, consistent with the decrease in the Company’s revenues.

 

*IncomeTaxes*

 

The Company recorded an income tax provision of $206 million, $274million and $483 million in 2002, 2001, and 2000, respectively.  These provisions resulted in effective taxrates of 21.8%, 24.3%, and 29.9%, respectively.

 

The decrease in the effective tax rate was primarily due to an overalldecrease in the level of pretax income, which increased the relative impact ofcertain tax preference items, particularly tax-exempt income.

 

Additional information about the Company’s income taxes can be found inNote 10 to the Consolidated Financial Statements.

 

**Segments**

 

The Company is segregated into three business segments (each of whichis described below): Investment Banking, Capital Markets and ClientServices.  Each segment represents agroup of activities and products with similar characteristics.  These business activities result in revenuesfrom both institutional and high-net-worth retail clients, which are recognizedacross all revenue categories contained in the Company’s Consolidated Statementof Income.  (Net revenues also containcertain internal allocations, including funding costs, which are centrallymanaged.)

 

25

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Segment Results

 
| **In  millions**                           |   | **Investment  Banking** | ** ** | **Capital  Markets** | ** ** | **Client  Services** | ** ** | **Total** | ** ** |
|--------------------------------------------|--------|-------------------------|------------|----------------------|------------|----------------------|------------|-----------|------------|
|                                       |   |                    |       |                 |       |                 |       |      |       |
| **Twelve  months ended November 30, 2002** |   |                    |       |                 |       |                 |       |      |       |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Principal  Transactions                    |   | $                       | —     |                 | $          | 73                   |       | $         | 504        |   | $ | 577 |   |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Interest and  Dividends                    |   | —                  |       | 8,947                |       | 38                   |       | 8,985     |       |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Investment  Banking                        |   | 1,452                   |       | —               |       | 5                    |       | 1,457     |       |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Commissions                                |   | —                  |       | 850                  |       | 223                  |       | 1,073     |       |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Other                                      |   | —                  |       | 10                   |       | 22                   |       | 32        |       |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Total Revenues                             |   | 1,452                   |       | 9,880                |       | 792                  |       | 12,124    |       |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Interest Expense                           |   | —                  |       | 8,172                |       | 25                   |       | 8,197     |       |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Net Revenues                               |   | 1,452                   |       | 1,708                |       | 767                  |       | 3,927     |       |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Non-Interest  Expenses (1)                 |   | 1,006                   |       | 1,312                |       | 575                  |       | 2,893     |       |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Earnings Before  Taxes (1)                 |   | $                       | 446        |                 | $          | 396                  |       | $         | 192        |   | $ | 1,034 |   |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| **Twelve  months ended November 30, 2001** |   |                    |       |                 |       |                 |       |      |       |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Principal  Transactions                    |   | $                       | —     |                 | $          | 448                  |       | $         | 455        |   | $ | 903 |   |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Interest and  Dividends                    |   | —                  |       | 14,174               |       | 102                  |       | 14,276    |       |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Investment  Banking                        |   | 1,484                   |       | —               |       | 24                   |       | 1,508     |       |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Commissions                                |   | —                  |       | 640                  |       | 208                  |       | 848       |       |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Other                                      |   | —                  |       | 20                   |       | 24                   |       | 44        |       |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Total Revenues                             |   | 1,484                   |       | 15,282               |       | 813                  |       | 17,579    |       |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Interest Expense                           |   | —                  |       | 13,404               |       | 81                   |       | 13,485    |       |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Net Revenues                               |   | 1,484                   |       | 1,878                |       | 732                  |       | 4,094     |       |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Non-Interest  Expenses (2)                 |   | 1,013                   |       | 1,340                |       | 561                  |       | 2,914     |       |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Earnings Before  Taxes (2)                 |   | $                       | 471        |                 | $          | 538                  |       | $         | 171        |   | $ | 1,180 |   |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| **Twelve  months ended November 30, 2000** |   |                    | ** ** |                 | ** ** |                 | ** ** |      | ** ** |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Principal  Transactions                    |   | $                       | —     |                 | $          | 1,558                |       | $         | 380        |   | $ | 1,938 |   |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Interest and  Dividends                    |   | —                  |       | 16,329               |       | 172                  |       | 16,501    |       |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Investment  Banking                        |   | 1,609                   |       | —               |       | 5                    |       | 1,614     |       |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Commissions                                |   | —                  |       | 473                  |       | 213                  |       | 686       |       |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Other                                      |   | —                  |       | 23                   |       | 32                   |       | 55        |       |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Total Revenues                             |   | 1,609                   |       | 18,383               |       | 802                  |       | 20,794    |       |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Interest Expense                           |   | —                  |       | 15,919               |       | 140                  |       | 16,059    |       |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Net Revenues                               |   | 1,609                   |       | 2,464                |       | 662                  |       | 4,735     |       |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Non-Interest  Expenses                     |   | 1,112                   |       | 1,555                |       | 451                  |       | 3,118     |       |
|                                       |   |                    |       |                 |       |                 |       |      |       |
| Earnings Before  Taxes                     |   | $                       | 497        |                 | $          | 909                  |       | $         | 211        |   | $ | 1,617 |   |

 

----

(1)                                  Excludesthe impact of the real estate reconfiguration charge of $8 million andregulatory settlement charge of $80 million.

 

(2)                                  Excludesthe impact of September 11th related expenses, net, of $51 million.

 

26

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The following discussion provides an analysis of the Company’s resultsby segment for the above periods.

 

In assessing the performance of Capital Markets and Client Services,the Company evaluates Principal transactions, Commissions and net interestrevenues in the aggregate.  Decisionsrelating to Capital Markets and Client Services activities are based on anoverall review of aggregate revenues, which includes an assessment of thepotential gain or loss associated with a transaction including any associatedcommissions, and the interest revenue or expense associated with financing orhedging the Company’s positions. Therefore, the Company views net revenues from Principal transactions,Commissions and Interest revenues, offset by related Interest expense, in theaggregate, because the revenue classifications, when analyzed individually, arenot always indicative of the performance of the Company’s Capital Markets andClient Services activities.

 

**Investment Banking**

 

This segment’s net revenues result from fees earned by the Company forunderwriting public and private offerings of fixed income and equitysecurities, and advising clients on merger and acquisition activities and otherservices.

 

Investment Banking net revenues decreased by $32 million in 2002 to$1,452 million from $1,484 million in 2001 and decreased $125 million in 2001from $1,609 million in 2000. The decrease in Investment Banking net revenues in2002 was primarily due to a decline in M&A advisory revenues partiallyoffset by an increase in equity underwriting revenues.  Investment Banking net revenues decreased 8%in 2001 from 2000 as record debt underwriting was more than offset by declinesin both equity underwriting and M&A fees due to industry-wide decreases involume.

 

**Investment Banking Net Revenues**

 
| **In  millions**                 |   | **2002** |   | **2001** |   | **2000** |   |
|----------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                             |   |     |   |     |   |     |   |
| Debt  Underwriting               |   | $        | 804    |     | $      | 812      |   | $ | 481 |   |
|                             |   |     |   |     |   |     |   |
| Equity  Underwriting             |   | 374      |   | 291      |   | 557      |   |
|                             |   |     |   |     |   |     |   |
| Merger and  Acquisition Advisory |   | 274      |   | 381      |   | 571      |   |
|                             |   | $        | 1,452  |     | $      | 1,484    |   | $ | 1,609 |   |

 

Debt underwriting revenues of $804 million in 2002remained relatively flat as compared to record results of $812 million in 2001as issuers continued to take advantage of historically low interest rates.  The Company also continued to improve itscompetitive position resulting in an increase in market share for U.S. debtorigination, which grew to 9.2% in calendar year 2002 from 9.0% in calendaryear 2001, according to Thomson Financial Securities Data Corp. (“TFSD”).  In 2001, debt underwriting revenuesincreased 69% to a record $812 million from $481 million in 2000 as issuerstook advantage of lower interest rates to raise long-term debt and replaceshort-term financing.  During 2001, theCompany’s market share increased to 9.0% from 8.1% for U.S. debt origination.

 

Equity origination revenues of $374 million in 2002increased 29% from $291 million in 2001. The increase was principally due to a gain in market share for commonstock offerings, particularly initial public offerings (“IPOs”.)  2002 equity origination revenues reflect theCompany’s participation as joint lead manager in the largest IPO of the fiscalyear. Equity origination revenues decreased 48% in 2001 from 2000 driven byindustry-wide equity underwriting volume decreases.

 

M&A advisory fees decreased 28% to $274 million in2002.  This decrease reflects extremelydifficult market conditions in the U.S. amid weakened demand for strategictransactions as corporations remained conservative amid an uncertain businessclimate.  Market volume in 2002 forM&A advisory was at a six-year low. Despite the low volume of activity in the advisory markets, the Companyimproved its market share for completed transactions in calendar year 2002 to9.9% vs. 8.1% for calendar year 2001 and its market share for announcedtransactions

 

27

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increased to 10.2% for calendar year 2002 from 8.8%for calendar year 2001, according to TFSD.****M&Aadvisory fees decreased 33% in 2001 from 2000 record results as a result ofdepressed market conditions in 2001.

 

Investment Banking pre-tax earnings of $446 million in 2002 decreasedby $25 million or 5% from 2001 driven by a $32 million decrease in netrevenues, partially offset by a slight decrease in non-interest relatedexpenses.  Investment Bankingnon-interest expenses decreased in 2002 compared to the previous year,reflecting reduced compensation associated with lower revenue and headcountlevels.   In 2001, Investment Bankingpre-tax earnings of $471 million decreased 5% from 2000, driven by a 8%decrease in net revenues, resulting from weakened market conditions, partiallyoffset by a 9% decrease in non-interest expenses.

 

**Capital Markets**

 

This segment’s earnings reflect institutional customer flow activitiesand secondary trading and financing activities related to fixed income andequity products.  These products includea wide range of cash, derivative, secured financing and structured instruments.

 

**Capital Markets Net Revenues**

 
|            |   | **2002**            |   | **2001**              |   | **2000**          |   |
|-----------------|--------|---------------------|--------|-----------------------|--------|-------------------|--------|
| **In millions** |   | **Gross  Revenues** |   | **Interest  Expense** |   | **Net  Revenues** |   | **Gross  Revenues** |   | **Interest  Expense** |   | **Net  Revenues** |   | **Gross  Revenues** |   | **Interest  Expense** |   | **Net  Revenues** |   |
| Fixed Income    |   | $                   | 8,272  |                  | $      | (7,008            | )      | $ | 1,264 |   | $ | 12,983 |   | $ | (11,908 | ) | $ | 1,075 |   | $ | 15,560 |   | $ | (14,456 | ) | $ | 1,104 |   |
| Equities        |   | 1,608               |   | (1,164                | )      | 444               |   | 2,299 |   | (1,496 | ) | 803 |   | 2,823 |   | (1,463 | ) | 1,360 |   |
|            |   | $                   | 9,880  |                  | $      | (8,172            | )      | $ | 1,708 |   | $ | 15,282 |   | $ | (13,404 | ) | $ | 1,878 |   | $ | 18,383 |   | $ | (15,919 | ) | $ | 2,464 |   |

 

Capital Markets net revenues were $1,708 million for 2002, down 9% from2001 as record fixed income revenues were more than offset by a 45% decline inequities net revenue.  Capital Marketsnets revenues decreased 24% in 2001, primarily attributable to declining U.S.equity markets in 2001.

 

Net revenues from the fixed income component of capital marketsincreased 18% to a record $1,264 million in 2002 from the previous year’s$1,075 million.  The increase wasprincipally driven by a strong level of institutional customer flow activity,particularly in mortgage-related products, as secondary flow was aided by nearrecord levels of origination activity as investors continued to minimize riskby moving toward more diversified and defensive asset categories.  The Federal Funds rate remained athistorically low levels throughout the fiscal year, with a 50 basis pointdecrease in the rate occurring in November 2002.  The low interest rate environment throughout 2002 contributed tostrong results in the Company’s mortgage businesses, principally from increasesin securitization transactions and the distribution of various mortgage loanproducts, which were bolstered by the active refinancing environment.  Additionally, the Company had improvedresults in structured credit related products, particularly in collateralizeddebt obligations (“CDO’s), as clients migrated to products offeringdiversification and hedging capabilities. In 2001, fixed income net revenues decreased 3% to $1,075 million asstrong  institutional customer flowactivity across most products was offset by a weak contribution from highyield, due to a deteriorating credit environment.

 

Net revenues from the equities component of Capital Markets decreased45% to $444 million in 2002 from $803 million in 2001, driven by negativemarket conditions which resulted in revenue declines across most equityproducts, including equity derivatives, equity financing and privateequity.  Equity derivative revenuesdeclined as market uncertainty reduced customer demand.  The decrease in equity finance revenues wasprimarily attributed to a decline in customer balances in the prime brokeragebusiness.  These declines in revenueswere partially offset by improvements in the Company’s market share in bothlisted and NASDAQ securities, which increased to 7.2% and 3.6%, respectively in2002 from 5.7% and 3.2% in 2001. Net revenues from the equities component ofCapital Markets decreased 41% to $803 million in 2001 from 2000, principally asa result of the declining equity markets.

 

Capital Markets pre-tax earnings of $396 million in 2002 decreased 26%from 2001 pre-tax earnings of $538 million, principally driven by a 9% decreasein net revenues. Capital Markets non-interest expenses declined by 2%

 

28

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in 2002 as compared to the previous year primarily as a result of adecrease in compensation and benefits. Capital markets pre-tax earnings of $538 million in 2001 decreased by41% from $909 million in 2000 driven by a 24% decrease in net revenues,reflecting the weakened market environment, partially offset by a 14% decreasein non-interest expenses.

 

*Interest and Dividends*:The Company evaluates the performance of its Capital Markets business revenuesin the aggregate, including Principal transactions, Commissions and netinterest.  Substantially all of theCompany’s net interest revenue is allocated to its Capital Marketssegment.  Decisions relating to theseactivities are based on anoverall review of aggregate revenues, which includes an assessment of thepotential gain or loss associated with a transaction, including any associatedcommissions, and the interest revenue or expense associated with financing orhedging the Company’s positions; therefore caution should be utilized whenanalyzing revenue categories individually.

 

Interest and dividend revenues for Capital Markets businesses decreased37% in 2002 from 2001, whereas interest expense decreased 39% over this sameperiod, reflecting the decline in interest rates over the year.  Net interest revenue in 2002 remainedrelatively flat from the prior year. Interest and dividend revenues for Capital Markets businesses decreased13% in 2001 from 2000, whereas interest expense decreased 16% over this sameperiod, reflecting the decline in interest rates during 2001.  Net interest revenue increased $360 millionin 2001 over the prior year,****primarilydue to a decrease in the cost of funding and a change in inventory mix.

 

**Client Services**

 

**Client Services Net Revenues**

 
| **In millions** |   | **2002** |   | **2001** |   | **2000** |   |
|-----------------|--------|----------|--------|----------|--------|----------|--------|
|            |   |     |   |     |   |     |   |
| Private  Client |   | $        | 761    |     | $      | 706      |   | $ | 651 |   |
|            |   |     |   |     |   |     |   |
| Private  Equity |   | 6        |   | 26       |   | 11       |   |
|            |   | $        | 767    |     | $      | 732      |   | $ | 662 |   |

 

Client Services net revenues reflect earnings from theCompany’s Private Client and Private Equity businesses.  Private Client net revenues reflect theCompany’s high-net-worth retail customer flow activities as well as assetmanagement fees, where the Company strives to add value to its client base ofhigh-net-worth individuals and mid-sized institutional investors throughinnovative financial solutions, global access to capital, research, globalproduct depth and personal service and advice. Private Equity net revenues include the management and incentive feesearned in the Company’s role as general partner for thirty-three private equitypartnerships.

 

Client Services net revenues were $767 million in 2002as compared to $732 million in 2001 and $662 million in 2000.  Despite the weak equity markets, PrivateClient net revenues increased in 2002 due to record fixed income activity whichmore than offset lower equities activities, as the Company’s high-net-worthclients continued to reposition their portfolios to more defensive assetclasses.  Private client net revenuesincreased 8% in 2001, driven by strong production results from the Company’shigh-net-worth sales force despite the weak equity market environment, asinvestors rebalanced their portfolios towards more defensive asset classes.

 

Private Equity net revenues decreased $20 million in2002 from 2001, principally as a result of lower incentive fees earned in2002.  Private Equity net revenuesincreased $15 million in 2001 from 2000, primarily due to $20 million incentivefee recognized from an individual Merchant Banking investment through theCompany’s role as general partner.

 

Client Services pre-tax earnings of $192 million in2002 increased 12% from 2001 as net revenues increased by $35 million to $767million.  Non-interest expenses of $575million remained relatively flat compared to 2001.  Client Services pre-tax earnings of $171 million in 2001decreased 19% from $211 in 2000 as a result of a 24% increase in non-interestexpenses, mainly attributable to the increase in headcount during 2001,partially offset by an 11% increase in net revenues.

 

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**Summary of Contractual Obligations**

 

In the normal course of business, the Company entersinto various commitments and guarantees, including lending commitments to highgrade and  high yield borrowers,liquidity commitments and other guarantees. In all instances, the Company marks-to-market these commitments andguarantees, with changes in fair value recognized in Principal transactionsrevenues.

 

As of November 30, 2002 and 2001, the Company was contingently liablefor $0.8 billion and $0.9 billion, respectively, of letters of credit,primarily used to provide collateral for securities and commodities borrowedand to satisfy margin deposits at option and commodity exchanges.

 

In connection with its financing activities, the Company hadoutstanding commitments under certain lending arrangements of approximately$1.1 billion and $1.5 billion at November 30, 2002 and 2001, respectively.These commitments require borrowers to provide acceptable collateral, asdefined in the agreements, when amounts are drawn under the lending facilities.Advances made under the above lending arrangements are typically at variableinterest rates and generally provide for over-collateralization based upon theborrowers’ creditworthiness. At November 30, 2002, the Company had commitmentsto enter into forward starting reverse repurchase and repurchase agreements,principally secured by government and government agency collateral, ofapproximately $68.6 billion and $38.1 billion, respectively, as compared to$43.6 billion and $21.5 billion, respectively, at November 30, 2001.

 

The Company, through its high grade and high yield sales, trading andunderwriting activities, makes commitments to extend credit in loan syndicationtransactions. The Company utilizes various hedging and funding strategies toactively manage its market, credit and liquidity exposures on thesecommitments. In addition, total commitments are not indicative of actual riskor funding requirements, as the commitments may not be drawn or fully utilized.These commitments and any related draw downs of these facilities typically havefixed maturity dates and are contingent upon certain representations,warranties and contractual conditions applicable to the borrower.

 

The Company had credit risk associated with lending commitments toinvestment grade borrowers (after consideration of hedges) of approximately$2.6 billion and $3.2 billion at November 30, 2002 and November 30, 2001,respectively. In addition, the Company had credit risk associated with lendingcommitments to non-investment grade borrowers (after consideration of hedges)of $1.1 billion and $1.0 billion at November 30, 2002 and November 30, 2001,respectively. Before consideration of hedges, the Company had commitments toinvestment and non-investment grade borrowers of $6.2 billion and $1.2 billionas compared to $4.3 billion and $1.0 billion at November 30, 2002 and November30, 2001, respectively. The Company had available undrawn borrowing facilitieswith third parties of approximately $2.8 billion and $2.9 billion at November 30,2002 and November 30, 2001, respectively, which can be drawn upon to providefunding for these commitments. These funding facilities contain limits forcertain concentrations of counterparty, industry or credit ratings of theunderlying loans.

 

In addition, the Company provided high yield contingent commitmentsrelated to acquisition financing of approximately $2.8 billion and $0.6 billionat November 30, 2002 and 2001, respectively. The Company’s intent is, and itspast practice has been, to sell down significantly all of the credit riskassociated with these loans, if closed, through loan syndications, consistentwith the Company’s credit facilitation framework. These commitments are notindicative of the Company’s actual risk as the borrower’s ability to draw issubject to there being no material adverse change in either market conditionsor the borrower’s financial condition, among other factors. In addition, thesecommitments contain certain flexible pricing features in order to adjust forchanging market conditions.

 

At November 30, 2002 the Company had liquidity commitments ofapproximately $0.6 billion related to trust certificates backed by investmentgrade municipal securities, as compared to $1.6 billion at November 30, 2001.The Company’s obligation under such liquidity commitments is generally lessthan one year and is typically further limited by the fact that the Company’sobligation ceases if the underlying assets are downgraded below investmentgrade or default.

 

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At November 30, 2002 and 2001, the Company had commitments to invest upto $384 million and $169 million, respectively, directly and throughpartnerships in private equity related investments. These commitments will befunded as required through the end of the respective investment periods,principally expiring in 2004.

 

Aggregate contractual obligations and other commitments as of November30, 2002 by maturity are as follows:

 
| **In millions  November 30, 2002**                                                          |   | **Total  Contractual  Amount** |   | **Amount of  Commitment Expiration  Per Period** |   |               |
|---------------------------------------------------------------------------------------------|--------|--------------------------------|--------|--------------------------------------------------|--------|--------------------|
|                                                                                        |        |
| **Less than  1 Year**                                                                       |   | **1-3  Years**                 |   | **4-5  Years**                                   |   | **After 5  Years** |
| Lending  commitments:                                                                       |   |                           |   |                                             |   |               |   |   |   |   |   |   |
| High  grade*                                                                                |   | $                              | 6,238  |                                             | $      | 3,887              |   | $ | 1,497 |   | $ | 832 |   | $ | 22 |   |   |
| High  yield**                                                                               |   | 1,192                          |   | 328                                              |   | 426                |   | 162 |   | 276 |   |   |
| High  yield contingent acquisition facilities                                               |   | 2,775                          |   | 2,775                                            |   | —             |   | — |   | — |   |   |
| Secured  lending transactions, including forward starting resale and repurchase  agreements |   | 107,713                        |   | 95,598                                           |   | 11,356             |   | 500 |   | 259 |   |   |
| Municipal  related liquidity commitments                                                    |   | 640                            |   | 194                                              |   | 101                |   | — |   | 345 |   |   |
| Standby  letters of credit                                                                  |   | 818                            |   | —                                           |   | 818                |   | — |   | — |   |   |
| Private  equity investments                                                                 |   | 384                            |   | —                                           |   | 146                |   | — |   | 238 |   |   |
| Operating  lease obligations                                                                |   | 1,106                          |   | 76                                               |   | 201                |   | 135 |   | 694 |   |   |
| Long-term  debt maturities                                                                  |   | 7,990                          |   | 2,098                                            |   | 4,888              |   | 339 |   | 665 |   |   |
|                                                                                             |        |                                |        |                                                  |        |                    |  |  |  |  |  |  |  |  |  |  |   |

 

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*                                       TheCompany views its net credit exposure for high grade commitments, afterconsideration of hedges, to be $2.6 billion.

**                                TheCompany views its net credit exposure for high yield commitments, afterconsideration of hedges, to be $1.1 billion.

 

For additional information on contractual obligationssee Note 16 to the Consolidated Financial Statements.

 

# **Off-Balance-Sheet Arrangements**

 

**DERIVATIVES **Derivatives are financial instruments, examplesof which include swaps, options, futures, forwards and warrants, whose value isbased upon an underlying asset (e.g., treasury bond), index (e.g., S&P 500)or reference rate (e.g., LIBOR). Derivatives are often referred to as“off-balance-sheet instruments,” as a derivative’s notional amount is notrecorded on-balance-sheet.  Notionalamounts are generally not exchanged, but rather represent the basis forexchanging cash flows during the duration of the contract. Notional amounts aregenerally not indicative of the Company’s at risk amount.

 

A derivative contract may be traded on an exchange ornegotiated in the over-the-counter markets. Exchange-traded derivatives arestandardized and include futures, warrants and certain option contracts listedon an exchange. Over-the-counter (“OTC”) derivative contracts are individuallynegotiated between contracting parties and include forwards, swaps and certainoptions, including caps, collars and floors. The use of derivative financialinstruments has expanded significantly over the past decade. A primary reasonfor this expansion is that derivatives provide a cost-effective alternative formanaging market risk. Additionally, derivatives provide users with access tomarket risk management tools that are often unavailable in traditional cashinstruments, as derivatives can be tailored to meet client needs. Derivativescan also be used to take proprietary trading positions.

 

Derivatives are subject to various risks similar tonon-derivative financial instruments including market, credit and operationalrisk. Market risk is the potential for a financial loss due to changes in thevalue of derivative financial instruments due to market changes, includingchanges in interest rates, foreign exchange rates and equity and commodityprices. Credit risk results from the possibility that a counterparty to aderivative transaction may fail to perform according to the terms of thecontract. Therefore, the Company’s exposure to credit risk is represented byits net receivable from derivative counterparties, after consideration ofcollateral. Operational risk is the possibility of financial loss resultingfrom a deficiency in the Company’s systems for executing derivativetransactions.

 

In addition to these risks, counterparties toderivative financial instruments may also be exposed to legal risks related toderivative activities, including the possibility that a transaction may beunenforceable under applicable law. The

 

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risks of derivatives should not be viewed in isolationbut rather should be considered on an aggregate basis along with the Company’sother trading-related activities.

 

As derivative products have continued to expand involume, so has market participation and competition. As a result, additionalliquidity has been added into the markets for conventional derivative products,such as interest rate swaps. Competition has also contributed to thedevelopment of more complex products structured for specific clients. It isthis rapid growth and complexity of certain derivative products which has ledto the perception, by some, that derivative products are unduly risky to usersand the financial markets.

 

In order to remove the public perception thatderivatives may be unduly risky and to ensure ongoing liquidity of derivativesin the marketplace, the Company supports the efforts of the regulators instriving for enhanced risk management disclosures which consider the effects ofboth derivative products and cash instruments. In addition, the Companysupports the activities of regulators that are designed to ensure that users ofderivatives are fully aware of the nature of risks inherent within derivativetransactions. As evidence of this support, the Company has been activelyinvolved with the various regulatory and accounting authorities in thedevelopment of additional enhanced reporting requirements related toderivatives.

 

The Company strongly believes that derivatives providesignificant value to the financial markets and is committed to providing itsclients with innovative products to meet their financial needs.

 

**LEHMAN BROTHERS’ USE OF DERIVATIVEINSTRUMENTS**In the normal course of business, the Companyenters into derivative transactions both in a trading capacity and as anend-user.

 

As an end-user, the Company utilizes derivative productsto adjust the interest rate nature of its funding sources from fixed tofloating interest rates, and to change the index upon which floating interestrates are based (e.g., Prime to LIBOR) (collectively, “End-User DerivativeActivities”.) For a further discussion of the Company’s End-User DerivativeActivities, see Note 11 to the Consolidated Financial Statements.

 

The Company utilizes derivative products in a tradingcapacity as a dealer, to satisfy the financial needs of its clients, and ineach of its trading businesses (collectively, “Trading-Related DerivativeActivities”). In this capacity the Company transacts extensively in derivativesincluding interest rate, credit (both single name and portfolio), foreignexchange and equity derivatives.  TheCompany’s use of derivative products in its trading businesses is combined withtransactions in cash instruments to allow for the execution of various tradingstrategies.

 

The Company conducts its derivative activities througha number of wholly-owned subsidiaries. The Company’s fixed income derivativeproducts business is conducted through its subsidiary, Lehman Brothers SpecialFinancing Inc., and separately capitalized “AAA” rated subsidiaries, LehmanBrothers Financial Products Inc. and Lehman Brothers Derivative Products Inc.The Company’s equity derivative product business is conducted through LehmanBrothers Finance S.A. In addition, as a global investment bank, the Company isalso a market-maker in a number of foreign currencies and actively trades inthe global commodity markets. Counterparties to the Company’s derivativeproduct transactions are primarily financial intermediaries (U.S. and foreignbanks), securities firms, corporations, governments and their agencies, financecompanies, insurance companies, investment companies and pension funds.

 

The Company manages the risks associated withderivatives on an aggregate basis, along with the risks associated with itsnon-derivative trading and market-making activities in cash instruments, as partof its firm-wide risk management policies. The Company utilizes industrystandard derivative contracts whenever appropriate. These contracts may containprovisions requiring the posting of additional collateral by the Company incertain events, including a downgrade in the Company’s credit rating. TheCompany believes that its funding framework incorporates all reasonably likelycollateral requirements related to these provisions. For a further discussionof the Company’s risk management policies, refer to the discussion whichfollows.

 

See the Notes to the Consolidated Financial Statementsfor a description of the Company’s accounting policies and further discussionof the Company’s Trading-Related Derivative Activities.

 

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**OTHER OFF-BALANCE-SHEET ARRANGEMENTS**  Special purpose entities (“SPEs”) arecorporations, trusts or partnerships which are established for a limitedpurpose.   SPEs by their naturegenerally do not provide equity owners with significant voting powers, as theSPE documents govern all material decisions. The Company’s primary involvement with SPEs relates to securitizationtransactions in which transferred assets, including mortgages, loans, receivablesand other assets, are sold to an SPE and repackaged into securities (i.e.securitized).  SPEs may also be utilizedby the Company to create securities with a unique risk profile desired byinvestors and as a means of intermediating financial risk.  In summary, in the normal course of business,the Company may establish SPEs; sell assets to SPEs; underwrite, distribute,and make a market in securities issued by SPEs; transact derivatives with SPEs;own securities or residual interests in SPEs; and provide liquidity or otherguarantees for SPEs.

 

The Company accounts for the transfers of financial assets, includingtransfers to SPEs, in accordance with Statement of Financial AccountingStandards (“SFAS”) No. 140, “Accounting for Transfers and Servicing ofFinancial Assets and Extinguishments of Liabilities—a replacement of FASB No.125” (“SFAS 140”). In accordance with this guidance, the Company recognizestransfers of financial assets as sales provided that control has beenrelinquished.  Control is deemed to berelinquished only when all of the following conditions have been met: (i)the assets have been isolated from the transferor, even in bankruptcy or otherreceivership (true sale opinions are required); (ii) the transferee has theright to pledge or exchange the assets received and (iii) the transferorhas not maintained effective control over the transferred assets (e.g. aunilateral ability to repurchase a unique or specific asset).  Therefore, in accordance with this guidance,the Company derecognizes financial assets transferred in securitizationsprovided that the Company has relinquished control over such assets.

 

The Company is also required to follow the accounting guidance underSFAS 140 and Emerging Issues Task Force (“EITF”) Topic D-14, “TransactionsInvolving Special-Purpose Entities,” to determine whether or not an SPE isrequired to be consolidated.

 

The majority of the Company’s involvement with SPEs relates tosecuritization transactions meeting the SFAS 140 definition of a qualifyingspecial purpose entity (“QSPE”).  A QSPEcan generally be described as an entity with significantly limited powers whichare intended to limit it to passively holding financial assets and distributingcash flows based upon pre-set terms. Based upon the guidance in SFAS 140, the Company is not required to anddoes not consolidate such QSPEs. Rather, the Company accounts for its involvement with QSPEs under afinancial components approach in which the Company recognizes only its retainedinvolvement with the QSPE.  The Companyaccounts for such retained interests at fair value with changes in fair valuereported in earnings.

 

The Company is a market leader in mortgage (both residential andcommercial), municipal and other asset-backed securitizations which areprincipally transacted through QSPEs. The Company securitized approximately$144 billion of financial assets during fiscal 2002 including $103 billion ofresidential, $11 billion of commercial and $30 billion of municipal and otherfinancial assets. As of November 30, 2002, the Company had approximately $1.1billion of non-investment grade retained interests from its securitizationactivities.  Retained interests arerecorded in Securities and other financial instruments owned within theCompany’s Consolidated Statement of Financial Condition and primarily representjunior interests in commercial and residential securitization transactions. TheCompany records it trading assets, including retained interests, on amark-to-market basis, with related gains or losses recognized in Principaltransactions in the Consolidated Statement of Income. (See Note 12 to theConsolidated Financial Statements.)

 

Certain special purpose entities do not meet the QSPE criteria due totheir permitted activities not being sufficiently limited, or because theassets are not deemed qualifying financial instruments (e.g. real estate).  In instances in which the Company is eitherthe sponsor of or transferor to a non-qualifying SPE, the Company follows theaccounting guidance provided by EITF Topic D-14 to determine whetherconsolidation is required.  Under thisguidance, the Company would not be required to, and does not consolidate suchSPE if a third party investor made a substantive equity investment in the SPE(minimum of 3%), was subject to first dollar risk of loss of such SPE, and hada controlling financial interest. Examples of the Company’s involvement with such SPEs include: CDOs,where the Company’s role is principally limited to acting as structuring andplacement agent, warehouse provider and underwriter for CDO transactions; andSynthetic Credit Transactions, where the Company’s role is primarily that ofunderwriter and buyer of credit risk protection from SPEs.

 

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On January 17, 2003, the Financial Accounting Standards Board (“FASB”)issued Interpretation No. 46, “Consolidation of Variable Interest Entities – aninterpretation of ARB No. 51,” (“Interpretation No. 46”).  This interpretation provides newconsolidation accounting guidance for entities involved with special purposeentities and will replace guidance provided by EITF Topic D-14.  This guidance does not impact the accountingfor securitizations transacted through QSPEs. This interpretation will require a primary beneficiary, defined as anentity which participates in either a majority of the risks or rewards of suchSPE, to consolidate the SPE.  An SPEwould not be subject to this interpretation if such entity has sufficientvoting equity capital (presumed to require a minimum of 10%), such that the entityis able to finance its activities without additional subordinated financialsupport from other parties.  While theCompany has not yet completed its analysis of the impact of the newinterpretation, the Company does not anticipate that the adoption of thisinterpretation will have a material impact to the Company’s financial conditionor its results of operations.

 

In addition to the above consolidation policies related to SPEs, theCompany follows SFAS No. 94, “Consolidation of All Majority-Owned Subsidiaries,”for its dealings with operating entities.  The Company consolidates operating entities when the Company has acontrolling financial interest over the business activities of such entities.  Non-controlled operating entities areaccounted for under the equity method when the Company is able to exercisesignificant influence over the business activities of such entities.  The cost method is applied when the abilityto exercise significant influence is not present.

 

**Risk Management**

 

As a leading global investment banking company, riskis an inherent part of the Company’s businesses. Global markets, by theirnature, are prone to uncertainty and subject participants to a variety ofrisks. The Company has developed policies and procedures to identify, measureand monitor each of the risks involved in its trading, brokerage and investmentbanking activities on a global basis. The principal risks of Lehman Brothersare market, credit, liquidity, legal and operational risks. Risk Management isconsidered to be of paramount importance in the Company’s day-to-dayoperations. Consequently, the Company devotes significant resources (includinginvestments in personnel and technology) across all of its worldwide tradingoperations to the measurement, management and analysis of risk.

 

The Company seeks to reduce risk through thediversification of its businesses, counterparties and activities in geographicregions. The Company accomplishes this objective by allocating the usage ofcapital to each of its businesses, establishing trading limits, and settingcredit limits for individual counterparties, including regional concentrations.The Company seeks to achieve adequate returns from each of its businessescommensurate with the risks that they assume. Nonetheless, the effectiveness ofthe Company’s policies and procedures for managing risk exposure can never becompletely or accurately predicted or fully assured.  For example, unexpectedly large or rapid movements or disruptionsin one or more markets or other unforeseen developments can have an adverseeffect on the Company’s results of operations and financial condition.  The consequences of these developments caninclude losses due to adverse changes in inventory values, decreases in theliquidity of trading positions, higher volatility in the Company’s earnings,increases in the Company’s credit exposure to customers and counterparties andincreases in general systemic risk.

 

Overall risk management policy is established at the Office of theChairman level and begins with The Capital Markets Committee which consists ofthe Chief Executive Officer, other members of the Company’s ExecutiveCommittee, the Global Head of Risk, the Chief Economist and Strategist as wellas various other business heads.  TheCapital Markets Committee serves to frame the Company’s risk opinion in thecontext of the global market environment. The Company’s Risk Committee, which consists of the Chief ExecutiveOfficer, members of the Executive Committee and the Global Head of Risk, meetsweekly and reviews all risk exposures, position concentrations and risk takingactivities.

 

The Global Risk Management Group (the “Group”) is independent of thetrading areas and reports directly into the Office of the Chairman.  The Group includes credit risk management,market risk management and operational risk management.  Combining these disciplines facilitates theanalysis of risk exposures, while leveraging personnel and informationtechnology resources in a cost-efficient manner.  The Group maintains staff in each of the Company’s

 

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regional trading centers and has daily contact with trading staff andsenior management at all levels within the Company.  These discussions include a review of trading positions and riskexposures.

 

**CREDIT RISK** Credit riskrepresents the possibility that a counterparty will be unable to honor itscontractual obligations to the Company. Credit risk management is therefore anintegral component of the Company’s overall risk management framework. TheCredit Risk Management Department (“CRM Department”) has global responsibilityfor implementing the Company’s overall credit risk management framework.

 

The CRM Department manages the credit exposure relatedto trading activities by giving initial credit approval for counterparties,establishing credit limits by counterparty, country and industry group and byrequiring collateral in appropriate circumstances. In addition, the CRMDepartment strives to ensure that master netting agreements are obtainedwhenever possible. The CRM Department also considers the duration oftransactions in making its credit decisions, along with the potential creditexposure for complex derivative transactions. The CRM Department is responsiblefor the continuous monitoring and review of counterparty credit exposure andcreditworthiness and recommending valuation adjustments, where appropriate.Credit limits are reviewed periodically to ensure that they remain appropriatein light of market events or the counterparty’s financial condition.

 

**MARKETRISK** Market risk represents the potential change in valueof a portfolio of financial instruments due to changes in market rates, pricesand volatilities. Market risk management also is an essential component of theCompany’s overall risk management framework. The Market Risk ManagementDepartment (“MRM Department”) has global responsibility for implementing theCompany’s overall market risk management framework. It is responsible for thepreparation and dissemination of risk reports, developing and implementing thefirm-wide Risk Management Guidelines, and evaluating adherence to theseguidelines. These guidelines provide a clear framework for risk managementdecision making. To that end, the MRM Department identifies and quantifies riskexposures, develops limits and reports and monitors these risks with respect tothe approved limits. The identification of material market risks inherent inpositions includes, but is not limited to, interest rate, equity and foreignexchange risk exposures. In addition to these risks, the MRM Department alsoevaluates liquidity risks, credit and sovereign concentrations.

 

The MRM Department utilizes qualitative as well asquantitative information in managing trading risk, believing that a combinationof the two approaches results in a more robust and complete approach to themanagement of trading risk. Quantitative information is developed from avariety of risk methodologies based upon established statistical principles. Toensure high standards of qualitative analysis, the MRM Department has retainedseasoned risk managers with the requisite experience and academic andprofessional credentials.

 

Market risk is present in cash products, derivativesand contingent claim structures that exhibit linear as well as non-linearprofit and loss sensitivity. The Company’s exposure to market risk varies inaccordance with the volume of client-driven market-making transactions, thesize of the Company’s proprietary positions, and the volatility of financialinstruments traded. The Company seeks to mitigate, whenever possible, excessmarket risk exposures through the use of futures and option contracts andoffsetting cash market instruments.

 

The Company participates globally in interest rate, equityand foreign exchange markets. The Company’s Fixed Income division has a broadlydiversified market presence in U.S. and foreign government bond trading,emerging market securities, corporate debt (investment and non-investmentgrade), money market instruments, mortgages and mortgage-backed securities,asset-backed securities, municipal bonds and interest rate derivatives. TheCompany’s Equities division facilitates domestic and foreign trading in equityinstruments, indices and related derivatives. The Company’s foreign exchangebusinesses are involved in trading currencies on a spot and forward basis aswell as through derivative products and contracts.

 

The Company incurs short-term interest rate risk whenfacilitating the orderly flow of customer transactions through the maintenanceof government bond inventories. Market-making in high yield instruments exposesthe Company to additional risk due to potential variations in credit spreads.Trading in international markets exposes the Company to spread risk between theterm structure of interest rates in different countries. Mortgages andmortgage-related securities are subject to prepayment risk and changes in thelevel of interest rates. Trading in derivatives and

 

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structured products exposes the Company to changes inthe level and volatility of interest rates. The Company actively managesinterest rate risk through the use of interest rate futures, options, swaps,forwards and offsetting cash market instruments. Inventory holdings,concentrations and agings are monitored closely and used by management toselectively hedge or liquidate undesirable exposures.

 

The Company is a significant intermediary in theglobal equity markets through its market-making in U.S. and non-U.S. equitysecurities, including common stock, convertible debt, exchange-traded and OTCequity options, equity swaps and warrants. These activities expose the Companyto market risk as a result of price and volatility changes in its equityinventory. Inventory holdings are also subject to market risk resulting fromconcentrations and changes in liquidity conditions that may adversely impactmarket valuation. Equity market risk is actively managed through the use ofindex futures, exchange-traded and OTC options, swaps and cash instruments.

 

The Company enters into foreign exchange transactionsin order to facilitate the purchase and sale of non-dollar instruments,including equity and interest rate securities. The Company is exposed to foreignexchange risk on its holdings of non-dollar assets and liabilities. The Companyis active in many foreign exchange markets and has exposure to the Euro,Japanese yen, British pound, Swiss franc and Canadian dollar, as well as avariety of developed and emerging market currencies. The Company hedges itsrisk exposures primarily through the use of currency forwards, swaps, futuresand options.

 

If any of the strategies utilized to hedge orotherwise mitigate exposures to the various types of risks described above arenot effective, the Company could incur losses.

 

**OPERATIONALRISK** Operational Risk is the risk of direct or indirectloss resulting from inadequate or failed internal processes, people andsystems, or from external events. Operational Risk Management (ORM) is responsible for implementing andmaintaining the Company’s overall global operational risk management framework,which seeks to minimize these risks through assessing, reporting, monitoringand tracking operational risks.

 

**VALUE-AT-RISK**For purposes of Securities and Exchange Commission (“SEC”) risk disclosurerequirements, the Company discloses an entity-wide value-at-risk for virtuallyall of its trading activities. In general, the Company’s value-at-risk measurespotential loss of trading revenues at a given confidence level over a specifiedtime horizon. Value-at-risk over a one-day holding period measured at a 95%confidence level implies that the potential loss of daily trading revenue willbe at least as large as the value-at-risk amount on one out of every 20 tradingdays.

 

The Company’s methodology estimates a reporting dayvalue-at-risk using actual daily trading revenues over the previous 250 tradingdays. This estimate is measured as the loss, relative to the median daily tradingrevenue. The Company also estimates an average value-at-risk measure over 250rolling reporting days, thus looking back a total of 500 trading days.

 

The following table sets forth the daily value-at-riskfor each component of market risk as well as total value-at-risk:

 

**Value-at-Risk**

 
|                     |   | **As of**              |   | **As of**              |   | **Year Ended  November 30, 2002** |   |
|--------------------------|--------|------------------------|--------|------------------------|--------|-----------------------------------|--------|
| **In millions**          |   | **November  30, 2002** |   | **November  30, 2001** |   | **Average**                       |   | **High** |   | **Low** |   |
|                     |   |                   |   |                   |   |                              |   |   |   |   |   |
| Interest  rate risk      |   | $                      | 10.5   |                   | $      | 10.0                              |   | $ | 10.8 |   | $ | 12.6 |   | $ | 9.8 |   |
|                     |   |                   |   |                   |   |                              |   |   |   |   |   |
| Equity  price risk       |   | 5.2                    |   | 8.4                    |   | 7.4                               |   | 8.6 |   | 5.2 |   |
|                     |   |                   |   |                   |   |                              |   |   |   |   |   |
| Foreign  exchange risk   |   | 0.5                    |   | 0.9                    |   | 0.6                               |   | 0.9 |   | 0.4 |   |
|                     |   |                   |   |                   |   |                              |   |   |   |   |   |
| Diversification  benefit |   | (2.0                   | )      | (5.6                   | )      | (4.7                              | )      |   |   |   |   |
|                     |   |                   |   |                   |   |                              |   |   |   |   |   |
| Total  Company           |   | $                      | 14.2   |                   | $      | 13.7                              |   | $ | 14.1 |   | $ | 14.9 |   | $ | 13.1 |   |

 

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Value-at-risk is one measure of potential loss in trading revenues thatmay result from adverse market movements over a specified period of time with aselected likelihood of occurrence. As with all measures of value-at-risk, theCompany’s estimate has substantial limitations due to its reliance onhistorical performance, which is not necessarily a predictor of the future.Consequently, this value-at-risk estimate is only one of a number of tools theCompany utilizes in its daily risk management activities.

 

**Critical Accounting Policies**

 

In May 2002, the Securities and Exchange Commission proposed rules torequire disclosures associated with critical accounting polices which are mostimportant in gaining an understanding of an entity’s financial statements.  The following is a summary of the Company’scritical accounting policies.  For afull description of these and other accounting policies, see Note 1 to theConsolidated Financial Statements.

 

**USE OF ESTIMATES**TheCompany’s financial statements are prepared in conformity with generallyaccepted accounting principles, many of which require the use of estimates andassumptions. Management believes that the estimates utilized in preparing its financialstatements are reasonable and prudent. Actual results could differ from theseestimates particularly in light of the industry in which the Company operates.

 

**FAIR VALUE**Thedetermination of fair value is a critical accounting policy which is fundamentalto the Company’s financial condition and results of operations.   The Company records its inventory positionsincluding Securities and other financial instruments owned and Securities soldbut not yet purchased at market or fair value with unrealized gains and lossesreflected in Principal transactions in the Consolidated Statement ofIncome.  In all instances, the Companybelieves that it has established rigorous internal control processes to ensurethat the Company utilizes reasonable and prudent measurements of fair value.

 

When evaluating the extent to which management estimates may berequired to be utilized in preparing the Company’s financial statements, theCompany believes it is useful to analyze the balance sheet as follows:

 
|                                                                                 |   | **November 30, 2002** |        |
|--------------------------------------------------------------------------------------|--------|-----------------------|-------------|
|                                                                                 |   | **In  millions**      |        |
| **Assets:**                                                                          |   |                  |        |   |   |
| Securities and  other financial  instruments owned                              |   | $                     | 70,881      |   | 36 | % |
| Secured  financings                                                                  |   | 101,149               |        | 52 | % |
| Receivables and  other assets                                                        |   | 24,189                |        | 12 | % |
| **Total  Assets**                                                                    |   | **$**                 | **196,219** | ** ** | **100** | **%** |
|                                                                                 |   |                  | ** **  |   | ** ** |
| **Liabilities  & Equity:**                                                       |   |                  |        |   |   |
| Securities and  other financial  instruments sold, but  not yet  purchased |   | $                     | 50,352      |   | 26 | % |
| Secured  financings                                                                  |   | 108,691               |        | 55 | % |
| Payables and  other liabilities                                                      |   | 26,034                |        | 13 | % |
| Total capital                                                                        |   | 11,142                |        | 6 | % |
| **Liabilities  & Equity**                                                        |   | **$**                 | 196,219     | ** ** | **100** | **%** |

 

A significant majority of the Company’s assets and liabilities arerecorded at amounts for which management estimates are not utilized. Thefollowing balance sheet categories comprising 64% of total assets and 74% ofliabilities and equity are valued at either historical cost or at contractvalue (including accrued interest) which by their nature, do not require theuse of significant estimates: Secured financings, Receivables/Payables andOther assets/liabilities, and Total capital. The remaining balance sheet categories, comprised of Securities andother financial instruments owned and Securities and other financialinstruments sold but not yet purchased (long and short inventory positions,respectively), are recorded at market or fair value, the components of whichmay require, to varying degrees, the use of estimates in determining fairvalue.

 

The majority of the Company’s long and short inventory is recorded atmarket value based upon listed market prices or utilizing third party brokerquotes and  therefore do not incorporatesignificant estimates.  Examples ofinventory valued in this manner include: government securities, agencymortgage-backed securities, listed equities, money markets, municipalsecurities, corporate bonds and listed futures.

 

37

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If listed market prices or broker quotes are not available, fair valueis determined based on pricing models, or other valuation techniques, includinguse of implied pricing from similar instruments.  Pricing models are typically utilized to derive fair value basedupon the net present value of estimated future cash flows includingadjustments, where appropriate, for liquidity, credit and/or otherfactors.  For the vast majority ofinstruments valued through pricing models, significant estimates are notrequired, as the market inputs into such models are readily observable andliquid trading markets provide clear evidence to support the valuations derivedfrom such pricing models.  Examples ofinventory valued utilizing pricing models or other valuation techniquesinclude: OTC derivatives, private equity investments, certain high yieldpositions, certain mortgage loans and direct real estate investments andnon-investment grade retained interests.

 

**OTC DERIVATIVES**  The fair value of the Company’s OTCderivative assets and liabilities at November 30, 2002 were $8.2 billion and$7.6 billion, respectively.  OTCderivative assets represent the Company’s unrealized gains, net of unrealizedlosses for situations in which the Company has a master netting agreement.  Similarly, liabilities represent net amountsowed to counterparties.

 

The vast majority of the Company’s OTC derivatives are transacted inliquid trading markets for which fair value is determined utilizing pricingmodels with readily observable market inputs. Examples of such derivatives include: interest rate swaps contracts,TBA’s, foreign exchange forward and option contracts in G-7 currencies andequity swap and option contracts on listed securities. However, thedetermination of fair value for certain less liquid derivatives requires theuse of significant estimates and include: certain credit derivatives, equityoption contracts greater than 5 years, and certain other complex derivativesutilized by the Company in providing clients with hedging alternatives tounique exposures.  The Company strivesto limit the use of significant judgment by using consistent pricingassumptions between reporting periods and utilizing observed market data formodels inputs whenever possible.  As themarket for complex products develops, the Company refines its pricing modelsbased upon market experience in order to utilize the most current indicators offair value.

 

**PRIVATE EQUITY INVESTMENTS **The Company’s privateequity investments of $389 at November 30, 2002 include both public and privateequity positions.  The determination offair value for these investments may require the use of estimates andassumptions as these investments are generally less liquid and often contain tradingrestrictions.  The determination of fairvalue of private equity investments is based on estimates incorporatingvaluations which take into account expected cash flows, earnings multiplesand/or comparison to similar market transactions. Valuation adjustments are anintegral part of pricing these instruments, reflecting consideration of creditquality, concentration risk, sale restrictions and other liquidity factors.

 

**HIGH YIELD**  At November 30, 2002, the Company had highyield long and short positions of $2.8 billion and $0.7 billion,respectively.    The majority of thesepositions are valued utilizing broker quotes or listed market prices. Incertain instances where broker quotes or listed prices are not available, theCompany utilizes prudent judgment in determining fair value which may involvethe utilization of analysis of credit spreads associated with pricing ofsimilar instruments,  or other valuationtechniques.

 

**MORTGAGE LOANS AND REAL ESTATE**  The Company is a market leader inmortgage-backed securities trading and mortgage securitizations (bothresidential and commercial).  TheCompany’s inventory of mortgage loans principally represents loans held priorto securitization.  In this activity,the Company purchases mortgage loans from loan originators or in the secondarymarkets and then aggregates pools of mortgages for securitization. The Companyrecords mortgage loans and direct real estate investments at fair value, withrelated mark-to-market gains and losses recognized in Principal transactionsrevenues.

 

As the Company’sinventory of residential loans turns over through sale to securitization trustsrather frequently, such loans are generally valued without the use ofsignificant estimates. In addition, the Company held approximately $1.1billion of non-investment grade retained interests at November 30, 2002, downfrom $1.4 billion at November 30, 2001. As these interests principally represent the junior interests incommercial and residential mortgage securitizations, for which there are notactive trading markets, estimates are generally required to be utilized indetermining fair value.  The Companyvalues these instruments using prudent estimates of expected cash flows, andconsiders the valuation of similar transactions in the market.  (See Note 12 to the Consolidated Financial

 

38

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Statements for additional information on the impact of adverse changesin assumptions on the fair value of these interests.)

 

**NewAccounting Developments**

 

In July 2001, the FASB issued SFAS No. 142, “Goodwill and OtherIntangible Assets” (“SFAS 142”.)  UnderSFAS 142, intangible assets with indefinite lives and goodwill will no longerbe amortized.  Instead, these assets arerequired to be tested annually for impairment. The Company adopted the provisions of SFAS 142 as of the beginning offiscal 2002, and such adoption did not have a material effect on the Company’sfinancial condition or results of operations.

 

In August 2001, the FASB issued SFAS No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets” (“SFAS 144”.)  SFAS 144 provides accounting guidance forthe impairment or disposal of long-lived assets, such as property, plant andequipment.  In addition, SFAS 144 amendsAccounting Research Bulletin No. 51, “Consolidated Financial Statements” toeliminate the exception to consolidation for a subsidiary for which control islikely to be temporary.  The Companywill adopt this standard in the first quarter of 2003.  The Company does not expect that theadoption will have a material impact to the Company’s financial condition orresults of operations.

 

In June, 2002, the FASB issued SFAS No. 146, “Accounting for CostsAssociated with Exit or Disposal Activities” (“SFAS 146”.)  This Statement addresses financialaccounting and reporting for costs associated with exit or disposal activitiesand nullifies EITF Issue No. 94-3, “Liability Recognition for CertainEmployee Termination Benefits and Other Costs to Exit an Activity (includingCertain Costs Incurred in a Restructuring).” The Company will adopt the provisions of SFAS 146 at the beginning offiscal 2003 and does not expect the adoption to have a material impact to theCompany’s financial condition or results of operations.

 

In October 2002, the EITF reached a consensus on Issue No. 02-03,“Issues Involved in Accounting for Derivative Contracts Held for TradingPurposes and Contracts Involved in Energy Trading and Risk ManagementActivities.”   This issues clarifies theFASB staff view that profits should not be recognized at the inception of aderivative contract if the contract does not have observable pricing.  In such instances, the transaction price isviewed by the FASB to be the best indicator of fair value.  The Company does not expect the applicationof this guidance to have a material impact on the Company’s financial conditionor results of operations.

 

On January 17, 2003, the FASB issued Interpretation No. 46,“Consolidation of Variable Interest Entities — an interpretation of ARB No.51,” (“Interpretation No. 46”).  Thisinterpretation provides new consolidation accounting guidance for entitiesinvolved with special purpose entities. This guidance does not impact the accounting for securitizationstransacted through QSPEs.  This interpretationwill require a primary beneficiary, defined as an entity which participates ineither a majority of the risks or rewards of such SPE, to consolidate theSPE.  An SPE would not be subject tothis interpretation if such entity had sufficient voting equity capital, suchthat the entity was able to finance its activities without the additionalsubordinated  financial support fromother parties.  Interpretation 46 alsorequires additional disclosures related to involvement with SPEs.  The accounting provisions of thisinterpretation are effective for new transactions executed after January 31,2003.  The interpretation will beeffective for all existing transactions with SPEs beginning in the Company’s  fourth quarter of 2003.  While the Company has not yet completed itsanalysis of the impacts of the new interpretation, the Company does notanticipate that the adoption of this interpretation will have a material impactto the Company’s financial condition or its results of operations.

 

**Effectsof Inflation**

 

Because the Company’sassets are, to a large extent, liquid in nature, they are not significantlyaffected by inflation. However, the rate of inflation affects the Company’sexpenses, such as employee compensation, office space leasing costs and communicationscharges, which may not be readily recoverable in the price of services offeredby the Company. To the extent inflation results in rising interest rates andhas other adverse effects upon the securities markets, it may adversely affectthe Company’s financial position and results of operations in certainbusinesses.

 

39

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**ITEM 7A****.  QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

The information under the caption “Management’s Analysis of Results ofOperations—Risk Management” in Item 7 of this Report is incorporated herein byreference.

 

##### **ITEM 8**.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

##### ** **

The financial statements and supplementary financial informationrequired by this Item, included in this Report beginning on page F-1, arelisted in the Index to Consolidated Financial Statements appearing on page F-land are incorporated herein by reference.

 

**ITEM 9****.  CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

None.

 

40

----

 

**PART III**

 

**ITEM 10****.  DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT**

 

Pursuant to General Instruction I of Form 10-K, the informationrequired by Item 10 is omitted.

 

**ITEM 11****.  EXECUTIVECOMPENSATION**

** **

Pursuant to General Instruction I of Form 10-K, the informationrequired by Item 11 is omitted.

 

**ITEM 12****.  SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**

 

Pursuant to General Instruction I of Form 10-K, the informationrequired by Item 12 is omitted.

 

**ITEM 13****.  CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS**

 

Pursuant to General Instruction I of Form 10-K, the informationrequired by Item 13 is omitted.

 

**ITEM 14****.  CONTROLS ANDPROCEDURES**

 

The Chairman and Chief Executive Officer and the Chief Financial Officerof LBI (its principal executive officer and principal financial officer,respectively) have concluded,based on their evaluation as of a date within 90 days prior to the date of thefiling of this Report, that the Company’s disclosure controls and proceduresare effective to ensure that information required to be disclosed by LBIin the reports filed or submitted by it under the Securities Exchange Act of1934, as amended, is recorded, processed, summarized and reported within thetime periods specified in the SEC’s rules and forms, and include controls andprocedures designed to ensure that information required to be disclosed by LBIin such reports is accumulated and communicated to the Company’s management,including the Chairman and ChiefExecutive Officer and the Chief Financial Officer of LBI, as appropriateto allow timely decisions regarding required disclosure.

 

There were nosignificant changes in the Company’s internal controls or in other factors thatcould significantly affect these controls subsequent to the date of suchevaluation.

 

41

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**PART IV**

 

**ITEM 15****.  EXHIBITS,FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K**

 

(a)                                  1.                                       Financial Statements:

 

SeeIndex to Consolidated Financial Statements appearing on page F-l.

 

2.                                       Financial Statement Schedules:

 

Schedulesare omitted since they are not required or are not applicable.

 

42

----

 

3.     Exhibits:

 
| **Exhibit****No.** |   |                                                                                                                                                                                                                                                                                                                                                 |
|--------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|               |   |                                                                                                                                                                                                                                                                                                                                                 |
| 3.01               |   | Restated  Certificate of Incorporation of the Registrant dated September 3, 1981 *(incorporated  by reference to Exhibit 3.01 to the Registrant’s Annual Report on Form10-K  for the year ended November 30, 2001)*                                                                                                                             |
| 3.02               |   | Certificate  of Amendment to Restated Certificate of Incorporation of the Registrant dated  May 11, 1984 *(incorporated by reference to  Exhibit 3.02 to the Registrant’s Annual Report on Form 10-K for the year  ended November 30, 2001)*                                                                                                    |
| 3.03               |   | Certificate  of Amendment to Restated Certificate of Incorporation of the Registrant,  dated March 6, 1985 *(incorporated by reference to  Exhibit 3.03 to the Registrant’s Annual Report on Form 10-K for the year  ended November 30, 2001)*                                                                                                  |
| 3.04               |   | Certificate  of Amendment to Restated Certificate of Incorporation of the Registrant,  dated August 31, 1987 *(incorporated by reference to  Exhibit 3.04 to the Registrant’s Annual Report on Form 10-K for the year  ended November 30, 2001)*                                                                                                |
| 3.05               |   | Certificate  of Amendment to Restated Certificate of Incorporation of the Registrant,  dated January 28, 1988 *(incorporated by reference to  Exhibit 3.05 to the Registrant’s Annual Report on Form 10-K for the year  ended November 30, 2001)*                                                                                               |
| 3.06               |   | Certificate  of Amendment to Restated Certificate of Incorporation of the Registrant,  dated July 19, 1990 *(incorporated by reference to  Exhibit 3.06 to the Registrant’s Annual Report on Form 10-K for the year  ended November 30, 2001)*                                                                                                  |
| 3.07               |   | Certificate  of Amendment to Restated Certificate of Incorporation of the Registrant,  dated August 2, 1993 *(incorporated by reference to  Exhibit 3.07 to the Registrant’s Annual Report on Form 10-K for the year  ended November 30, 2001)*                                                                                                 |
| 3.08               |   | Certificate  of Designations of Floating Rate Preferred Stock, filed April 30, 1996 *(incorporated by reference to Exhibit 3.8 to the  Registrant’s Annual Report on Form 10-K for the year ended December 31, 1996)*                                                                                                                           |
| 3.09               |   | By-Laws  of the Registrant, amended as of January 30, 1997 *(incorporated by reference to Exhibit 3.9 to the Registrant’s Annual  Report on Form 10-K for the year ended December 31, 1996)*                                                                                                                                               |
| 4.01               |   | The instruments  defining the rights of holders of the long-term debt securities of the  Registrant and its subsidiaries are omitted pursuant to  section (b)(4)(iii)(A) of Item 601 of Regulation S-K. The  Registrant hereby agrees to furnish copies of these instruments to the  Securities and Exchange Commission upon request. |
| 12.01*             |   | Computation in support  of ratio of earnings to fixed charges                                                                                                                                                                                                                                                                                        |
| 21.01              |   | Pursuant  to General Instruction I of Form 10-K, the list of the Registrant’s  Subsidiaries is omitted.                                                                                                                                                                                                                                         |
| 23.01*             |   | Consent of Ernst &  Young LLP                                                                                                                                                                                                                                                                                                                    |
| 24.01*             |   | Powers of Attorney                                                                                                                                                                                                                                                                                                                                   |
| 99.01*             |   | Statement of Chief Executive Officer Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                      |
| 99.02*             |   | Statement of Chief  Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                      |

 

----

*                                         Filed herewith

 

(b)         The following CurrentReports on Form 8-K were filed during the Registrant’s 2002 fourth fiscalquarter ended November 30, 2002:

 

None

 

43

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**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the Registrant has duly caused this Annual Report to be signed on itsbehalf by the undersigned, thereunto duly authorized.

 
|               | LEHMAN  BROTHERS INC.  (REGISTRANT) |
|--------------------|-------------------------------------|
|               |                                |   |
|               |                                |   |
| February  28, 2003 | By:                                 | /s/ DAVID GOLDFARB |
|               |                                | David GoldfarbChief Financial Officer |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this Report has beensigned below by the following persons on behalf of the Registrant and in thecapacities and on the dates indicated.

 
| **Signature**              |   | **Title**                                                       |   | **Date**          |
|----------------------------|--------|-----------------------------------------------------------------|--------|-------------------|
|                       |   |                                                            |   |              |
| /s/ RICHARD S. FULD, JR.   |   | Chief Executive Officer and                                     |   | February 28, 2003 |
| Richard s. Fuld, Jr.       |   | Chairman of the Board of Directors(principal executive officer) |   |              |
|                       |   |                                                            |   |              |
| /s/ DAVID GOLDFARB         |   | Chief Financial Officer                                         |   | February 28, 2003 |
| David Goldfarb             |   | (principal financial and accounting officer)                    |   |              |
|                       |   |                                                            |   |              |
| /s/ ROGER S. BERLIND       |   | Director                                                        |   | February 28, 2003 |
| Roger s. Berlind           |   |                                                            |   |              |
|                       |   |                                                            |   |              |
| /s/  HOWARD L. CLARK, JR.  |   | Director                                                        |   | February 28, 2003 |
| Howard  l. Clark, Jr.      |   |                                                            |   |              |
|                       |   |                                                            |   |              |
| /s/  FREDERICK FRANK       |   | Director                                                        |   | February 28, 2003 |
| Frederick  Frank           |   |                                                            |   |              |
|                       |   |                                                            |   |              |
| /s/  HARVEY M. KRUEGER     |   | Director                                                        |   | February 28, 2003 |
| Harvey  m. Krueger         |   |                                                            |   |              |
|                       |   |                                                            |   |              |
| /s/  SHERMAN R. LEWIS, JR. |   | Director                                                        |   | February 28, 2003 |
| Sherman r. Lewis, Jr.      |   |                                                            |   |              |

 

44

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**CERTIFICATIONS**

 

I, Richard S. Fuld, Jr., certify that:

 

1.                                       I have reviewed this annual report on Form10-K of Lehman Brothers Inc.;

 

2.                                       Based on my knowledge, this annual report doesnot contain any untrue statement of a material fact or omit to state a materialfact necessary to make the statements made, in light of the circumstances underwhich such statements were made, not misleading with respect to the periodcovered by this annual report;

 

3.                                       Based on my knowledge, the financialstatements, and other financial information included in this annual report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this annual report;

 

4.                                       The registrant’s other certifying officers andI are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:

 

a)              designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this annual report isbeing prepared;

 

b)             evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this annual report (the “Evaluation Date”); and

 

c)              presented in this annual report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5.                                       The registrant’s other certifying officers andI have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent function):

 

a)              all significant deficiencies in the design oroperation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

b)             any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theregistrant’s internal controls; and

 

6.                                       The registrant’s other certifying officers andI have indicated in this annual report whether or not there were significantchanges in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 
| Date:    February 28, 2003 |   |
|-------------------------------------------|--------|
|                                      |   |   |
|                                      |   |   |
|                                      |   | /s/ Richard S. Fuld, Jr |
|                                      |   | Richard S. Fuld, Jr.Chairman and Chief Executive  Officer |

 

45

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I, David Goldfarb, certify that:

 

1.                                       I have reviewed this annual report on Form10-K of Lehman Brothers Inc.;

 

2.                                    Based on my knowledge, this annual report doesnot contain any untrue statement of a material fact or omit to state a materialfact necessary to make the statements made, in light of the circumstances underwhich such statements were made, not misleading with respect to the period coveredby this annual report;

 

3.                                    Based on my knowledge, the financialstatements, and other financial information included in this annual report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this annual report;

 

4.                                    The registrant’s other certifying officers andI are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:

 

a)           designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this annual report isbeing prepared;

 

b)          evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this annual report (the “Evaluation Date”); and

 

c)           presented in this annual report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5.                                    The registrant’s other certifying officers andI have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent function):

 

a)              all significant deficiencies in the design oroperation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

b)          any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theregistrant’s internal controls; and

 

6.                                    The registrant’s other certifying officers andI have indicated in this annual report whether or not there were significantchanges in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 
| Date:    February 28, 2003 |   |
|-------------------------------------------|--------|
|                                      |   |   |
|                                      |   |   |
|                                      |   | /s/ DAVID GOLDFARB |
|                                      |   | David GoldfarbChief Financial Officer |

 

46

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**LEHMANBROTHERS INC. and SUBSIDIARIES**

**INDEX TOCONSOLIDATED FINANCIAL STATEMENTS**

 
|                                                                                                                                                                    | **Page** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------|
| Report of Independent  Auditors                                                                                                                                         | F-2      |
|                                                                                                                                                                    |     |
| Consolidated Statement  of Income for the Twelve Months Ended November 30, 2002,  November 30,  2001, and November 30, 2000                         | F-3      |
|                                                                                                                                                                    |     |
| Consolidated  Statement of Financial Condition at November 30, 2002 and  November 30, 2001                                                                    | F-4      |
|                                                                                                                                                                    |     |
| Consolidated  Statement of Changes in Stockholder’s Equity for the Twelve Months Ended  November 30, 2002, November 30, 2001, and November 30, 2000 | F-6      |
|                                                                                                                                                                    |     |
| Consolidated  Statement of Cash Flows for the Twelve Months Ended November 30, 2002,  November 30, 2001, and November 30, 2000                           | F-7      |
|                                                                                                                                                                    |     |
| Notes to  Consolidated Financial Statements                                                                                                                             | F-8      |

 

F-1

----

 

**Report of Independent Auditors**

 

The Board of Directors and Stockholder ofLehman Brothers Inc.

 

We have audited the accompanying consolidated statement of financialcondition of Lehman Brothers Inc. and Subsidiaries (the “Company”) as ofNovember 30, 2002 and 2001, the related consolidated statements of income,changes in stockholder’s equity and cash flows for each of the three years inthe period ended November 30, 2002 and the consolidated statement of changes inliabilities subordinated to claims of general creditors for the years endedNovember 30, 2002 and 2001.  Thesefinancial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

 

We conducted our audits in accordance with auditing standards generallyaccepted in the United States.  Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above presentfairly, in all material respects, the consolidated financial position of LehmanBrothers Inc. and Subsidiaries at November 30, 2002 and 2001, the consolidatedresults of its operations and its cash flows for each of the three years in theperiod ended November 30, 2002, and the consolidated changes in liabilitiessubordinated to claims of general creditors for the years ended November 30,2002 and 2001, in conformity with accounting principles generally accepted inthe United States.

 

Our audits were conducted for the purpose of forming an opinion on thebasic consolidated financial statements taken as a whole.  The supplemental information is presentedfor purposes of additional analysis and is not a required part of the basicconsolidated financial statements, but is supplementary information required byRule 17a-5 under the Securities Exchange Act of 1934 and Regulation 1.10 of theCommodity Futures Trading Commission. Such information has been subjected to the auditing procedures appliedin our audit of the basic consolidated financial statements and, in ouropinion, is fairly stated in all material respects in relation to the basic consolidatedfinancial statements taken as a whole.

 
| /s/ *Ernst &  Young LLP* |   |   |
|------------------------------|--------|--------|
|                         |
| New York, New York           |
| January 10, 2003             |

 

F-2

----

 

**LEHMANBROTHERS INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENT OF INCOME**

**(inmillions)**

 
|                                                      |   | **Twelve months ended November 30,** |         |
|-----------------------------------------------------------|--------|--------------------------------------|--------------|
|                                                      |   | **2002**                             | ** **   | **2001** | ** ** | **2000** | ** ** |
|                                                      |   | **(in millions)**                    | *** *** |
| **Revenues**                                              |   |                                 |         |   |   |   |   |
| Principal  transactions                                   |   | $                                    | 577          |   | $ | 903 |   | $ | 1,938 |   |
| Investment  banking                                       |   | 1,457                                |         | 1,508 |   | 1,614 |   |
| Commissions                                               |   | 1,073                                |         | 848 |   | 686 |   |
| Interest and  dividends                                   |   | 8,985                                |         | 14,276 |   | 16,501 |   |
| Other                                                     |   | 32                                   |         | 44 |   | 55 |   |
| Total revenues                                            |   | 12,124                               |         | 17,579 |   | 20,794 |   |
| Interest expense                                          |   | 8,197                                |         | 13,485 |   | 16,059 |   |
| Net revenues                                              |   | 3,927                                |         | 4,094 |   | 4,735 |   |
|                                                      |   |                                 |         |   |   |   |   |
| **Non-interest  expenses**                                |   |                                 |         |   |   |   |   |
| Compensation and  benefits                                |   | 2,002                                |         | 2,088 |   | 2,304 |   |
| Brokerage and  clearance                                  |   | 258                                  |         | 238 |   | 212 |   |
| Technology and  communications                            |   | 206                                  |         | 265 |   | 192 |   |
| Occupancy                                                 |   | 185                                  |         | 115 |   | 57 |   |
| Business  development                                     |   | 96                                   |         | 121 |   | 120 |   |
| Professional  fees                                        |   | 66                                   |         | 69 |   | 90 |   |
| Management fees,  net                                     |   | 50                                   |         | (39 | ) | 88 |   |
| Other                                                     |   | 30                                   |         | 57 |   | 55 |   |
| Regulatory  settlement                                    |   | 80                                   |         | — |   | — |   |
| Other real  estate reconfiguration charge                 |   | 8                                    |         | — |   | — |   |
| September 11th   related (recoveries)/expenses,  net |   | —                               |         | 51 |   | — |   |
| Total  non-interest expenses                              |   | 2,981                                |         | 2,965 |   | 3,118 |   |
| Income before  taxes                                      |   | 946                                  |         | 1,129 |   | 1,617 |   |
| Provision for  income taxes                               |   | 206                                  |         | 274 |   | 483 |   |
| Net income                                                |   | $                                    | 740          |   | $ | 855 |   | $ | 1,134 |   |

 

*SeeNotes to Consolidated Financial Statements.*

 

F-3

----

 

**LEHMANBROTHERS INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENT OF FINANCIAL CONDITION**

**(inmillions)**

 
|                                                                                                                                             |   | **November  30,** |         |
|--------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|--------------|
|                                                                                                                                             |   | **2002**          | ** **   | **2001** | ** ** |
|                                                                                                                                             |   | **(in millions)** | *** *** |
| **Assets**                                                                                                                                       |   |              |         |   |   |
| Cash and cash  equivalents                                                                                                                       |   | $                 | 369          |   | $ | 648 |   |
| Cash and  securities segregated and on deposit for regulatory and other purposes                                                                 |   | 1,896             |         | 2,793 |   |
| Securities and other  financial instruments owned:                                                                                               |   |              |         |   |   |
| Pledged as  collateral                                                                                                                           |   | 22,407            |         | 19,105 |   |
| Not pledged as  collateral                                                                                                                       |   | 48,474            |         | 48,562 |   |
|                                                                                                                                             |   | 70,881            |         | 67,667 |   |
|                                                                                                                                             |   |              |         |   |   |
| Collateralized  short-term agreements:                                                                                                           |   |              |         |   |   |
| Securities  purchased under agreements to resell                                                                                                 |   | 75,769            |         | 75,185 |   |
| Securities  borrowed                                                                                                                             |   | 25,380            |         | 22,467 |   |
|                                                                                                                                             |   |              |         |   |   |
| Receivables:                                                                                                                                     |   |              |         |   |   |
| Brokers, dealers  and clearing organizations                                                                                                     |   | 5,783             |         | 4,209 |   |
| Customers                                                                                                                                        |   | 5,146             |         | 7,284 |   |
| Receivables from  affiliates                                                                                                                     |   | 9,884             |         | 9,345 |   |
| Others                                                                                                                                           |   | 378               |         | 501 |   |
| Property,  equipment and leasehold improvements   (net of accumulated depreciation and amortization  of $129 in 2002 and $140 in 2001) |   | 138               |         | 273 |   |
| Other assets                                                                                                                                     |   | 443               |         | 412 |   |
| Excess of cost  over fair value of net assets acquired   (net of accumulated amortization of   $134 in 2002  and $131 in 2001)    |   | 152               |         | 154 |   |
| Total assets                                                                                                                                     |   | $                 | 196,219      |   | $ | 190,938 |   |

 

*SeeNotes to Consolidated Financial Statements.*

 

F-4

----

 

**LEHMANBROTHERS INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENT OF FINANCIAL CONDITION-(Continued)**

**(inmillions)**

 
|                                                                                           |   | **November  30,**                       |         |
|------------------------------------------------------------------------------------------------|--------|-----------------------------------------|--------------|
|                                                                                           |   | **2002**                                | ** **   | **2001** | ** ** |
|                                                                                           |   | **(in millions except per share data)** | *** *** |
| **Liabilities  and stockholder’s equity**                                                 |   |                                    |         |   |   |
| Short-term debt                                                                                |   | $                                       | 123          |   | $ | 1,038 |   |
| Securities and  other financial instruments sold but not yet purchased                         |   | 50,352                                  |         | 32,970 |   |
| Collateralized  short-term financing:                                                          |   |                                    |         |   |   |
| Securities sold  under agreements to repurchase                                                |   | 83,343                                  |         | 83,676 |   |
| Securities  loaned                                                                             |   | 23,682                                  |         | 26,535 |   |
| Other secured  financing                                                                       |   | 1,666                                   |         | 2,525 |   |
| Advances from  Holdings and other affiliates                                                   |   | 13,153                                  |         | 21,487 |   |
| Payables:                                                                                      |   |                                    |         |   |   |
| Brokers, dealers  and clearing organizations                                                   |   | 3,473                                   |         | 3,599 |   |
| Customers                                                                                      |   | 6,474                                   |         | 7,004 |   |
| Accrued  liabilities and other payables                                                        |   | 2,811                                   |         | 2,537 |   |
| Long-term debt:                                                                                |   |                                    |         |   |   |
| Senior notes                                                                                   |   | 3,511                                   |         | 1,930 |   |
| Subordinated  indebtedness                                                                     |   | 4,479                                   |         | 4,197 |   |
| Total  liabilities                                                                             |   | 193,067                                 |         | 187,498 |   |
|                                                                                           |   |                                    |         |   |   |
| Commitments and  contingencies                                                                 |   |                                    |         |   |   |
|                                                                                           |   |                                    |         |   |   |
| **Stockholder’s  equity**                                                                 |   |                                    |         |   |   |
| Preferred stock,  $0.10 par value; 10,000 shares authorized; none outstanding                  |   |                                    |         |   |   |
| Common stock,  $0.10 par value; 10,000 shares authorized; 1,006 shares issued and  outstanding |   |                                    |         |   |   |
| Additional paid-in  capital                                                                    |   | 1,738                                   |         | 1,682 |   |
| Accumulated other  comprehensive income                                                        |   | 3                                       |         | 2 |   |
| Retained  earnings                                                                             |   | 1,411                                   |         | 1,756 |   |
| Total  stockholder’s equity                                                               |   | 3,152                                   |         | 3,440 |   |
| Total  liabilities and stockholder’s equity                                               |   | $                                       | 196,219      |   | $ | 190,938 |   |

 

*SeeNotes to Consolidated Financial Statements.*

 

F-5

----

 

**LEHMANBROTHERS INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENT OF CHANGES IN STOCKHOLDER’S EQUITY**

**(inmillions)**

 
|                                   |   | **Twelve months ended November 30,** |         |
|----------------------------------------|--------|--------------------------------------|--------------|
|                                   |   | **2002**                             | ** **   | **2001** | ** ** | **2000** | ** ** |
|                                   |   | **(in millions)**                    | *** *** |
| Additional paid-in capital             |   |                                 |         |   |   |   |   |
| Beginning  balance                     |   | $                                    | 1,682        |   | $ | 1,683 |   | $ | 1,684 |   |
| Capital  distributions                 |   | —                               |         | (1 | ) | (1 | ) |
| Capital  contributions                 |   | 56                                   |         | — |   | — |   |
| Ending balance                         |   | 1,738                                |         | 1,682 |   | 1,683 |   |
| Accumulated other comprehensive income |   |                                 |         |   |   |   |   |
| Beginning  balance                     |   | 2                                    |         | 2 |   | 2 |   |
| Foreign currency  translation          |   | 1                                    |         | — |   | — |   |
| Ending balance                         |   | 3                                    |         | 2 |   | 2 |   |
| Retained earnings                      |   |                                 |         |   |   |   |   |
| Beginning  balance                     |   | 1,756                                |         | 1,953 |   | 1,417 |   |
| Net income                             |   | 740                                  |         | 855 |   | 1,134 |   |
| Dividends                              |   | (1,085                               | )            | (1,052 | ) | (598 | ) |
| Ending balance                         |   | 1,411                                |         | 1,756 |   | 1,953 |   |
| Total  stockholder’s equity       |   | $                                    | 3,152        |   | $ | 3,440 |   | $ | 3,638 |   |

 

*SeeNotes to Consolidated Financial Statements.*

 

F-6

----

 

**LEHMANBROTHERS INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENT OF CASHFLOWS**

**(inmillions)**

 
|                                                                                         |   | **2002**          |         | **2001** |       | **2000** |       |
|----------------------------------------------------------------------------------------------|--------|-------------------|--------------|----------|------------|----------|------------|
|                                                                                         |   | **(in millions)** | *** *** |
| **Cash flows from operating  activities**                                                    |   |              |         |     |       |     |       |
| Net Income                                                                                   |   | $                 | 740          |     | $          | 855      |       | $ | 1,134 |   |
| Adjustments to  reconcile net income to net cash provided by (used in) operating activities: |   |              |         |     |       |     |       |
| Depreciation and  amortization                                                               |   | 61                |         | 70       |       | 39       |       |
| Deferred tax  (benefit)                                                                      |   | (456              | )            | (193     | )          | (83      | )          |
| September 11th  (recoveries)/expenses                                                        |   | —            |         | 230      |       | —   |       |
| Other real  estate reconfiguration costs                                                     |   | 8                 |         | —   |       | —   |       |
| Regulatory  settlement                                                                       |   | 80                |         | —   |       | —   |       |
| Other  adjustments                                                                           |   | 21                |         | (2       | )          | 49       |       |
| Net change in:                                                                               |   |              |         |     |       |     |       |
| Cash and  securities segregated and on deposit                                               |   | 897               |         | (805     | )          | (554     | )          |
| Securities and  other financial instruments owned                                            |   | (3,194            | )            | (3,308   | )          | (12,288  | )          |
| Securities  borrowed                                                                         |   | (2,913            | )            | (3,591   | )          | (7,633   | )          |
| Receivables from  brokers, dealers and clearing organizations                                |   | (1,574            | )            | (1,907   | )          | 44       |       |
| Receivables from  customers                                                                  |   | 2,138             |         | (2,982   | )          | (1,380   | )          |
| Securities and  other financial instruments sold but not yet purchased                       |   | 17,383            |         | 15,536   |       | (1,213   | )          |
| Securities  loaned                                                                           |   | (2,853            | )            | 2,453    |       | 14,273   |       |
| Other secured  financing                                                                     |   | (859              | )            | 1,325    |       | 1,200    |       |
| Payables to  brokers, dealers and clearing organizations                                     |   | (126              | )            | 279      |       | 835      |       |
| Payables to  customers                                                                       |   | (530              | )            | 2,946    |       | (1,477   | )          |
| Accrued  liabilities and other payables                                                      |   | 257               |         | (166     | )          | (148     | )          |
| Other operating  assets and liabilities, net                                                 |   | 445               |         | 27       |       | 134      |       |
| Net cash  provided by (used in) operating activities                                         |   | 9,525             |         | 10,767   |       | (7,068   | )          |
|                                                                                         |   |              |         |     |       |     |       |
| **Cash flows from financing  activities**                                                    |   |              | ** **   |     | ** ** |     | ** ** |
| Proceeds from  issuance of senior notes                                                      |   | 1,745             |         | 1,765    |       | —   |       |
| Principal  payments of senior notes                                                          |   | —            |         | (43      | )          | —   |       |
| Proceeds from  issuance of subordinated indebtedness                                         |   | 800               |         | 800      |       | —   |       |
| Principal  payments of subordinated indebtedness                                             |   | (706              | )            | (194     | )          | (192     | )          |
| Net proceeds  from (payments for) short-term debt                                            |   | (915              | )            | 297      |       | 126      |       |
| Resale  agreements net of repurchase agreements                                              |   | (917              | )            | (18,112  | )          | 11,381   |       |
| Advances due to  affiliates net of affiliate receivables                                     |   | (8,873            | )            | 4,345    |       | (2,599   | )          |
| Dividends and  capital distribution paid                                                     |   | (1,085            | )            | (1,052   | )          | (598     | )          |
| Capital  contribution                                                                        |   | 56                |         | —   |       | —   |       |
| Net cash (used  in) provided by financing activities                                         |   | (9,895            | )            | (12,194  | )          | 8,118    |       |
|                                                                                         |   |              | ** **   |     | ** ** |     | ** ** |
| **Cash flows from investing  activities**                                                    |   |              | ** **   |     | ** ** |     | ** ** |
| Purchases of  property, equipment and leasehold improvements, net                            |   | (31               | )            | (248     | )          | (70      | )          |
| Acquisition, net  of cash acquired                                                           |   | —            |         | —   |       | (41      | )          |
| Proceeds from the sale  of 3 World Financial Center                                          |   | 122               |         | —   |       | —   |       |
| Net cash provided  by (used in) investing activities                                         |   | 91                |         | (248     | )          | (111     | )          |
| Net change in  cash and cash equivalents                                                     |   | (279              | )            | (1,675   | )          | 939      |       |
| Cash and cash  equivalents, beginning of period                                              |   | 648               |         | 2,323    |       | 1,384    |       |
| Cash and cash  equivalents, end of period                                                    |   | $                 | 369          |     | $          | 648      |       | $ | 2,323 |   |

 

**Supplementaldisclosure of cash flow information (in millions)**

Interest paid totaled $8,214 in 2002, $13,653in 2001 and  $16,048 in 2000.

Income taxes paid totaled $592 in 2002, $648in 2001 and $516 in 2000.

 

*SeeNotes to Consolidated Financial Statements.*

 

F-7

----

 

**LEHMANBROTHERS INC. AND SUBSIDIARIES**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

**TABLE OFCONTENTS**

 
| Note  1.  | Summary  of Significant Accounting Policies        | F-9    |
|-----------|----------------------------------------------------|--------|
|      |                                               |   |
| Note  2.  | September  11th Related (Recoveries)/Expenses, Net | F-14   |
|      |                                               |   |
| Note  3.  | Costs  Associated with Real-Estate Reconfiguration | F-15   |
|      |                                               |   |
| Note  4.  | Regulatory  Settlement                             | F-15   |
|      |                                               |   |
| Note  5.  | Short-term  Financings                             | F-15   |
|      |                                               |   |
| Note  6.  | Long-term  Debt                                    | F-16   |
|      |                                               |   |
| Note  7.  | Holdings’  Benefit and Incentive Plans        | F-18   |
|      |                                               |   |
| Note  8.  | Capital  Requirements                              | F-19   |
|      |                                               |   |
| Note  9.  | Holdings’  Employee Benefit Plans             | F-20   |
|      |                                               |   |
| Note  10. | Income  Taxes                                      | F-21   |
|      |                                               |   |
| Note  11. | Derivative  Financial Instruments                  | F-22   |
|      |                                               |   |
| Note  12. | Securitizations                                    | F-26   |
|      |                                               |   |
| Note  13. | Fair  Value of Financial Instruments               | F-28   |
|      |                                               |   |
| Note  14. | Financial  Instruments                             | F-29   |
|      |                                               |   |
| Note  15. | Securities  Pledged as Collateral                  | F-29   |
|      |                                               |   |
| Note  16. | Other  Commitments and Contingencies               | F-30   |
|      |                                               |   |
| Note  17. | Related  Party Transactions                        | F-32   |
|      |                                               |   |
| Note  18. | Segments                                           | F-33   |
|      |                                               |   |
| Note  19. | Quarterly  Information (Unaudited)                 | F-35   |

 

F-8

----

 

**Note 1****. Summary of Significant Accounting Policies**

** **

***Basis of Presentation***

 

The consolidated financial statements include theaccounts of Lehman Brothers Inc., a registered broker-dealer (“LBI”) andsubsidiaries (collectively, the “Company”). LBI is a wholly-owned subsidiary ofLehman Brothers Holdings Inc. (“Holdings”). (Holdings and its subsidiaries arecollectively referred to as “Lehman Brothers”.) The Company is one of theleading global investment banks serving institutional, corporate, governmentand high-net-worth individual clients and customers. The Company’s worldwideheadquarters in New York are complemented by offices in additional locations inNorth America, Europe, the Middle East, Latin America and the Asia PacificRegion. The Company is engaged primarily in providing financial services. Allmaterial intercompany accounts and transactions have been eliminated inconsolidation.

 

The consolidated financial statements are preparedin conformity with generally accepted accounting principles which requiremanagement to make estimates and assumptions that affect the amounts reportedin the financial statements and accompanying notes. Management estimates arerequired to be utilized in determining the valuation of trading inventoryparticularly in the area of OTC derivatives, certain high yield positions andprivate equity securities. Additionally, management estimates are required inassessing the realizability of deferred tax assets, the outcome of litigationand determining the components of the September 11th relatedrecoveries/expenses and other real estate reconfiguration costs. Managementbelieves that the estimates utilized in preparing its financial statements arereasonable and prudent. Actual results could differ from these estimates.

 

The Company uses the trade date basis ofaccounting.

 

Certain prior period amounts reflect reclassificationsto conform to the current year’s presentation.

 

***Securities and OtherFinancial Instruments***

 

Securities and other financial instruments ownedand securities and other financial instruments sold but not yet purchased arevalued at market or fair value, as appropriate, with unrealized gains andlosses reflected in Principal transactions in the Consolidated Statement ofIncome. Market value is generally based on listed market prices. If listedmarket prices are not available, or if liquidating the Company’s position isreasonably expected to affect market prices, fair value is either determined onbroker quotes, internal valuation pricing models which take into account timevalue and volatility factors underlying the financial instrument, or management’sestimate of the amounts that could be realized under current market conditions,assuming an orderly liquidation over a reasonable period of time.

 

As of November 30, 2002 and 2001, all firm-ownedsecurities pledged to counterparties where the counterparty has the right, bycontract or custom, to sell or repledge the securities are classified asSecurities Owned Pledged as Collateral as required by Statement of FinancialAccounting Standard (“SFAS”) No. 140, “Accounting for Transfers and Servicing ofFinancial Assets and Extinguishment of Liabilities.”

 

***Derivative FinancialInstruments***

 

A derivative is typically defined as an instrumentwhose value is “derived” from an underlying instrument, index or rate, such asa future, forward, swap, or option contract, or other financial instrument withsimilar characteristics. A derivative contract generally represents futurecommitments to exchange interest payment streams or currencies based on thecontract or notional amount or to purchase or sell other financial instrumentsat specified terms on a specified date.

 

Derivatives utilized for trading purposes arerecorded at market or fair value in the Consolidated Statement of FinancialCondition on a net by counterparty basis where a legal right of set-off existsand are netted across products when such provisions are stated in the masternetting agreement. Derivatives are often referred to as off-balance-sheetinstruments since neither their notional amounts nor the underlying instrumentsare reflected as assets or liabilities of the Company. Instead, the market orfair value related to the derivative transactions is reported in theConsolidated Statement of Financial Condition as an asset or liability inDerivatives and other contractual agreements, as applicable. Margin on futurescontracts is included in receivables and payables from/to brokers, dealers andclearing organizations, as applicable. Changes in fair

 

F-9

----

 

values of derivatives are recorded as principaltransactions revenues in the current period. Market or fair value fortrading-related instruments is generally determined by either quoted marketprices (for exchange-traded futures and options) or pricing models (forover-the-counter swaps, forwards and options). Pricing models utilize a seriesof market inputs to determine the present value of future cash flows, withadjustments, as required for credit risk and liquidity risk. Further valuationadjustments may be recorded, as deemed appropriate for new or complex productsor for positions with significant concentrations. These adjustments areintegral components of the mark-to-market process. Credit-related valuationadjustments incorporate business and economic conditions, historicalexperience, concentrations, estimates of expected losses and the character,quality and performance of credit sensitive financial instruments.

 

As an end-user, the Company primarily utilizesderivatives to modify the interest rate characteristics of its long-term debtand secured financing activities. The Company also utilizes equity derivativesto hedge its exposure to equity price risk embedded in certain of its debtobligations and foreign exchange forwards to manage the currency exposurerelated to its net monetary investment in non-U.S. dollar functional currencyoperations (collectively, “end-user derivative activities”).

 

Effective December 1, 2000, the Company adoptedSFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,”as amended by SFAS No. 138, “Accounting for Certain Derivative Instruments andCertain Hedging Activities” (collectively, “SFAS 133”), which requires that allderivative instruments be reported on the consolidated statement of financialcondition at fair value. SFAS 133 changed the Company’s accounting methodologyapplied to its end-user derivative activities, however the adoption of SFAS 133had no effect on the accounting for the Company’s trading-related derivativeactivities, as such derivatives were already recorded on a fair value basis.

 

Under SFAS 133, the accounting for end-userderivative activities is dependent upon the nature of the hedging relationship.In certain hedging relationships, both the derivative and the hedged item willbe marked-to-market through earnings for changes in fair value (“fair valuehedge”). In many instances the hedge relationship is fully effective so thatthe mark-to-market on the derivative and the hedged item will offset. In otherhedging relationships, the derivative will be marked-to-market with theoffsetting gains or losses recorded in Accumulated Other Comprehensive Income,a component of Stockholder’s Equity, until the related hedged item is realizedin earnings (“cash flow hedge”). SFAS 133 also requires certain derivativesembedded in long-term debt to be bifurcated and marked-to-market throughearnings.

 

SFAS 133 changed the accounting treatment for thehedged item in a fair value hedge (e.g., long-term debt or secured financingactivities) from what was an accrual basis to a modified mark-to-market value.The hedged item’s carrying value may differ from a full mark-to-market valuesince SFAS 133 requires that the hedged item be adjusted only for changes infair value associated with the designated risks being hedged during the hedge period.

 

The Company principally utilizes fair value hedgesto convert a substantial portion of the Company’s fixed rate debt and certainlong-term secured financing activities to floating interest rates. Any hedgeineffectiveness in these relationships is recorded as a component of interestexpense on the Company’s Statement of Income. Gains or losses from revaluingforeign exchange contracts associated with hedging the Company’s netinvestments in foreign affiliates are reported within Accumulated Other ComprehensiveIncome in Stockholder’s Equity. Unrealized receivables/payables resulting fromthe mark-to-market on end-user derivatives are included in Securities and OtherFinancial Instruments Owned or Sold but not yet Purchased.

 

The adoption of SFAS 133, as of December 1, 2000,did not have a material effect on the Company’s consolidated statement offinancial condition or the results of operations, as most of the Company’sderivative transactions are entered into for trading-related activities forwhich the adoption of SFAS 133 had no impact. Prior year amounts have not beenrestated to conform with the current SFAS 133 accounting treatment. Therefore,end-user derivative activities for all periods prior to December 1, 2001 arerecorded on an accrual basis provided that the derivative was designated anddeemed to be a highly effective hedge. For periods prior to 2001, realizedgains or losses on early terminations of derivatives that were designated ashedges were deferred and amortized to interest income or interest expense overthe remaining life of the instrument being hedged.

 

F-10

----

 

***Secured Financing Activitie****s*

 

*Repurchase and Resale Agreements*

 

Securities purchased under agreements to reselland securities sold under agreements to repurchase, which are treated asfinancing transactions for financial reporting purposes, are collateralizedprimarily by government and government agency securities and are carried net bycounterparty, when permitted, at the amounts at which the securities will besubsequently resold or repurchased plus accrued interest. It is the policy ofthe Company to take possession of securities purchased under agreements toresell. The Company monitors the market value of the underlying positions on adaily basis as compared to the related receivable or payable balances,including accrued interest. The Company requires counterparties to depositadditional collateral or return collateral pledged as necessary, to ensure thatthe market value of the underlying collateral remains sufficient. Securitiesand other financial instruments owned that are financed under repurchaseagreements are carried at market value with changes in market value reflectedin the Consolidated Statement of Income.

 

The Company utilizes interest rate swaps as anend-user to modify the interest rate exposure associated with certain fixedrate resale and repurchase agreements. In accordance with SFAS No. 133, theCompany adjusted the carrying value of these secured financing transactionsthat had been designated as the hedge.

 

*Securities Borrowed and Loane*d

 

Securities borrowed and securities loaned arecarried at the amount of cash collateral advanced or received plus accruedinterest. It is the Company’s policy to value the securities borrowed andloaned on a daily basis, and to obtain additional cash as necessary to ensuresuch transactions are adequately collateralized.

 

*Other SecuredBorrowings*

 

Other secured borrowings are recorded atcontractual amounts plus accrued interest.

 

***Private EquityInvestments***

 

The Company carries its private equityinvestments, including its partnership interests, at fair value based upon theCompany’s assessment of each underlying investment. As the general partner inits private equity funds, the Company may be entitled to receive a preferreddistribution of realized profits.

 

***Income Taxes***

 

The Company accounts for income taxes under theprovisions of SFAS No. 109, “Accounting for Income Taxes.” The Companyrecognizes the current and deferred tax consequences of all transactions thathave been recognized in the financial statements using the provisions of theenacted tax laws.

 

In this regard, deferred tax assets are recognizedfor temporary differences that will result in deductible amounts in futureyears and for tax loss carry-forwards, if in the opinion of management, it ismore likely than not that the deferred tax asset will be realized. SFAS 109requires companies to set up a valuation allowance for that component of netdeferred tax assets which does not meet the “more likely than not” criterionfor realization. Deferred tax liabilities are recognized for temporarydifferences that will result in taxable income in future years.

 

***Translation of ForeignCurrencies***

 

Assets and liabilities of foreign subsidiarieshaving non-U.S. dollar functional currencies are translated at exchange ratesat the statement of financial condition date. Revenues and expenses aretranslated at average exchange rates during the period. The gains or losses resultingfrom translating foreign currency financial statements into U.S. dollars, netof hedging  gains or losses and taxes,are included in Accumulated Other Comprehensive Income, a separate component ofStockholders’ Equity. Gains or losses resulting from foreign currencytransactions are included in the Consolidated Statement of Income.

 

F-11

----

 

***Property, Equipmentand Leasehold Improvement****s*

 

Property, equipment and leasehold improvements arerecorded at historical cost, net of accumulated depreciation and amortization.Depreciation is recognized on a straight-line basis over the estimated usefullives. Buildings are depreciated up to a maximum of 40 years.   Leasehold improvements are amortized overthe lesser of their economic useful lives or the terms of the underlyingleases, ranging up to 20 years. Equipment, furniture and fixtures aredepreciated over periods of up to 15 years. Internal use of Software whichqualifies for capitalization under American Institute of Certified PublicAccountants (“AICPA”) Statement of position 98-1, “Accounting for the costs ofComputer Software Developed or Obtained for Internal Use” is capitalized andsubsequently amortized over the estimated useful life of the software, generally3 years, with a maximum of 7 years.

 

***Long Lived Ass*ets**

 

In accordance with SFAS121, “Accounting for the Impairment of Long-Lived Assets and for Long-LivedAssets to be Disposed Of,” the Company reviews assets, such as property,equipment and leasehold improvements for impairment whenever events or changesin circumstances indicate that the carrying value amount may not berecoverable. If the total of the expected future undiscounted cash flows isless than the carrying amount of the asset, then an impairment loss would berecognized to the extent that the carrying value of such asset exceeded itsfair value.

 

***Goodwill***

 

As of December 1, 2002, the Company adopted SFASNo. 141, “Business Combinations” and SFAS No. 142, “Goodwill and OtherIntangible Assets.” SFAS 141 requires all business combinations initiated afterJune 30, 2001 to be accounted for using the purchase method. Under SFAS 142,intangible assets with indefinite lives and goodwill are no longer required tobe amortized. Instead, these assets are evaluated annually for impairment. TheCompany adopted the provisions of SFAS 142 at the beginning of fiscal year 2002and the change did not have a material impact to the Company’s financialposition or its results of operations. Prior to December 1, 2002 the Companyamortized goodwill using the straight-line method over periods not exceeding 35years. Goodwill is reduced upon the recognition of certain acquired netoperating loss carryforward benefits.

 

***Stock-Based Awards***

 

The Company’s employees participate in Holdings’stock-based incentive plans. Holdings accounts for these awards on aconsolidated basis in accordance with Accounting Principles Board Opinion No.25, “Accounting for Stock Issued to Employees” (“APB 25”) and its relatedinterpretations. The Company records as compensation and benefits the allocatedshare of Holdings’ compensation cost.

 

***Statement of CashFlows***

 

For purposes of the Consolidated Statement of CashFlows, the Company defines cash equivalents as highly liquid investments withoriginal maturities of three months or less, other than those held for sale inthe ordinary course of business.

 

***ConsolidationAccounting Policies***

 

*Operating Companies*

 

The Company followsStatement of Financial Accounting Standards (“SFAS”) No. 94, “Consolidation ofAll Majority-Owned Subsidiaries,” and consolidates operating entities when theCompany has a controlling financial interest over the business activities ofsuch entities. Non-controlled operating entities are accounted for under theequity method when the Company is able to exercise significant influence overthe business activities of such entities. The cost method is applied when theability to exercise significant influence is not present.

 

F-12

----

 

*Special Purpose Entities*

 

For those entities which do not meet thedefinition of conducting a business, often referred to as special purposeentities (“SPE’s”), the Company follows the accounting guidance under SFAS 140,“Accounting for Transfers and Servicing of Financial Assets and Extinguishmentsof Liabilities—a replacement of FASB No. 125,” and Emerging Issues Task Force(“EITF”) Topic D-14, “Transactions Involving Special-Purpose Entities,” todetermine whether or not such SPE’s are required to be consolidated. Themajority of the Company’s involvement with SPE’s relates to securitizationtransactions meeting the SFAS 140 definition of a qualifying special purposeentity (“QSPE”). A QSPE can generally be described as an entity with significantlylimited powers which are intended to limit such entity to passively holdingfinancial assets and distributing cash flows based upon predetermined criteria.Based upon the guidance in SFAS 140, the Company does not consolidate suchQSPE’s. Rather, the Company accounts for its involvement with such QSPE’s undera financial components approach in which the Company recognizes only itsretained involvement with the QSPE. The Company accounts for such retainedinterests at fair value.

 

Certain special purposeentities do not meet the QSPE criteria due to their permitted activities notbeing sufficiently limited, or because the assets are not deemed qualifyingfinancial instruments (e.g., real estate). In instances in which the Company iseither the sponsor of or transferor of assets to a non-qualifying SPE, theCompany follows the accounting guidance provided by EITF Topic D-14 todetermine whether consolidation is required. Under this guidance, the Companywould not consolidate such SPE if a third party investor made a substantialequity investment in the SPE (minimum of 3%), was subject to first dollar riskof loss of such SPE, and had a controlling financial interest.

 

***Transfers of FinancialAssets***

 

The Company accounts for transfers of financialassets in accordance with SFAS 140. In accordance with this guidance theCompany recognizes the transfer of financial assets as sales provided thatcontrol has been relinquished. Control is deemed to be relinquished only whenall of the following conditions have been met: i) the assets have been isolatedfrom the transferor even in bankruptcy or other receivership (true saleopinions are required), ii) the transferee has the right to pledge or exchangethe assets received and iii) the transferor has not maintained effectivecontrol over the transferred assets (e.g., through a unilateral ability torepurchase a unique or specific asset).

 

***Revenue Recognition Policies***

 

*Principal Transactions*

 

Securities and other financial instruments ownedand securities and other financial instruments sold but not yet purchased (bothof which are recorded on a trade date basis) are valued at market or fairvalue, as appropriate, with unrealized gains and losses reflected in Principaltransactions in the Consolidated Statement of Income. Market value is generallybased on listed market prices. If listed market prices are not available, or ifliquidating the Company’s position is reasonably expected to affect marketprices, fair value is determined based on broker quotes, internal valuation pricingmodels which take into account time value and volatility factors underlying thefinancial instruments, or management’s estimate of the amounts that could berealized under current market conditions, assuming an orderly liquidation overa reasonable period of time.

 

*Investment Banking*

 

Underwriting revenues and fees for merger andacquisition advisory services are recognized when services for the transactionsare determined to be completed. Underwriting expenses are deferred andrecognized at the time the related revenues are recorded.

 

*Commissions*

 

Commissions primarily include fees from executingand clearing client transactions on stock, options and futures marketsworldwide. These fees are recognized on a trade date basis.

 

F-13

----

 

*Interest Revenue/Expense*

 

The Company recognizes contractual interest onsecurities and other financial instruments owned and securities and otherfinancial instruments sold but not yet purchased on an accrual basis as a componentof Interest and dividends revenues and Interest expense, respectively. Interestflows on the Company’s derivative transactions are included as part of theCompany’s mark-to-market valuation of these contracts within Principaltransactions and are not recognized as a component of interest revenue/expense.

 

The Company accounts for its secured financingactivities, and short and long-term borrowings on an accrual basis with relatedinterest recorded as interest revenue or interest expense, as applicable.

 

**Note 2****. September 11th Related (Recoveries)/Expenses,Net**

 

As a result of the September 11, 2001 terroristattack, the Company’s leased facilities in the World Trade Center weredestroyed and its leased and owned facilities in the World Financial Center(“WFC”) complex (including the 3 World Financial Center building owned jointlywith American Express) were significantly damaged. All employees and operationsin the downtown New York area were displaced. Key business activities andnecessary support functions were quickly relocated to the Company’s back-upfacilities in New Jersey and to various other temporary sites.

 

Holdings had significant levels of insurance inplace to cover the losses resulting from the terrorist attack including apolicy covering damage to the core and shell of the 3 WFC building and aseparate policy covering the property damage at the WTC and WFC facilities,losses resulting from business interruption and extra expenses associated withthe relocation to, and occupancy of, the temporary facilities.

 

During 2001, the Company recognized a pretaxcharge of $51 million ($29 million after-tax) associated with the net lossesstemming from the events of September 11, 2001. The September 11 charge in 2001includes losses and costs of approximately $291 million offset by estimatedinsurance recoveries of $240 million. These losses and costs include thewrite-off of property damaged, destroyed or abandoned at the Company’s downtownfacilities totaling approximately $213 million, with the remainder representingcompensation paid to employees during the time they were idled and/or engagedspecifically in business recovery efforts, costs incurred to maintain thefacilities while they are unusable and other costs associated with theredeployment of the Company’s workforce to the temporary facilities. Allexpenses associated with the Company’s use of temporary facilities during 2001have been reflected as part of occupancy or technology and communicationsexpenses in the accompanying consolidated statement of income. The insurancerecovery recorded through November 30, 2001 was limited to the net historicalbook value of assets believed damaged, destroyed or abandoned and theout-of-pocked costs for certain extra expenses incurred during the period.

 

During fiscal 2002, the Company incurred costs ofapproximately $22 million, primarily related to technology restoration andother costs associated with unusable facilities, which were fully offset byestimated insurance recoveries. In addition, during 2002, the Company incurredcosts of approximately $16 million to repair damage incurred to the core andshell of the Company’s 3 World Financial Center facility, which were alsooffset by estimated insurance recoveries. The Company transferred any receivablesrecorded under its insurance policies as well as its interest in the 3 WorldFinancial Center building to Holdings for book value during 2002.

 

During the fourth quarter of 2002, Holdingssettled its insurance claim for $700 million, the policy limit, with itsinsurance carriers with respect to the property damaged at the World TradeCenter and World Financial Center facilities, losses resulting from businessinterruption and extra expenses associated with its relocation to and occupancyof temporary facilities.  During thefourth quarter of 2002, after further consideration of maintaining real-estatein both downtown and midtown New York City locations, the Company decided tocompletely exit its downtown area facilities. As a result, the Companyrecognized a charge of approximately $152 million in the fourth quarter of 2002relating to decisions to exit excess space resulting from occupancy actionstaken following September 11th. The charge relates to subleaselosses on the Company’s facilities at 1 World Financial Center and 399 ParkAvenue. In addition, included in the September 11th related(recoveries)/expenses, net is $152 million of insurance recoveries allocated tothe Company by Holdings.

 

F-14

----

 

**Note 3****. Costs Associated with Real-Estate Reconfiguration**

 

During 2002 the Company recorded a pre-tax chargeof approximately $8 million ($4 million after-tax) for costs associated withthe consolidation or closure of certain U.S. branch locations.

 

**Note 4****. Regulatory Settlement**

 

In the fourth quarter of 2002 the Company recordeda pre-tax charge of $80 million ($56 million after-tax) associated with aproposed agreement reached with various Federal and State regulatoryauthorities to settle inquiries related to alleged conflicts of interestinvolving equity research analysts. An agreement in principal was signed onDecember 20, 2002 and includes certain organizational structural reforms,including providing independent research to clients in the future, as well asthe payment of $80 million, including $50 million in retrospective relief, $5million for investor education and $25 million (over the course of 5 years) tofund the purchase of independent research. The net after-tax amount of thisregulatory settlement was paid to the Company by Holdings in the form of acapital contribution.

 

**Note 5****. Short-term Financings**

 

The Company obtains short-term financing on both asecured and unsecured basis. The secured financing is obtained through theuse of repurchase agreements and securities loaned agreements, which areprimarily collateralized by government, agency and equity securities. Theunsecured financing is generally obtained through short-term debt and theissuance of commercial paper.

 

The Company’s short-term debt financing iscomprised of the following:

 
|                       |   | **November 30,**  |         |
|----------------------------|--------|-------------------|--------------|
|                       |   | **2002**          | ** **   | **2001** | ** ** |
|                       |   | **(in millions)** | *** *** |
| Short-term debt:           |   |              |         |   |   |
| Payables to banks          |   | $                 | 89           |   | $ | 522 |   |
| Master notes               |   | 8                 |         | 16 |   |
| Secured bank loans         |   | 26                |         | 500 |   |
| Total Short-term Debt  (1) |   | $                 | 123          |   | $ | 1,038 |   |

 

----

(1)                                  AtNovember 30, 2002 and 2001 the weighted average interest rates for short-termborrowings were 1.4% and 3.0%, respectively.

 

F-15

----

 

**Note 6****. Long-term Debt**

 
|                            |   | **U.S. Dollar**   |       |         |       |             |       |
|---------------------------------|--------|-------------------|------------|--------------|------------|------------------|------------|
|                            |   | **Fixed**         | ** ** | **Floating** | ** ** | **November 30,** | ** ** |
|                            |   | **Rate**          | ** ** | **Rate**     | ** ** | **2002**         | ** ** | **2001** | ** ** |
|                            |   | **(in millions)** | ** ** |
| **Senior Notes**                |   |              | ** ** |         | ** ** |             | ** ** |   | ** ** |
| Maturing in Fiscal 2002         |   |              |       |         |       |             |       | $ | 14 |   |
| Maturing in Fiscal 2003         |   | $                 | 1          |         | —     |             | $          | 1 |   | 32 |   |
| Maturing in Fiscal 2004         |   | 1,765             |       | —       |       | 1,765            |       | 1,778 |   |
| Maturing in Fiscal 2005         |   | —            |       | —       |       | —           |       | 13 |   |
| Maturing in Fiscal 2006         |   | 1,350             |       | $            | 395        |             | 1,745      |   | 30 |   |
| Maturing in Fiscal 2007         |   | —            |       | —       |       | —           |       | 29 |   |
| December 1, 2007 and thereafter |   | —            |       | —       |       | —           |       | 34 |   |
| Senior Notes                    |   | 3,116             |       | 395          |       | 3,511            |       | 1,930 |   |
|                            |   |              |       |         |       |             |       |   |   |
| **Subordinated  Indebtedness**  |   |              |       |         |       |             |       |   |   |
| Maturing in Fiscal 2002         |   |              |       |         |       |             |       | 1,211 |   |
| Maturing in Fiscal 2003         |   | 497               |       | 1,600        |       | 2,097            |       | 1,275 |   |
| Maturing in Fiscal 2004         |   | 200               |       | 735          |       | 935              |       | 191 |   |
| Maturing in Fiscal 2005         |   | 106               |       | —       |       | 106              |       | 94 |   |
| Maturing in Fiscal 2006         |   | 337               |       | —       |       | 337              |       | 300 |   |
| Maturing in Fiscal 2007         |   | 339               |       | —       |       | 339              |       | 300 |   |
| December 1, 2007 and thereafter |   | 665               |       | —       |       | 665              |       | 826 |   |
| Subordinated Indebtedness       |   | 2,144             |       | 2,335        |       | 4,479            |       | 4,197 |   |
| **Long-Term Debt**              |   | $                 | 5,260      |         | $          | 2,730            |       | $ | 7,990 |   | $ | 6,127 |   |

 

Of the Company’s long-term debt outstanding as ofNovember 30, 2002, $200 million is repayable prior to maturity at the option ofthe holder, at par value. These obligations are reflected in the above table asmaturing at their put dates of fiscal 2003, rather than at their contractualmaturities of 2026.

 

As of November 30, 2002, the Company hadapproximately $1.8 billion available for the issuance of debt securities undervarious shelf registrations.

 

***End-User DerivativeActivities***

 

The Company utilizes interest rate swaps as an enduser to modify the interest rate characteristics of its long-term debtportfolio and certain secured financing activities. Effective 2001, the Companyadopted SFAS No. 133, and as such all end user derivatives at November 30, 2002and November 30, 2001 are recorded at fair value on the balance sheet. TheCompany adjusts the carrying value of a substantial portion of the its fixedrate debt to a modified mark-to-market value in accordance with SFAS No. 133,as such debt was designated as the hedged item in a fair value hedge. (See Note1 Derivative Financial Instruments).

 

F-16

----

 

At November 30, 2002 and 2001, the notionalamounts of the Company’s interest rate swaps related to its long-term debtobligations were approximately $2.0 billion and $2.4 billion, respectively.These derivatives are principally utilized to convert the Company’s fixed ratedebt to floating interest rates. In terms of notional amounts outstanding,these derivative contracts mature as follows:

 
|                                            |   | **November 30,**  |       |
|-------------------------------------------------|--------|-------------------|------------|
|                                            |   | **2002**          | ** ** | **2001** | ** ** |
|                                            |   | **(in millions)** | ** ** |
|                                            |   |              | ** ** |   | ** ** |
| Maturing in Fiscal 2002                         |   |              |       | $ | 451 |   |
| Maturing in Fiscal 2003                         |   | $                 | 475        |   | 475 |   |
| Maturing in Fiscal 2004                         |   | 191               |       | 191 |   |
| Maturing in Fiscal 2005                         |   | 94                |       | 94 |   |
| Maturing in Fiscal 2006                         |   | 300               |       | 300 |   |
| Maturing in Fiscal 2007                         |   | 300               |       | 299 |   |
| December 1, 2007 and thereafter                 |   | 600               |       | 600 |   |
| Total                                           |   | $                 | 1,960      |   | $ | 2,410 |   |
|                                            |   |              |       |   |   |
| Weighted-average interest rate  at November 30: |   |              |       |   |   |
| Receive rate                                    |   | 7.39              | %          | 7.35 | % |
| Pay rate                                        |   | 2.30              | %          | 2.97 | % |
|                                                 |        |                   |            |  |  |  |  |  |

 

In addition, the Company’s end-user derivativeactivities resulted in the following changes to the Company’s mix of fixed andfloating rate debt and effective weighted-average rates of interest:

 
|             |   | **November 30, 2002**            |       |
|------------------|--------|----------------------------------|------------|
|             |   | **Long-Term Debt**               | ** ** | **Weighted-Average** | ** ** |
|             |   | **Before  End User  Activities** | ** ** | **After  End User  Activities** | ** ** | **Contractual  Interest  Rate** | ** ** | **Effective Rate  After End User  Activities** | ** ** |
|             |   | **(in millions)**                |       |   |   |   |   |
| USD obligations: |   |                             |       |   |   |   |   |   |   |
| Fixed rate       |   | $                                | 5,260      |   | $ | 3,124 |   |   |   |   |   |
| Floating rate    |   | 2,730                            |       | 4,866 |   |   |   |   |   |
| Total            |   | $                                | 7,990      |   | $ | 7,990 |   | 5.04 | % | 3.79 | % |

 
|             |   | **November 30, 2001**            |       |
|------------------|--------|----------------------------------|------------|
|             |   | **Long-Term Debt**               |       | **Weighted-Average** |   |
|             |   | **Before  End User  Activities** | ** ** | **After  End User  Activities** | ** ** | **Contractual  Interest  Rate** | ** ** | **Effective Rate  After End User  Activities** |   |
|             |   | **(in millions)**                |       |   |   |   |   |
| USD obligations: |   |                             |       |   |   |   |   |   |   |
| Fixed rate       |   | $                                | 4,460      |   | $ | 1,894 |   |   |   |   |   |
| Floating rate    |   | 1,667                            |       | 4,233 |   |   |   |   |   |
| Total            |   | $                                | 6,127      |   | $ | 6,127 |   | 6.44 | % | 4.73 | % |

 

F-17

----

 

**Note 7****. Holdings’ Benefit and Incentive Plans**

 

The Company’s employees participate in Holdings’various benefit and incentive plans. The Company records its allocated share ofHoldings’ stock-based compensation cost. Holdings’ stock-based compensationcost was $570 million, $544 million and $520 million for the years endedNovember 30, 2002, 2001 and 2000, respectively. The Company’s allocated costwas $364 million, $330 million and $319 million for the years ended November30, 2002, 2001 and 2000, respectively. Holdings recognizes its stock basedcompensation costs in accordance with APB 25. The following is a description ofHoldings’ various benefit and incentive plans.

 

***Employee StockPurchase Plan***

 

Holdings’ Employee Stock Purchase Plan (the“ESPP”) allows employees to purchase Common Stock at a 15% discount from marketvalue, with a maximum of $25,000 in annual aggregate purchases by any oneindividual. The number of shares of Common Stock authorized for purchase byeligible employees is 12.0 million. As of November 30, 2002 and 2001, 5.8million shares and 5.5 million shares, respectively, of Common Stock hadcumulatively been purchased by eligible employees through the ESPP.

 

***1994 Incentive Plans***

 

Holdings’ 1994 Management Ownership Plan (the“1994 Plan”) provides for the issuance of restricted stock units (“RSUs”), performancestock units (“PSUs”), stock options and other equity awards for a period of upto ten years to eligible employees. A total of 33.3 million shares of CommonStock may be granted under the 1994 Plan. At November 30, 2002, RSU, PSU andstock option awards with respect to 31.2 million shares of Common Stock havebeen made under the 1994 Plan of which 1.5 million are outstanding and 29.7million have been converted to freely transferable Common Stock. Holdings willutilize the remaining authorization of 2.1 million shares to satisfy dividendreinvestment requirements for outstanding awards and to fund the annual RSUawards for non-employee directors of Holdings.

 

***1996 ManagementOwnership Plan***

 

During 1996, Holdings’ stockholders approved the1996 Management Ownership Plan (the “1996 Plan”) under which awards similar tothose of the 1994 Plan may be granted, and under which up to 42.0 millionshares of Common Stock may be subject to awards. At November 30, 2002, RSU, PSUand stock option awards with respect to 34.8 million shares of Common Stockhave been made under the 1996 Plan of which 19.2 million are outstanding and15.6 million have been converted to freely transferable Common Stock.

 

***Employee IncentivePlan***

 

The Employee Incentive Plan (“EIP”) has provisionssimilar to the 1994 Plan and the 1996 Plan, and authorization from the HoldingsBoard of Directors for the issuance of up to 246.0 million shares of CommonStock which may be subject to awards. At November 30, 2002, awards with respectto 186.7 million shares of Common Stock have been made under the EIP of which132.2 million are outstanding and 54.5 million have been converted to freelytransferable Common Stock.

 

F-18

----

 

**Note 8****. Capital Requirements**

 

As a registered broker-dealer, LBI is subject tothe Securities and Exchange Commission (“SEC”) Rule 15c3–1, the NetCapital Rule, which requires LBI to maintain net capital of not less than thegreater of 2% of aggregate debit items arising from customer transactions, asdefined, or 4% of funds required to be segregated for customers’ regulatedcommodity accounts, as defined. At November 30, 2002, LBI’s regulatory netcapital, as defined, of $1,485 million exceeded the minimum requirement by$1,357 million.

 

As a clearing broker-dealer, the Company haselected to compute a reserve requirement for Proprietary Accounts ofIntroducing Broker-Dealers (“PAIB calculation”), as defined. The PAIBcalculation is completed in order for each correspondent firm that uses theCompany as its clearing broker-dealer to classify its assets held by theCompany as allowable assets in the correspondents’ net capital calculation. AtNovember 30, 2002, the Company had a reserve requirement for PAIB of $3million. Additionally, the Company had $53 million of qualified securities orcash on deposit in a Special Reserve Bank Account as of November 30, 2002.

 

The Company’s “AAA” rated derivativessubsidiaries, Lehman Brothers Financial Products Inc. (“LBFP”) and LehmanBrothers Derivative Products Inc. (“LBDP”), have established certain capitaland operating restrictions which are reviewed by various rating agencies. AtNovember 30, 2002, LBFP and LBDP each had capital which exceeded therequirement of the most stringent rating agency by approximately $60 millionand $35 million, respectively.

 

Repayment of subordinated indebtedness and certainadvances and dividend payments by LBI are restricted by the regulations of theSEC and other regulatory agencies. At November 30, 2002, $2,745 million of netassets of the Company were restricted as to the payment of dividends,principally as a result of regulations of the SEC and other regulatoryagencies. In addition, certain covenants governing the indebtedness of LBIcontractually limit its ability to pay dividends.

 

F-19

----

 

**Note 9****. Holdings’ Employee Benefit Plans**

 

Holdings provides various pension plans for themajority of its employees worldwide. In addition, Holdings provides certainother postretirement benefits, primarily health care and life insurance, toeligible employees. The Company records as compensation and benefits itsallocated share of the cost of these plans. The following summarizes Holdings’domestic employee benefit plans in which the Company’s employees participate:

 
|                                            |   | **Pension Benefits**                           |       | **Postretirement Benefits** |       |
|-------------------------------------------------|--------|------------------------------------------------|------------|-----------------------------|------------|
|                                            |   | **November 30,**                               | ** ** | **November 30,**            | ** ** |
|                                            |   | **2002**                                       | ** ** | **2001**                    | ** ** | **2002** | ** ** | **2001** | ** ** |
|                                            |   | **(in millions, except for weighted-average)** | ** ** |
| **Change in  benefit obligation**               |   |                                           | ** ** |                        | ** ** |   | ** ** |   | ** ** |
| Benefit obligation at beginning  of year        |   | $                                              | 555        |                        | $          | 486 |   | $ | 53 |   | $ | 50 |   |
| Service cost                                    |   | 16                                             |       | 10                          |       | 1 |   | 1 |   |
| Interest cost                                   |   | 40                                             |       | 37                          |       | 4 |   | 3 |   |
| Plan amendment                                  |   | —                                         |       | 4                           |       | — |   | — |   |
| Actuarial loss                                  |   | 55                                             |       | 38                          |       | 15 |   | 3 |   |
| Benefits paid                                   |   | (22                                            | )          | (20                         | )          | (5 | ) | (4 | ) |
| Benefit obligation at end of  year              |   | $                                              | 644        |                        | $          | 555 |   | $ | 68 |   | $ | 53 |   |
|                                            |   |                                           |       |                        |       |   |   |   |   |
| **Change in plan  assets**                      |   |                                           | ** ** |                        | ** ** |   | ** ** |   | ** ** |
| Fair value of plan assets at  beginning of year |   | $                                              | 653        |                        | $          | 750 |   |   |   |   |   |
| Actual return on plan assets                    |   | (82                                            | )          | (77                         | )          |   |   |   |   |
| Employer contributions                          |   | 80                                             |       | —                      |       |   |   |   |   |
| Benefits paid                                   |   | (22                                            | )          | (20                         | )          |   |   |   |   |
| Fair value of plan assets at  end of year       |   | $                                              | 629        |                        | $          | 653 |   |   |   |   |   |
| Funded (underfunded) status                     |   | $                                              | (15        | )                           | $          | 97 |   | $ | (68 | ) | $ | (53 | ) |
| Unrecognized net actuarial  loss/(gain)         |   | 394                                            |       | 214                         |       | (3 | ) | (19 | ) |
| Unrecognized prior service  cost/(credit)       |   | 3                                              |       | 3                           |       | (4 | ) | (4 | ) |
| Prepaid benefit/(accrued) cost                  |   | $                                              | 382        |                        | $          | 314 |   | $ | (75 | ) | $ | (76 | ) |
|                                            |   |                                           |       |                        |       |   |   |   |   |
| **Weighted-average  assumptions**               |   |                                           | ** ** |                        | ** ** |   | ** ** |   | ** ** |
| Discount rate                                   |   | 6.75                                           | %          | 7.00                        | %          | 6.75 | % | 7.25 | % |
| Expected return on plan assets                  |   | 9.00                                           | %          | 11.25                       | %          |   |   |   |   |
| Rate of compensation increase                   |   | 4.90                                           | %          | 5.00                        | %          | 5.00 | % | 5.00 | % |

 

Holdings’ accumulated benefit obligation atNovember 30, 2002 was approximately $612 million. The fair value of plan assetsat November 30, 2002 exceeded the accumulated benefit obligation by $17million.

 
|                                                  |   | **Pension Benefits**                  |       | **Postretirement Benefits**           |       |
|-------------------------------------------------------|--------|---------------------------------------|------------|---------------------------------------|------------|
|                                                  |   | **Twelve Months Ended  November 30,** | ** ** | **Twelve Months Ended  November 30,** | ** ** |
|                                                  |   | **2002**                              | ** ** | **2001**                              | ** ** | **2000** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
|                                                  |   | **(in millions)**                     | ** ** |
| **Components of  net periodic benefit (income) cost** |   |                                  |       |                                  |       |   |   |   |   |   |   |   |   |
| Service cost                                          |   | $                                     | 16         |                                  | $          | 10 |   | $ | 10 |   | $ | 1 |   | $ | 1 |   | $ | 1 |   |
| Interest cost                                         |   | 40                                    |       | 37                                    |       | 35 |   | 4 |   | 3 |   | 4 |   |
| Expected return on plan assets                        |   | (57                                   | )          | (83                                   | )          | (83 | ) | — |   | — |   | — |   |
| Recognized net actuarial loss  (gain)                 |   | 13                                    |       | —                                |       | — |   | (1 | ) | (1 | ) | (2 | ) |
| Net periodic benefit cost/(income)                    |   | $                                     | 12         |                                  | $          | (36 | ) | $ | (38 | ) | $ | 4 |   | $ | 3 |   | $ | 3 |   |

 

F-20

----

 

For measurement purposes, the annual health carecost trend rate was assumed to be 12.0% for the year ended November 30, 2003.The rate was assumed to decrease 1.0% per year to 5.0% in the year endedNovember 30, 2009 and remain at that level thereafter.  

 

Assumed health care cost trend rates have aneffect on the amount reported for postretirement benefits. Aone-percentage-point change in assumed health care cost trend rates would havethe following effects:

 
|                                                                |   | **1% Point Increase** |   | **1% Point Decrease** |   |
|---------------------------------------------------------------------|--------|-----------------------|--------|-----------------------|--------|
|                                                                |   | **(in millions)**     |   |
| Effect on total service and interest cost components in fiscal 2002 |   | $                     | 0.4    |                  | $      | (0.1 | ) |
| Effect on postretirement benefit obligation at November 30, 2002    |   | $                     | 3.6    |                  | $      | (3.2 | ) |

 

**Note 10****. Income Taxes**

 

The Company’s income is included in theconsolidated U.S. federal income tax return of Holdings and its subsidiaries.The income tax provision for the Company is computed in accordance with the taxsharing agreement between Holdings and its subsidiaries. In accordance withthis agreement, the balances due to Holdings at November 30, 2002 and 2001 were$409 million and $343 million, respectively.  

 

The provision for income taxes consists of the following:

 
|     |   | **Twelve months ended November 30,** |       |
|----------|--------|--------------------------------------|------------|
|     |   | **2002**                             | ** ** | **2001** | ** ** | **2000** | ** ** |
|     |   | **(in  millions)**                   | ** ** |
| Current  |   |                                 |       |   |   |   |   |
| Federal  |   | $                                    | 293        |   | $ | 174 |   | $ | 300 |   |
| State    |   | 201                                  |       | 140 |   | 142 |   |
| Foreign  |   | 168                                  |       | 153 |   | 124 |   |
|     |   | 662                                  |       | 467 |   | 566 |   |
| Deferred |   |                                 |       |   |   |   |   |
| Federal  |   | (315                                 | )          | (131 | ) | (47 | ) |
| State    |   | (141                                 | )          | (62 | ) | (36 | ) |
|     |   | (456                                 | )          | (193 | ) | (83 | ) |
|     |   | $                                    | 206        |   | $ | 274 |   | $ | 483 |   |

 

Income before taxes included $15 million, $(17)million and $26 million that has also been subject to income taxes of foreignjurisdictions for 2002, 2001 and 2000, respectively.  

 

The income tax provision (benefit) differs fromthat computed by using the statutory federal income tax rate for the reasonsshown below:

 
|                                   |   | **Twelve months ended November 30,** |       |
|----------------------------------------|--------|--------------------------------------|------------|
|                                   |   | **2002**                             | ** ** | **2001** | ** ** | **2000** | ** ** |
|                                   |   | **(in  millions)**                   | ** ** |
|                                   |   |                                 | ** ** |   | ** ** |   | ** ** |
| Federal income taxes at statutory rate |   | $                                    | 331        |   | $ | 394 |   | $ | 566 |   |
| State and local taxes                  |   | 39                                   |       | 51 |   | 69 |   |
| Tax-exempt income                      |   | (180                                 | )          | (176 | ) | (130 | ) |
| Amortization of goodwill               |   | —                               |       | 2 |   | 2 |   |
| Other, net                             |   | 16                                   |       | 3 |   | (24 | ) |
|                                   |   | $                                    | 206        |   | $ | 274 |   | $ | 483 |   |

 

F-21

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Deferred income taxes are provided for thedifferences between the tax basis of assets and liabilities and their reportedamounts in the consolidated financial statements. These temporary differenceswill result in future income or deductions for income tax purposes and aremeasured using the enacted tax rates that will be in effect when such items areexpected to reverse. The Company provides for deferred income taxes onundistributed earnings of foreign subsidiaries.  

 

At November 30, 2002 and 2001 the deferred tax assets and liabilitiesconsisted of the following:

 
|                                            |   | **November 30,**   |       |
|-------------------------------------------------|--------|--------------------|------------|
|                                            |   | **2002**           | ** ** | **2001** | ** ** |
|                                            |   | **(in  millions)** | ** ** |
| Deferred tax assets:                            |   |               |       |   |   |
| Liabilities / accruals not currently deductible |   | $                  | 69         |   | $ | — |   |
| Unrealized trading and investment activity      |   | 87                 |       | 104 |   |
| Other                                           |   | 25                 |       | 17 |   |
| Deferred tax assets                             |   | 181                |       | 121 |   |
|                                            |   |               |       |   |   |
| Deferred tax liabilities                        |   | —             |       | (1 | ) |
| Net deferred tax assets                         |   | $                  | 181        |   | $ | 120 |   |

 

The net deferred tax assets are included in Otherassets in the accompanying Consolidated Statement of Financial Condition. It isanticipated that the Company’s net deferred tax assets will be realized,therefore no valuation allowance has been recorded against deferred tax assets.

 

In accordance with thetax sharing agreement with Holdings, LBI was reimbursed for $395 million and$230 million of net deferred tax assets in 2002 and 2001, respectively.  The net deferred tax assets transferred inboth 2002 and 2001 were principally comprised of deferred tax assets associatedwith unrealized trading activity, liabilities and other accruals not currentlydeductible and deferred compensation partially offset by deferred taxliabilities associated with an excess of tax over financial depreciation.

 

**Note 11****. Derivative Financial Instruments**

 

Derivativesare financial instruments whose value is based upon an underlying asset (e.g.,Treasury bond), index (e.g., S&P 500) or reference rate (e.g., LIBOR).Over-the-counter (“OTC”) derivative products are privately negotiatedcontractual agreements that can be tailored to meet individual client needs andinclude forwards, swaps and certain options including caps, collars and floors.Exchange-traded derivative products are standardized contracts transactedthrough regulated exchanges and include futures and certain option contractslisted on an exchange.

 

Inthe normal course of business, the Company enters into derivative transactionsboth in a trading capacity and as an end-user. The Company’s derivativeactivities (both trading and end-user) are recorded at fair value on theCompany’s Consolidated Statement of Financial Condition. Acting in a tradingcapacity, the Company enters into derivative transactions to satisfy the needsof its clients and to manage the Company’s own exposure to market and credit risksresulting from its trading activities (collectively, “Trading-RelatedDerivative Activities”). As an end-user, the Company primarily enters intointerest rate swap and option contracts to adjust the interest rate nature ofits funding sources from fixed to floating rates, and to change the index uponwhich floating interest rates are based (e.g., Prime to LIBOR) (collectively,“End-User Derivative Activities”). There is an extensive range of derivativeproducts available in the marketplace, which can vary from a simple forwardforeign exchange contract to a complex derivative instrument with multiple riskcharacteristics involving the aggregation of the risk characteristics of anumber of derivative product types including swap products, options and forwards.Listed below are examples of various derivative product types along with abrief discussion of the performance mechanics of certain specific derivativeinstruments.

 

F-22

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***Swap Products***

 

Interestrate swap products include interest rate and currency swaps, leveraged swaps,swap options, other interest rate option products including caps, collars andfloors, and credit default swaps. An interest rate swap is a negotiated OTCcontract in which two parties agree to exchange periodic interest payments fora defined period, calculated based upon a predetermined notional amount.Interest payments are usually exchanged on a net basis throughout the durationof the swap contract. A currency swap is an OTC agreement to exchange a fixedamount of one currency for a specified amount of a second currency at theoutset and completion of the swap term. Leveraged swaps involve themultiplication of the interest rate factor upon which the interest paymentstreams are based (e.g., Party A pays three times the six month LIBOR). Capsare contractual commitments that require the writer to pay the purchaser theamount by which an interest reference rate exceeds a defined contractual rate,if any, at specified times during the contract. Conversely, a floor is acontractual commitment that requires the writer to pay the amount by which adefined contractual rate exceeds an interest reference rate at specified timesover the life of the contract, if any. Equity swaps are contractual agreementswhereby one party agrees to receive the appreciation (or depreciation) valueover a strike price on an equity investment in return for paying another rate,which is usually based upon equity index movements or interest rates. Commodityswaps are contractual commitments to exchange the fixed price of a commodityfor a floating price (which is usually the prevailing spot price) throughoutthe swap term. Credit derivatives are contractual agreements that provideinsurance against a credit event of one or more referenced credits. The natureof the credit event is established by the buyer and seller at the inception ofthe transaction, and such events include bankruptcy, insolvency, rating agencydowngrade and failure to meet payment obligations when due. The buyer of thecredit derivative pays a periodic fee in return for a contingent payment by theseller (insurer) following a credit event. The Company acts as both a buyer andseller of credit derivatives.

 

***Options***

 

Optioncontracts provide the option purchaser (holder) with the right but not theobligation to buy or sell a financial instrument, commodity or currency at apredetermined exercise price (strike price) during a defined period (AmericanOption) or at a specified date (European Option). The option purchaser pays apremium to the option seller (writer) for the right to exercise the option. Theoption seller is obligated to buy (put) or sell (call) the item underlying thecontract at a set price, if the option purchaser chooses to exercise. Optioncontracts also exist for various indices and are similar to options on asecurity or other instrument except that, rather than physically settling withdelivery of the underlying instrument, they are cash settled. As a purchaser ofan option contract, the Company is subject to credit risk, since thecounterparty is obligated to make payments under the terms of the optioncontract, if the Company exercises the option. As the writer of an optioncontract, the Company is not subject to credit risk but is subject to marketrisk, since the Company is obligated to make payments under the terms of theoption contract if exercised.

 

Optioncontracts may be exchange-traded or OTC. Exchange-traded options are theobligations of the exchange and generally have standardized terms andperformance mechanics. In contrast, all of the terms of an OTC option includingthe method of settlement, term, strike price, premium and security aredetermined by negotiation of the parties.

 

***Futures and Fo*rwards**

 

Futurescontracts are exchange-traded contractual commitments to either receive(purchase) or deliver (sell) a standard amount or value of a financialinstrument or commodity at a specified future date and price. Maintaining afutures contract requires the Company to deposit with the exchange an amount ofcash or other specified assets as security for its obligation. Additionally,futures exchanges generally require the daily cash settlement of unrealizedgains/losses on open contracts with the futures exchange. Therefore, futurescontracts provide a reduced funding alternative to purchasing the underlyingcash position in the marketplace. Futures contracts may be settled by physicaldelivery of the underlying asset or cash settlement (for index futures) on thesettlement date or by entering into an offsetting futures contract with thefutures exchange prior to the settlement date.

 

Forwardsare OTC contractual commitments to purchase or sell a specified amount of afinancial instrument, foreign currency or commodity at a future date at apredetermined price. TBAs are forward contracts which give the purchaser/selleran obligation to obtain/deliver mortgage securities in the future. Therefore,TBAs subject the holder to both interest rate risk and principal prepaymentrisk.

 

F-23

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***Trading-Related Derivative Activities***

 

Derivativesare subject to various risks similar to other financial instruments includingmarket, credit and operational risk. In addition, the Company may be exposed tolegal risks related to its derivative activities including the possibility thata transaction may be unenforceable under applicable law. The risks ofderivatives should not be viewed in isolation, but rather should be consideredon an aggregate basis along with the Company’s other trading-relatedactivities. The Company manages the risks associated with derivatives on anaggregate basis along with the risks associated with its proprietary tradingand market-making activities in cash instruments as part of its firm-wide riskmanagement policies.

 

Derivativesare generally based upon notional amounts. Notional amounts are not recordedon-balance sheet, but rather are utilized solely as a basis for determiningfuture cash flows to be exchanged. Therefore, notional amounts provide ameasure of the Company’s involvement with such instruments, but are notindicative of actual or potential risk. As of November 30, 2002 and 2001, theCompany had total notional/contract amounts of trading related derivative activitiesof  $6,307 billion and $4,679 billion,respectively. Of the total notional amounts approximately $5,964 billion and$4,302 billion are over-the-counter and $343 billion and $377 billion areexchange-traded as of November 30, 2002 and 2001, respectively. The totalweighted-average maturity at November 30, 2002 and 2001, for over-the-counterand exchange-traded contracts was 4.7 years and 0.7 years and 4.9 and 0.8years, respectively. Approximately $1,837 billion of the notional/contractamount of the Company’s Trading-Related Derivative Activities mature within theyear ending November 30, 2003.

 

TheCompany records its Trading-Related Derivative Activities on a mark-to-marketbasis with realized and unrealized gains and losses recognized currently inPrincipal transactions in the Consolidated Statement of Income. Unrealizedgains and losses on derivative contracts are recorded on a net basis in theConsolidated Statement of Financial Condition for those transactions withcounterparties executed under a legally enforceable master netting agreementand are netted across products when such provisions are stated in the masternetting agreement. The Company offers equity, fixed income and foreign exchangeproducts to its customers. Because of the integrated nature of the market forsuch products, each product area trades cash instruments as well as derivativeproducts.

 

Listedin the following table is the fair value of the Company’s Trading-RelatedDerivative Activities as of November 30, 2002 and 2001. Assets and liabilitiesrepresent net unrealized gains (amounts receivable from counterparties) and netunrealized losses (amounts payable to counterparties), respectively.

 

**Fair Value ofTrading-Related Derivative Financial Instruments**  

 
|                                                                                                 |   | **Fair  Value***       |       | **Fair Value***        |       |
|------------------------------------------------------------------------------------------------------|--------|------------------------|------------|------------------------|------------|
|                                                                                                 |   | **November  30, 2002** | ** ** | **November  30, 2001** | ** ** |
|                                                                                                 |   | **Assets**             | ** ** | **Liabilities**        | ** ** | **Assets** | ** ** | **Liabilities** | ** ** |
|                                                                                                 |   | **(in  millions)**     | ** ** |
| Interest rate ,  currency and credit default swaps and options (including caps, collars and  floors) |   | $                      | 7,594      |                   | $          | 6,832 |   | $ | 5,474 |   | $ | 5,025 |   |
| Foreign exchange  forward contracts and options                                                      |   | 368                    |       | 391                    |       | 240 |   | 197 |   |
| Other fixed  income securities contracts (including futures contracts, options and TBAs)             |   | 247                    |       | 214                    |       | 476 |   | 226 |   |
| Equity contracts  (including equity swaps,  warrants and  options)                              |   | 537                    |       | 627                    |       | 537 |   | 510 |   |
|                                                                                                 |   | $                      | 8,746      |                   | $          | 8,064 |   | $ | 6,727 |   | $ | 5,958 |   |

 

----

*                                         Amountsrepresent carrying value (exclusive of collateral). Amounts do not includereceivables or payables related to exchange-traded futures contracts.

 

Assets included in the table above represent theCompany’s unrealized gains, net of unrealized losses for situations in whichthe Company has a master netting agreement. Similarly, liabilities representnet amounts owed to counterparties. Therefore,

 

F-24

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the fair value of assets/liabilities related toderivative contracts at November 30, 2002 and 2001 represents the Company’s netreceivable/payable for derivative financial instruments before consideration ofcollateral. Included within the $8,746 million fair value of assets at November30, 2002 was $8,209 million related to swaps and other OTC contracts and $537million related to exchange-traded option and warrant contracts. Includedwithin the $6,727 million fair value of assets at November 30, 2001 was $6,239million related to swaps and other OTC contracts and $488 million related toexchange-traded option and warrant contracts.

 

The primary difference in risks related to OTC andexchange-traded contracts is credit risk. OTC contracts contain credit risk forunrealized gains from various counterparties for the duration of the contract,net of collateral. With respect to OTC contracts, including swaps, the Companyviews its net credit exposure to third-parties to be $6,676 million at November30, 2002, representing the fair value of the Company’s OTC contracts in anunrealized gain position, after consideration of collateral.

 

Counterparties to the Company’s OTC derivativeproducts are primarily financial intermediaries (U.S. and foreign banks),securities firms, corporations, governments and their agencies, financecompanies, insurance companies, investment companies and pension funds.Collateral held related to OTC contracts generally includes U.S. government andfederal agency securities. Presented below is an analysis of the Company’s netcredit exposure at November 30, 2002 for OTC contracts based upon actualratings made by external rating agencies or by equivalent ratings establishedand utilized by the Company’s Credit Risk Management Department.

 
| **Counterparty****  Risk Rating** |   | **S&P/Moody’s Equivalent** |   | **Net Credit Exposure** |   |
|----------------------------------------|--------|-------------------------------------|--------|-------------------------|--------|
| 1                                      |   | AAA/Aaa                             |   | 15                      | %      |
| 2                                      |   | AA-/Aa3 or higher                   |   | 26                      | %      |
| 3                                      |   | A-/A3 or higher                     |   | 42                      | %      |
| 4                                      |   | BBB-/Baa3 or higher                 |   | 13                      | %      |
| 5                                      |   | BB-/Ba3 or higher                   |   | 4                       | %      |
| 6                                      |   | B+/B1 or lower                      |   | —                  |   |

 

The Company is also subject to credit risk relatedto its exchange-traded derivative contracts. Exchange-traded contracts,including futures and certain options, are transacted directly on the exchange.To protect against the potential for a default, all exchange clearinghousesimpose net capital requirements for their membership. Additionally, exchangeclearinghouses require counterparties to futures contracts to post margin uponthe origination of the contracts and for any changes in the market value of thecontracts on a daily basis (certain foreign exchanges provide for settlementwithin three days). Therefore, the potential for losses from exchange-tradedproducts is limited.

 

***End-User DerivativeActivities***

 

The Company utilizes a variety of derivative productsfor non-trading purposes as an end-user to modify the interest ratecharacteristics of its long-term debt portfolio and certain secured financingactivities. In this regard, the Company primarily enters into fair value hedgesutilizing interest rate swaps to convert a substantial portion of the Company’sfixed rate long-term debt and certain term fixed rate secured financingactivities to a floating interest rate. The ineffective portion of the fairvalue hedges were included in Interest expense on the Consolidated Statement ofIncome and were not material to the Company’s results for the twelve monthsended November 30, 2002, 2001 and 2000. At November 30, 2002 and 2001, thenotional amounts of the Company’s end-user activities related to its long-termdebt obligations were approximately $2.0 billion and $2.4 billion,respectively. (For a further discussion of the Company’s long-term debt relatedend-user derivative activities see Note 6.)

 

The Company also utilizes derivative products asan end user to modify its interest rate exposure associated with its securedfinancing activities, including securities purchased under agreements toresell, securities borrowed, securities sold under agreements to repurchase andsecurities loaned. At November 30, 2002 and 2001, the Company had $210 billionof  such secured financing activities.As with the Company’s long-term debt, its secured financing activities exposethe Company to interest rate risk. The Company, as an end user, manages theinterest rate risk related to these activities by

 

F-25

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utilizing derivative financial instruments,including interest rate swaps and purchased options. The Company designatesderivative transactions against specific assets and liabilities with matchingmaturities. At November 30, 2002 and 2001, the Company, as an end user,utilized derivative financial instruments with an aggregate notional amount of$6.9 billion and $8.8 billion, respectively, to modify the interest rate characteristicsof its secured financing activities. The total notional amount of these agreements had a weighted-averagematurity of 5.3 years and 5.1 years as of November 30, 2002 and 2001,respectively.

 

**Note 12****. Securitizations**

 

The Company is a market leader in mortgage- andasset-backed securitizations and other structured financing arrangements. Inconnection with these activities, the Company utilizes special purpose entitiesprincipally for (but not limited to) the securitization of commercial and residentialmortgages, home equity loans, government and corporate bonds, and lease andtrade receivables. The Company derecognizes financial assets transferred insecuritizations provided that the Company has relinquished control over suchassets. For further information regarding the accounting for securitizationtransactions, refer to Note 1, Basisof Presentation – Consolidation Accounting Policies — Transfers of Financial Assets. TheCompany may retain an interest in the financial assets it securitizes (“RetainedInterests”), which may include assets in the form of residual interests in thespecial purpose entities established to facilitate the securitization. AnyRetained Interests are included in Securities and Other Financial InstrumentsOwned (principally Mortgages and Mortgage-Backed) within the Company’sConsolidated Statement of Financial Condition. During fiscal 2002 and 2001, theCompany securitized approximately $144 billion and $105 billion of financialassets, including: $103 billion and $49 billion of residential mortgages, $11billion and $9 billion of commercial mortgages, and $30 billion and $47 billionof other asset-backed financial instruments, respectively.

 

As of November 30, 2002 and November 30, 2001, theCompany had approximately $1.1 billion and $1.4 billion, respectively, ofnon-investment grade Retained Interests from its securitization activities(principally junior security interests in securitizations) including $0.5billion and $0.9 billion of commercial mortgages, $0.4 billion and $0.3 billionof residential mortgages, and $0.2 billion and $0.2 billion of otherasset-backed financial instruments, respectively. The Company records itstrading assets on a mark-to-market basis, including those assets held prior tosecuritization, as well as any retained interests post securitization.Mark-to-market gains or losses are recorded in Principal transactions in theConsolidated Statement of Income. Fair value is determined based upon listedmarket prices, if available. When listed market prices are not available, fairvalue is determined based on other relevant factors, including broker or dealerprice quotations and valuation pricing models which take into account timevalue and volatility factors underlying the financial instruments among otherfactors.

 

F-26

----

 

The tables below outline the key economicassumptions used in measuring the fair value of retained interests:  

 

At November 30, 2002:

 
|                           |   | **Residential  Mortgages** |   | **Commercial****Mortgages** |   | **Other****Asset Backed** |   |
|--------------------------------|--------|----------------------------|--------|-----------------------------|--------|---------------------------|--------|
|                           |   |                       |   |                        |   |                      |   |
| Weighted average life          |   | 3  years                   |   | 1  year                     |   | 5  years                  |   |
| Annual prepayment rate         |   | 4  – 65 CPR           |   | 0  – 15 CPR            |   | 8  – 15 CPR          |   |
| Credit Loss Assumption         |   | .5  – 6%              |   | 2  –  17%         |   | 3  – 10%             |   |
| Weighted average Discount rate |   | 17%                        |   | 20%                         |   | 5%                        |   |

 

At November 30, 2001:

 
|                           |   | **Residential****Mortgages** |   | **Commercial****Mortgages** |   | **Other****Asset Backed** |   |
|--------------------------------|--------|------------------------------|--------|-----------------------------|--------|---------------------------|--------|
|                           |   |                         |   |                        |   |                      |   |
| Weighted average life          |   | 4 years                      |   | 1 year                      |   | 2 years                   |   |
| Annual prepayment rate         |   | 6 – 45 CPR              |   | 0 – 10 CPR             |   | 6 – 12 CPR           |   |
| Credit Loss Assumption         |   | .5  – 6%                |   | 2  – 17%               |   | 3  – 10%             |   |
| Weighted average Discount rate |   | 19%                          |   | 20%                         |   | 8%                        |   |

 

The tables below outline the sensitivity of thefair value of the retained interests to immediate 10% and 20% adverse changesin the above assumptions (dollars in millions):

 
|                         |   | **At November 30, 2002**     |       | **At November 30, 2001**    |       |
|------------------------------|--------|------------------------------|------------|-----------------------------|------------|
|                         |   | **Residential****Mortgages** | ** ** | **Commercial****Mortgages** | ** ** | **Other  Asset  Backed** | ** ** | **Residential****Mortgages** | ** ** | **Commercial****Mortgages** | ** ** | **Other****Asset  Backed** | ** ** |
|                         |   |                         | ** ** |                        | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Prepayment speed:            |   |                         |       |                        |       |   |   |   |   |   |   |   |   |
| Impact of 10% adverse change |   | $                            | 4          |                        | $          | — |   | $ | 1 |   | $ | 9 |   | $ | — |   | $ | — |   |
| Impact of 20% adverse change |   | $                            | 8          |                        | $          | — |   | $ | 2 |   | $ | 17 |   | $ | — |   | $ | — |   |
| Assumed credit losses:       |   |                         |       |                        |       |   |   |   |   |   |   |   |   |
| Impact of 10% adverse change |   | $                            | 17         |                        | $          | — |   | $ | 12 |   | $ | 16 |   | $ | — |   | $ | 2 |   |
| Impact of 20% adverse change |   | $                            | 33         |                        | $          | 12 |   | $ | 24 |   | $ | 32 |   | $ | — |   | $ | 4 |   |
| Discount rate:               |   |                         |       |                        |       |   |   |   |   |   |   |   |   |
| Impact of 10% adverse change |   | $                            | 17         |                        | $          | — |   | $ | 12 |   | $ | 26 |   | $ | 2 |   | $ | 2 |   |
| Impact of 20% adverse change |   | $                            | 34         |                        | $          | — |   | $ | 24 |   | $ | 52 |   | $ | 4 |   | $ | 3 |   |

 

The sensitivity analysis in the preceding table ishypothetical and should be used with caution as the above stresses areperformed without consideration of the impact of hedges, which serve to reducethe Company’s actual risk. In addition, these results are calculated bystressing a particular economic assumption independent of changes in any otherassumption (as required by U.S. GAAP); in reality, changes in one factor oftenresult in changes in another (for example, changes in discount rates will oftenimpact expected prepayment speeds). Further, changes in the fair value basedupon a 10% or 20% variation in an assumption should not be extrapolated becausethe relationship of the change in the assumption to the change in fair valuemay not be linear.  

 

F-27

----

 

The following table summarizes cash flows fromsecuritization trusts for the fiscal year ended November 30, 2002:

 
|                                      |   | **Residential  Mortgages** |       | **Commercial****Mortgages** |   | **Other****Asset Backed** |   |
|-------------------------------------------|--------|----------------------------|------------|-----------------------------|--------|---------------------------|--------|
|                                      |   | **(in millions)**          | ** ** |
| Purchases of delinquent loans             |   | $                          | —     |                        | $      | (22                       | )      | $ | — |   |
| Cash flows received on retained  interest |   | $                          | 240        |                        | $      | 73                        |   | $ | 133 |   |
|                                           |        |                            |            |                             |        |                           |        |  |  |  |  |

 

**Note 13****. Fair Value of Financial Instruments**

 

SFASNo. 107 “Disclosures about Fair Value of Financial Instruments” requires theCompany to report the fair value of financial instruments, as defined. Assetsand liabilities that are carried at fair value include all of the Company’strading assets and liabilities including derivative financial instruments usedfor trading purposes as described in Note 1, which are recorded as securitiesand other financial instruments owned and securities and other financialinstruments sold but not yet purchased. 

 

Assetsand liabilities, which are recorded at contractual amounts that approximatemarket or fair value include cash and cash equivalents, cash and securitiessegregated and on deposit for regulatory and other purposes, receivables,certain other assets, commercial paper and short-term debt, and payables. Themarket value of such items are not materially sensitive to shifts in marketinterest rates because of the limited term to maturity of these instruments andtheir variable interest rates.  

 

In2002 and 2001, the Company’s long-term debt was recorded at historical amounts,unless designated as the hedged item in a fair value hedge under SFAS 133. TheCompany carries such hedged debt on a modified mark-to-market basis, whichcould differ from fair value.

 

Thefollowing table provides a summary of the fair value of the Company’s long-termdebt and related end user derivative activities. The fair value of the Company’slong-term debt was estimated using either quoted market prices or discountedcash flow analyses based on the Company’s current borrowing rates for similartypes of borrowing arrangements.

 
|                                           |   | **2002**          |         | **2001** |   |
|------------------------------------------------|--------|-------------------|--------------|----------|--------|
|                                           |   | **(in millions)** | *** *** |
| Carrying value of long-term debt               |   | $                 | 7,990        |     | $      | 6,127 |   |
| Fair value of long-term debt                   |   | $                 | 8,019        |     | $      | 6,105 |   |
| Unrecognized net (loss) gain on long-term debt |   | $                 | (29          | )        | $      | 22 |   |

 

The Company carries its secured financingactivities, including securities purchased under agreements to resell,securities borrowed, securities sold under agreements to repurchase, securitiesloaned and other secured borrowings, at their original contract amount plusaccrued interest. As the majority of such financing activities are short-termin nature, carrying value approximates fair value. At November 30, 2002 and2001, the Company had $210 billion of such secured financing activities. Aswith the Company’s long-term debt, its secured financing activities expose theCompany to interest rate risk.

 

At November 30, 2002 and 2001, the Company, as anend user, utilized derivative financial instruments with an aggregate notionalamount of $6.9 billion and $8.8 billion, respectively, to modify the interestrate characteristics of its secured financing activities. At November 30, 2002and 2001, the carrying value of the related secured financing activitiesapproximated its fair value. Additionally, at November 30, 2002 and 2001, theCompany had approximately $30 million of unrecognized losses related toapproximately $4 billion of unhedged long-term fixed rate secured financingactivities.

 

F-28

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**Note 14****. Financial Instruments**

 

Securitiesand other financial instruments owned and securities and other financialinstruments sold, but not yet purchased are recorded at fair value and werecomprised of the following:

 
|                                                                   |   | **November 30,** |       |
|------------------------------------------------------------------------|--------|------------------|------------|
|                                                                   |   | **2002**         | ** ** | **2001** | ** ** |
| Securities and other financial instruments owned:                      |   |             |       |   |   |
| Mortgages and mortgage backed                                          |   | $                | 9,032      |   | $ | 8,079 |   |
| Government and agencies                                                |   | 21,845           |       | 19,868 |   |
| Derivatives and other contractual agreements                           |   | 8,746            |       | 6,727 |   |
| Corporate debt and other                                               |   | 11,065           |       | 9,423 |   |
| Corporate equities                                                     |   | 17,562           |       | 20,433 |   |
| Certificates of deposits and other money market instruments            |   | 2,631            |       | 3,137 |   |
|                                                                   |   | $                | 70,881     |   | $ | 67,667 |   |
| Securities and other financial instruments sold but not yet purchased: |   |             |       |   |   |
| Government and agencies                                                |   | $                | 31,395     |   | $ | 19,294 |   |
| Derivatives and other contractual agreements                           |   | 8,064            |       | 5,958 |   |
| Corporate debt and other                                               |   | 7,101            |       | 4,342 |   |
| Corporate equities                                                     |   | 3,792            |       | 3,376 |   |
|                                                                   |   | $                | 50,352     |   | $ | 32,970 |   |

 

**Note 15****. Securities Pledged as Collateral**

 

The Company enters into secured borrowing andlending transactions to finance trading inventory positions, obtain securitiesfor settlement, and meet customers’ needs. The Company primarily receivescollateral in connection with resale agreements, securities borrowedtransactions, customer margin loans and certain other loans. The Company isgenerally permitted to sell or repledge these securities held as collateral anduse the securities to secure repurchase agreements, enter into securitieslending transactions or deliver to counterparties to cover short positions. TheCompany carries secured financing agreements for financial reporting purposeson a net basis by counterparty when permitted under the provisions of FinancialAccounting Standards Board Interpretation No. 41 (“FIN 41”).

 

At November 30, 2002 and 2001, the fair value ofsecurities received as collateral and securities owned that have not been sold,repledged or otherwise encumbered totaled approximately $13 billion and $9billion, respectively. At November 30, 2002 and 2001, the gross fair value ofsecurities received as collateral where the Company was permitted to sell orrepledge the securities was approximately $290 billion and $190 billion,respectively. Of this collateral, approximately $286 billion and $183 billionat November 30, 2002 and 2001, respectively, has been sold or repledged,generally as collateral under repurchase agreements or to cover securities andother financial instruments sold but not yet purchased.

 

The Company also pledges its own assets,principally to collateralize certain financing arrangements. These pledgedsecurities, where the counterparty has the right, by contract or custom, torehypothecate the financial instruments are classified as securities and otherfinancial instruments owned, pledged as collateral on the Company’sConsolidated Statement of Financial Condition as required by SFAS 140.

 

In addition, the carrying value of securities andother financial instruments owned that have been pledged to counterpartieswhere those counterparties do not have the right to sell or repledge wereapproximately $30 billion and $40 billion at November 30, 2002 and 2001, respectively.

 

F-29

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**Note 16****. Other Commitments and Contingencies**

 

As of November 30, 2002 and 2001, the Company wascontingently liable for $0.8 billion and $0.9 billion, respectively, of lettersof credit, primarily used to provide collateral for securities and commoditiesborrowed and to satisfy margin deposits at option and commodity exchanges.

 

In connection with its financing activities, theCompany had outstanding commitments under certain lending arrangements ofapproximately $1.1 billion and $1.5 billion at November 30, 2002 and 2001,respectively. These commitments require borrowers to provide acceptablecollateral, as defined in the agreements, when amounts are drawn under thelending facilities. Advances made under the above lending arrangements aretypically at variable interest rates and generally provide forover-collateralization based upon the borrowers’ creditworthiness. At November30, 2002, the Company had commitments to enter into forward starting securedfinancing transactions including reverse repurchase agreements and repurchaseagreements of approximately $68.6 billion and $38.1 billion, respectively, ascompared to $43.6 billion and $21.5 billion, respectively, at November 30,2001.

 

The Company, through its high grade and high yieldsales, trading and underwriting activities, makes commitments to extend creditin loan syndication transactions. The Company utilizes various hedging andfunding strategies to actively manage its market, credit and liquidityexposures on these commitments. In addition, total commitments are notindicative of actual risk or funding requirements, as the commitments may notbe drawn or fully utilized. These commitments and any related draw downs ofthese facilities typically have fixed maturity dates and are contingent uponcertain representations, warranties and contractual conditions applicable tothe borrower.

 

The Company had lending commitments to investmentgrade borrowers (after consideration of hedges) of approximately $2.6 billionand $3.2 billion at November 30, 2002 and November 30, 2001, respectively. Inaddition, the Company had credit risk associated with lending commitments tonon-investment grade borrowers (after consideration of hedges) of $1.1 billionand $1.0 billion at November 30, 2002 and November 30, 2001, respectively.Before consideration of hedges, the Company had commitments to investment andnon-investment grade borrowers of $6.2 billion and $1.2 billion as compared to$4.3 billion and $1.0 billion at November 30, 2002 and November 30, 2001,respectively. The Company had available undrawn borrowing facilities with thirdparties of approximately $2.8 billion and $2.9 billion at November 30, 2002 andNovember 30, 2001, respectively, which can be drawn upon to provide funding forthese commitments. These funding facilities contain limits for certainconcentrations of counterparty, industry or credit ratings of the underlyingloans.

 

In addition, the Company provided high yieldcontingent commitments related to acquisition financing of approximately $2.8billion and $0.6 billion at November 30, 2002 and 2001, respectively. TheCompany’s intent is, and its past practice has been, to sell down significantlyall the credit risk associated with these loans, if closed, through loansyndications, consistent with the Company’s credit facilitation framework.These commitments are not indicative of the Company’s actual risk as theborrower’s ability to draw is subject to there being no material adverse changein either market conditions or the borrower’s financial condition, among otherfactors. In addition, these commitments contain certain flexible pricingfeatures in order to adjust for changing market conditions.

 

At November 30, 2002 the Company had liquiditycommitments of approximately $0.6 billion related to trust certificates backedby investment grade municipal securities, as compared to $1.6 billion atNovember 30, 2001. The Company’s obligation under such liquidity commitments isgenerally less than one year and is typically further limited by the fact thatthe Company’s obligation ceases if the underlying assets are downgraded belowinvestment grade or default.

 

As of November 30, 2002 and 2001, the Company hadpledged securities, primarily fixed income, having a market value ofapproximately $23.4 billion and $16.6 billion, respectively, as collateral forsecurities borrowed having a market value of approximately $23.3 billion and$16.4 billion, respectively.

 

Securities and other financial instruments soldbut not yet purchased represent obligations of the Company to purchase thesecurities at prevailing market prices. Therefore, the future satisfaction ofsuch obligations may be for an amount greater or less than the amount recorded.The ultimate gain or loss is dependent upon the price at which the underlyingfinancial instrument is purchased to settle the Company’s obligation under thesale commitment.

 

F-30

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In the normal course of business, the Company isexposed to off-balance sheet credit and market risk as a result of executing,financing and settling various customer security and commodity transactions.Off-balance sheet risk arises from the potential that customers orcounterparties fail to satisfy their obligations and that the collateralobtained is insufficient. In such instances, the Company may be required topurchase or sell financial instruments at unfavorable market prices. TheCompany seeks to control these risks by obtaining margin balances and othercollateral in accordance with regulatory and internal guidelines.

 

At November 30, 2002 and 2001, the Company hadcommitments to invest up to $384 million and $169 million, respectively,directly and through partnerships in private equity related investments. Thesecommitments will be funded as required through the end of the respectiveinvestment periods, principally expiring in 2004.

 

Subsidiaries of the Company, as general partner,are contingently liable for the obligations of certain public and privatelimited partnerships organized as pooled investment funds or engaged primarilyin real estate activities. In the opinion of the Company, contingentliabilities, if any, for the obligations of such partnerships will not in theaggregate have a material adverse effect on the Company’s consolidatedfinancial position or results of operations.

 

In the normal course of its business, the Companyhas been named a defendant in a number of lawsuits and other legal proceedings.After considering all relevant facts, available insurance coverage and theadvice of counsel, in the opinion of the Company such litigation will not, inthe aggregate, have a material adverse effect on the Company’s consolidatedfinancial position or cash flows, but may be material to the Company’soperating results for any particular period, depending on the level of incomefor such period.

 

***Concentrations of Credit Risk***

 

As a leading global investment bank, the Companyis actively involved in securities underwriting, brokerage, distribution andtrading. These and other related services are provided on a worldwide basis toa large and diversified group of clients and customers, including multinationalcorporations, governments, emerging growth companies, financial institutionsand individual investors.

 

A substantial portion of the Company’s securitiesand commodities transactions are collateralized and are executed with, and onbehalf of, commercial banks and other institutional investors, including otherbrokers and dealers. The Company’s exposure to credit risk associated with thenon-performance of these customers and counterparties in fulfilling theircontractual obligations pursuant to securities transactions can be directlyimpacted by volatile or illiquid trading markets, which may impair the abilityof customers and counterparties to satisfy their obligations to the Company.

 

Securities and other financial instruments ownedby the Company include U.S. government and agency securities and securitiesissued by non-U.S. governments, which in the aggregate, represented 11% of theCompany’s total assets at November 30, 2002. In addition, resale agreementsrepresented 39% of total assets at November 30, 2002, and consisted principallyof securities issued by the U.S. government, federal agencies or non-U.S.governments. The Company’s most significant industry concentration is financialinstitutions, which include other brokers and dealers, commercial banks andinstitutional clients. This concentration arises in the normal course of theCompany’s business.

 

***Lease Commitments***

 

The Company leases office space and equipmentprimarily in the United States. Total rent expense for 2002, 2001 and 2000 was$75 million, $46 million and $23 million, respectively. Certain leases onoffice space contain escalation clauses providing for additional rentals basedupon maintenance, utility and tax increases.

 

F-31

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Minimum future rental commitments undernon-cancelable operating leases (net of subleases of $52 million) are asfollows:

 

***MinimumFuture Rental Commitments***

 
| **(in millions)**               |   |   |       |
|---------------------------------|--------|--------|------------|
|                            |   |   | ** ** |
| Fiscal 2003                     |   | $      | 76         |   |
| Fiscal 2004                     |   | 58     |       |
| Fiscal 2005                     |   | 72     |       |
| Fiscal 2006                     |   | 71     |       |
| Fiscal 2007                     |   | 69     |       |
| December 1, 2007 and thereafter |   | 760    |       |
|                            |   | $      | 1,106      |   |

 

Included in the above table are net rentalcommitments of approximately $603 million associated with properties vacated bythe Company due to the events of September 11, 2001. The Company recognizedcertain charges in 2002 related to its decision to exit its down-town New YorkCity campus resulting from occupancy actions taken after the events ofSeptember 11th, as well as costs associated with the consolidationof certain U.S. branches (See Notes 2 and 3 for additional informationregarding September 11th Related (Recoveries)/Expenses, Net andCosts Associated with Real Estate Reconfiguration).

 

The Company allocates a portion of the costsassociated with the above properties to certain related parties based uponheadcount usage.

 

**Note 17****. Related Party Transactions**

 

Inthe normal course of business, the Company engages in various securitiestrading, investment banking and financing activities with Holdings and many ofits subsidiaries (the “Related Parties”). Various charges, such as compensationand benefits, occupancy, administration and computer processing are allocatedbetween the Related Parties, based upon specific identification and otherallocation methods.

 

Holdingshas allocated to the Company the cost of certain employees and space in variousNew York City and surrounding locations. In addition, the Company charges otheraffiliates of Holdings for services it provides and also has certain revenuesharing arrangements. A portion of these reimbursements are variable in nature.The aggregate of these amounts, including any reimbursements, are classified inthe Consolidated Statement of Income as a component of Management fees,Compensation and benefits, or Revenues as appropriate.

 

Holdingsand subsidiaries of Holdings raise money through short- and long-term fundingin the capital markets, which is used to fund the operations of certain of theCompany’s wholly owned subsidiaries. Advances from Holdings and otheraffiliates were $13.2 billion and $21.5 billion at November 30, 2002 and 2001,respectively.

 

Inconnection therewith, advances from Holdings aggregating approximately $11.5billion and $20.3 billion at November 30, 2002 and 2001, respectively, aregenerally payable on demand. The average interest rate charged on theseadvances is primarily based on Holdings’ average daily cost of funds, which was1.8% and 4.8% for the twelve months ended November 30, 2002 and 2001,respectively. In addition, the Company had borrowings from Holdings andsubsidiaries of Holdings, classified as subordinated indebtedness, ofapproximately $2.1 billion and $1.6 billion at November 30, 2002 and 2001,respectively. In addition, the Company has advances from other subsidiaries ofHoldings aggregating approximately $1.7 billion and $1.2 billion at November30, 2002 and 2001, respectively, with various repayment terms.

 

AtNovember 30, 2002, the Company has $11.0 billion of securities purchased underagreements to resell and $15.7 billion of securities sold under agreements torepurchase with Holdings and subsidiaries of Holdings. Additionally, atNovember 30, 2002, the Company has $0.9 billion and $2.0 billion includedwithin derivatives and other contractual agreements owned and sold but not yetpurchased, respectively, with Holdings and subsidiaries of Holdings.

 

F-32

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TheCompany believes that amounts arising through related party transactions,including those allocated expenses referred to above, are reasonable andapproximate the amounts that would have been recorded if the Company operatedas an unaffiliated entity.

 

During2002, the Company distributed $1,085 million to Holdings as dividends. In 2001,the Company distributed $1,052 million to Holdings. During 2002, Holdingscontributed capital of $56 million associated with the Company’s regulatorysettlement. Additional information about the Company’s regulatory settlementcan be found in Note 4 to the Consolidated Financial Statements.

 

**Note 18****. Segments**

 

LehmanBrothers operates in three segments: Investment Banking, Capital Markets, andClient Services.

 

TheInvestment Banking Division provides advice to corporate, institutional andgovernment clients throughout the world on mergers, acquisitions and otherfinancial matters. The Division also raises capital for clients by underwritingpublic and private offerings of debt and equity securities.

 

TheCapital Markets Division includes the Company’s institutional sales, trading,research and financing activities in equity and fixed income cash andderivatives products. Through the Division, the Company is a globalmarket-maker in numerous equity and fixed income products, including U.S.,European and Asian equities, government and agency securities, money marketproducts, corporate high grade, high yield and emerging market securities,mortgage- and asset-backed securities, municipal securities, bank loans,foreign exchange and derivatives products. The Division also includes theCompany’s risk arbitrage and secured financing business, as well as realizedand unrealized gains and losses related to the Company’s direct private equityinvestments. The financing business manages the Company’s equity and fixedincome matched book activities, supplies secured financing to institutionalclients and customers, and provides secured funding for the Company’s inventoryof equity and fixed income products.

 

ClientServices revenues reflect earnings from the Company’s private client andprivate equity businesses. Private Client revenues reflect the Company’shigh-net-worth retail customer flow activities as well as asset management feesearned from these clients. Private Equity revenues include the management andincentive fees earned in the Company’s role as general partner for thirty-threePrivate Equity partnerships. In addition, these revenues also include theappreciation of its general partnership interests.

 

TheCompany’s segment information for the years ended November 30, 2002, November30, 2001 and November 30, 2000 is prepared utilizing the followingmethodologies:

 

•                                          Revenuesand expenses directly associated with each segment are included in determiningpre-tax earnings.

 

•                                          Certainexpenses not directly associated with specific segments are allocated basedupon the most relevant measures applicable, including each segment’s revenues,headcount and other factors.

 

•                                          Netrevenues include allocations of interest income and interest expense tosecurities and other positions in relation to the cash generated by, or fundingrequirements of, the underlying positions.

 

•                                          Segmentassets include an allocation of indirect corporate assets which have been fullyallocated to the Company’s business segments, generally based on each segment’srespective headcount figures.

 

F-33

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**Segments**

** **
|                                  |   | **Investment**     |       | **Capital** |       | **Client**   |       |      |       |
|---------------------------------------|--------|--------------------|------------|-------------|------------|--------------|------------|-----------|------------|
|                                  |   | **Banking**        | ** ** | **Markets** | ** ** | **Services** | ** ** | **Total** | ** ** |
|                                  |   | **(in  millions)** | ** ** |
| **November 30, 2002**                 |   |               |       |        |       |         |       |      |       |
| Gross revenues                        |   | $                  | 1,452      |        | $          | 9,880        |       | $         | 792        |   | $ | 12,124 |   |
| Interest expense                      |   | —             |       | 8,172       |       | 25           |       | 8,197     |       |
| Net revenues                          |   | 1,452              |       | 1,708       |       | 767          |       | 3,927     |       |
| Other expenses                        |   | 997                |       | 1,269       |       | 566          |       | 2,832     |       |
| Depreciation and amortization expense |   | 9                  |       | 43          |       | 9            |       | 61        |       |
| Earnings before taxes*                |   | $                  | 446        |        | $          | 396          |       | $         | 192        |   | $ | 1,034 |   |
| Segment assets (billions)             |   | $                  | 0.3        |        | $          | 192.4        |       | $         | 3.5        |   | $ | 196.2 |   |
|                                  |   |               |       |        |       |         |       |      |       |   |   |   |   |
| **November 30, 2001**                 |   |               |       |        |       |         |       |      |       |
| Gross revenues                        |   | $                  | 1,484      |        | $          | 15,282       |       | $         | 813        |   | $ | 17,579 |   |
| Interest expense                      |   | —             |       | 13,404      |       | 81           |       | 13,485    |       |
| Net revenues                          |   | 1,484              |       | 1,878       |       | 732          |       | 4,094     |       |
| Other expenses                        |   | 1,006              |       | 1,285       |       | 553          |       | 2,844     |       |
| Depreciation and amortization expense |   | 7                  |       | 55          |       | 8            |       | 70        |       |
| Earnings before taxes*                |   | $                  | 471        |        | $          | 538          |       | $         | 171        |   | $ | 1,180 |   |
| Segment assets (billions)             |   | $                  | 0.7        |        | $          | 185.5        |       | $         | 4.7        |   | $ | 190.9 |   |
|                                  |   |               |       |        |       |         |       |      |       |   |   |   |   |
| **November 30, 2000**                 |   |               |       |        |       |         |       |      |       |
| Gross revenues                        |   | $                  | 1,609      |        | $          | 18,383       |       | $         | 802        |   | $ | 20,794 |   |
| Interest expense                      |   | —             |       | 15,919      |       | 140          |       | 16,059    |       |
| Net revenues                          |   | 1,609              |       | 2,464       |       | 662          |       | 4,735     |       |
| Other expenses                        |   | 1,105              |       | 1,527       |       | 447          |       | 3,079     |       |
| Depreciation and amortization expense |   | 7                  |       | 28          |       | 4            |       | 39        |       |
| Earnings before taxes*                |   | $                  | 497        |        | $          | 909          |       | $         | 211        |   | $ | 1,617 |   |
| Segment assets (billions)             |   | $                  | 0.7        |        | $          | 175.1        |       | $         | 4.4        |   | $ | 180.2 |   |

 

----

*                                         Excludes the impact of the regulatory settlement,the other real estate reconfiguration costs and September 11threlated (recoveries)/expenses, net.  

 

The following are net revenues by geographic region:

 
|                   |   | **Twelve months ended November 30,** |       |
|------------------------|--------|--------------------------------------|------------|
|                   |   | **2002**                             | ** ** | **2001** | ** ** | **2000** | ** ** |
|                   |   | **(in millions)**                    | ** ** |
| U.S.                   |   | $                                    | 3,199      |   | $ | 3,446 |   | $ | 4,177 |   |
| Europe                 |   | 500                                  |       | 524 |   | 352 |   |
| Asia Pacific and other |   | 228                                  |       | 124 |   | 206 |   |
| Total                  |   | $                                    | 3,927      |   | $ | 4,094 |   | $ | 4,735 |   |

 

The following information describes the Company’smethods of allocating consolidated net revenues to geographic regions. Netrevenues, if syndicated or trading-related, have been distributed based uponthe location where the primary or secondary position was fundamentally risk managed:if fee-related, by the location of the senior coverage banker; ifcommission-related, by the location of the salespeople. In addition, certainrevenues associated with domestic products and services which resulted fromrelationships with international clients and customers have been reclassifiedas international revenues using an allocation consistent with the Company’sinternal reporting.

 

F-34

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**Note 19****.  QuarterlyInformation (Unaudited)**

** **

The following information represents the Company’s unaudited quarterlyresults of operations for 2002 and 2001. Certain amounts reflect reclassifications to conform to the currentperiod’s presentation.  These quarterlyresults reflect all normal recurring adjustments which are, in the opinion ofmanagement, necessary for a fair presentation of the results.  Revenues and earnings of the Company canvary significantly from quarter to quarter due to the nature of the Company’sbusiness activities.

 
|                                       |   | **2002**    |       | **2001**    |       |
|--------------------------------------------|--------|-------------|------------|-------------|------------|
| **(in millions)**                          |   | **Nov. 30** | ** ** | **Aug. 31** | ** ** | **May 31** | ** ** | **Feb. 28** | ** ** | **Nov. 30** | ** ** | **Aug. 31** | ** ** | **May 31** | ** ** | **Feb. 28** | ** ** |
| Total revenue                              |   | $           | 2,644      |        | $          | 2,886 |   | $ | 3,192 |   | $ | 3,402 |   | $ | 3,290 |   | $ | 3,567 |   | $ | 4,948 |   | $ | 5,771 |   |
| Interest expense                           |   | 1,934       |       | 2,058       |       | 2,150 |   | 2,055 |   | 2,676 |   | 2,893 |   | 3,421 |   | 4,494 |   |
| Net revenues                               |   | 710         |       | 828         |       | 1,042 |   | 1,347 |   | 614 |   | 674 |   | 1,527 |   | 1,277 |   |
|                                       |   |        |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-interest  expenses                     |   |        |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Compensation and  benefits                 |   | 363         |       | 421         |       | 531 |   | 687 |   | 314 |   | 344 |   | 778 |   | 651 |   |
| Other expenses                             |   | 242         |       | 234         |       | 242 |   | 173 |   | 185 |   | 206 |   | 222 |   | 213 |   |
| Regulatory  Settlement                     |   | 80          |       | —      |       | — |   | — |   | — |   | — |   | — |   | — |   |
| Other real  estate reconfiguration costs   |   | 8           |       | —      |       | — |   | — |   | — |   | — |   | — |   | — |   |
| September 11th  (recoveries)/expenses, net |   | —      |       | —      |       | — |   | — |   | 51 |   | — |   | — |   | — |   |
| Total non-interest  expenses               |   | 693         |       | 655         |       | 773 |   | 860 |   | 550 |   | 550 |   | 1,000 |   | 864 |   |
| Income before  taxes                       |   | 17          |       | 173         |       | 269 |   | 487 |   | 64 |   | 124 |   | 527 |   | 413 |   |
| Provision for  income taxes                |   | (46         | )          | 30          |       | 71 |   | 151 |   | (39 | ) | 17 |   | 155 |   | 142 |   |
| Net income                                 |   | $           | 63         |        | $          | 143 |   | $ | 198 |   | $ | 336 |   | $ | 103 |   | $ | 107 |   | $ | 372 |   | $ | 271 |   |
|                                            |        |             |            |             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

F-35

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**EXHIBIT INDEX**

 
| **Exhibit No.** |   | **Exhibit**                                                                                     |
|-----------------|--------|-------------------------------------------------------------------------------------------------|
| 12.01           |   | Computation in support  of ratio of earnings to fixed charges                                   |
| 23.01           |   | Consent of Ernst &  Young LLP                                                               |
| 24.01           |   | Powers of Attorney                                                                              |
| 99.01           |   | Statement of Chief Executive Officer Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 |
| 99.02           |   | Statement of Chief  Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |

 

 

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