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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549





FORM 10-K







|x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ------------------------------------------------------------------------------------

For the Fiscal Year Ended: December 31, 2008

OR



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

Commission File Number: 000-18188





PAULSON CAPITAL CORP.

(Exact name of registrant as specified in its charter)







|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Oregon                                                         |  | 93-0589534                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



|                                                  |  |           
|------------------------------------------------- |  | ----------
|811 SW Naito Parkway, Suite 200, Portland, Oregon |  | 97204     
|(Address of principal executive offices)          |  | (Zip Code)

Registrants telephone number, including area code: (503) 243-6000







|                                                            |  |                                          
|----------------------------------------------------------- |  | -----------------------------------------
|Securities Registered pursuant to Section 12(b) of the Act: |  |                                          
|                                                            | 
|Title of each class                                         |  | Name of each exchange on which registered
|Common Stock                                                |  | The NASDAQ Stock Market LLC              

Securities registered pursuant to Section 12(g) of the Act: None





Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act:

Yes   ̈    No  x

Indicate by check
mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act:

Yes   ̈    No  x

Indicate by check mark whether the registrant
(1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days:    Yes  x    No   ̈



Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K, or any amendment to this Form
10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer or a smaller reporting company. See definition of accelerated filer, large accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.



|                        |  |                                                  |  |                           |  |  
|----------------------- |  | ------------------------------------------------ |  | ------------------------- |  | -
|Large accelerated filer |  |  ̈                                                |  | Accelerated filer         |  |  ̈
|                        |  |                                                  | 
|Non-accelerated filer   |  |  ̈  (Do not check if a smaller reporting company) |  | Smaller reporting company |  | x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes    ̈    No  x

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant was $10,435,102, computed by reference to the last sales
price ($4.36) as reported by the Nasdaq Capital Market, as of the last business day of the Registrants most recently completed second fiscal quarter (June 30, 2008).

The number of shares outstanding of the registrants common stock as of March 27, 2009 was 5,928,285 shares.

Documents Incorporated by Reference

Portions of the registrants definitive Proxy Statement for its 2009
Annual Meeting of Shareholders are incorporated by reference into Part III.









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PAULSON CAPITAL CORP.

2008 FORM 10-K ANNUAL REPORT

TABLE OF CONTENTS



|            |  |                                                                                                              |  |     
|----------- |  | ------------------------------------------------------------------------------------------------------------ |  | ----
|            |  |                                                                                                              |  | Page
|            |  | PART I                                                                                                       |  |     
|            |  |                                                                                                             
|Item 1.     |  | Business                                                                                                     |  | 2   
|            |  |                                                                                                             
|Item 1A.    |  | Risk Factors                                                                                                 |  | 8   
|            |  |                                                                                                             
|Item 1B.    |  | Unresolved Staff Comments                                                                                    |  | 8   
|            |  |                                                                                                             
|Item 2.     |  | Properties                                                                                                   |  | 8   
|            |  |                                                                                                             
|Item 3.     |  | Legal Proceedings                                                                                            |  | 8   
|            |  |                                                                                                             
|Item 4.     |  | Submission of Matters to a Vote of Security Holders                                                          |  | 8   
|            |  |                                                                                                             
|            |  | PART II                                                                                                      |  |     
|            |  |                                                                                                             
|Item 5.     |  | Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |  | 9   
|            |  |                                                                                                             
|Item 6.     |  | Selected Financial Data                                                                                      |  | 9   
|            |  |                                                                                                             
|Item 7.     |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                        |  | 10  
|            |  |                                                                                                             
|Item 7A.    |  | Quantitative and Qualitative Disclosures About Market Risk                                                   |  | 17  
|            |  |                                                                                                             
|Item 8.     |  | Financial Statements and Supplementary Data                                                                  |  | 18  
|            |  |                                                                                                             
|Item 9.     |  | Changes in and Disagreements With Accountants on Accounting and Financial Disclosure                         |  | 18  
|            |  |                                                                                                             
|Item 9A(T). |  | Controls and Procedures                                                                                      |  | 18  
|            |  |                                                                                                             
|Item 9B.    |  | Other Information                                                                                            |  | 18  
|            |  |                                                                                                             
|            |  | PART III                                                                                                     |  |     
|            |  |                                                                                                             
|Item 10.    |  | Directors, Executive Officers and Corporate Governance                                                       |  | 19  
|            |  |                                                                                                             
|Item 11.    |  | Executive Compensation                                                                                       |  | 19  
|            |  |                                                                                                             
|Item 12.    |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters               |  | 19  
|            |  |                                                                                                             
|Item 13.    |  | Certain Relationships and Related Transactions, and Director Independence                                    |  | 19  
|            |  |                                                                                                             
|Item 14.    |  | Principal Accountant Fees and Services                                                                       |  | 20  
|            |  |                                                                                                             
|            |  | PART IV                                                                                                      |  |     
|            |  |                                                                                                             
|Item 15.    |  | Exhibits and Financial Statement Schedules                                                                   |  | 20  
|            |  |                                                                                                             
|Signatures  |  |                                                                                                              |  | 21  



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PART I



|ITEM 1. | BUSINESS
|------- | --------

Forward-Looking Statements

This report, including, without limitation, Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations, contains
or incorporates both historical and forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Words such as
anticipates, believes, expects, intends, future and similar expressions identify forward-looking statements. Any such forward-looking statements in this report reflect our current views
with respect to future events and financial performance and are subject to a variety of factors that could cause our actual results to differ materially from historical results or from anticipated results expressed or implied by such forward-looking
statements. Because of such factors, we cannot assure you that the results anticipated in this report will be realized. As noted elsewhere in this report, various aspects of our business are subject to extreme volatility often as a result of factors
beyond our ability to anticipate or control. In particular, factors, such as the condition of the securities markets, which are in turn based on popular perceptions of the health of the economy generally, can be expected to affect the volume of our
business as well as the value of the securities maintained in our trading and investment accounts.

General

Paulson Capital Corp., established in 1970, is a holding company whose operating subsidiary, Paulson Investment Company, Inc., is a full service brokerage firm
engaged in operations in four principal categories, all of them in the financial services industry. These categories are:



| |  |  | securities brokerage activities for which we earn commission revenues;
| | - |  | ----------------------------------------------------------------------



| |  |  | corporate finance revenues consisting principally of underwriting discounts and underwriter warrants;
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | securities trading from which we record profit or loss, depending on trading results; and
| | - |  | -----------------------------------------------------------------------------------------



| |  |  | investment income resulting from earnings on, and increases or decreases in the value of, our investment portfolio.
| | - |  | -------------------------------------------------------------------------------------------------------------------

In addition, in the third quarter of 2008, we formed a new 100% owned subsidiary for the purpose of purchasing, improving and remarketing underappreciated real estate.
Through December 31, 2008, we had not purchased any real estate.

Overview

Because we operate in the financial services industry, our revenues and earnings are substantially affected by general conditions in financial markets. In our securities brokerage business, the amount of our revenues
depends on levels of market activity requiring the services we provide. Our corporate finance activity, which consists of acting as the managing underwriter of initial and follow-on public offerings, private investments in public equity
(PIPEs) and private placements for smaller companies, is similarly affected by the strength of the market for new equity offerings, which has historically experienced substantial cyclical fluctuation. The number of initial public
offerings (IPOs) in the U.S. has declined as volatility in the U.S. economy continues. During 2008, 43 companies completed IPOs in the U.S., with proceeds totaling $28 billion. This compares to 272 IPOs in 2007, with proceeds totaling
$59.7 billion. With the VISA IPO excluded from the 2008 results, the IPOs in 2008 raised $10 billion. 2008 was the slowest year for U.S. IPOs since 1978. The low demand for IPOs was also evidenced by the 101 companies that filed to withdraw proposed
offerings with the SEC, almost double the 51 that did so in 2007. Although we attempt to match operating costs with activity levels, many of our expenses are either fixed or difficult to change on short notice. Accordingly, fluctuations in brokerage
and corporate finance revenues tend to result in sharper fluctuations, on a percentage basis, in net income or loss.



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Our investment and trading income or loss is affected by changes in market valuation of securities generally and, in
particular, by changes in valuation of the equity securities of microcap companies in which our investments and trading activities tend to be concentrated. Equity markets in general, and microcap equity markets in particular, have always experienced
significant volatility and this volatility has, in recent years, been extreme. The result of this volatility on the value of our investment portfolio and securities held in connection with our trading and investment activities include large
quarterly fluctuations in income or loss from these operations and substantial increases or decreases in our net worth as our securities holdings are marked to market.

A substantial portion of our corporate finance business consists of acting as managing underwriter of initial and follow-on public offerings for microcap and smallcap companies. As a part of our compensation for
these activities, we typically receive warrants exercisable to purchase securities similar to those that we offer and sell to the public. The warrants generally have a five-year expiration date and vest immediately. The warrants are generally
subject to a restricted period of six months to one-year during which we cannot exercise. The exercise price is typically 120% of the price at which the securities were initially sold to the public. Accordingly, unless there is at least a 20%
increase in the price of these securities at some time more than six months and less than five years after the offering, the warrants will remain under water and will ultimately expire unexercised. We also receive warrants in connection
with PIPEs, which have varying terms and conditions.

The following table shows the portion of our revenues that was attributable to each revenue category
for the last two fiscal years (in thousands):



|                         |  |      |         |   |      |   |       
|------------------------ |  | ---- | ------- | - | ---- | - | ------
|Year Ended December 31,  |  | 2008 |         |   | 2007
|Commissions              |  | $    | 14,390  |   |      | $ | 17,008
|Corporate finance        |  |      | 395     |   |      |   | 6,032 
|Investment income (loss) |  |      | (17,729 | ) |      |   | 3,108 
|Trading income (loss)    |  |      | (5,232  | ) |      |   | 3,535 
|Interest and dividends   |  |      | 53      |   |      |   | 101   
|Other                    |  |      | 108     |   |      |   | 257   
|                         |  |      |         |   |      |   |       
|                         |  | $    | (8,015  | ) |      | $ | 30,041
|                         |  |      |         |   |      |   |       

In 2007 and 2008, none of our revenue was from foreign sources and no customer represented 10% or more of our
total revenue. In addition, all of our long-lived assets were located within the U.S.

Current Events

As a result of the continuing global economic turmoil and our poor operating results, in February 2009, we terminated 15% of our back office staff, discontinued the
401(k) matching contribution and implemented 10% pay cuts for all salaried employees effective April 1, 2009. In addition, we suspended the summer 2009 investment banking conference and the November 2009 Westergaard Conference, as well as
eliminated other non-essential business expenditures. We anticipate that these actions will result in annualized cost savings of approximately $1.5 million. Costs associated with these actions were primarily for severance and related costs and were
immaterial.

Clearing Firm

Pursuant to our agreement
with RBC Correspondent Services, a division of RBC Capital Markets Corporation (RBC CS), RBC CS carries all of our customer securities accounts and performs the following services: (1) preparation and mailing of monthly statements
to our customers; (2) settlement of contracts and transactions in securities between us and other broker-dealers and between us and our customers; (3) custody and safe-keeping of securities and cash, the handling of margin accounts,
dividends, exchanges, rights offerings and tender offers; and (4) the execution of customer orders placed on an exchange. We determine the amount of commission to be charged to our customers on principal and agency transactions, as well as the
price of securities purchased or sold in principal transactions. RBC CS receives compensation based on the number of transactions and revenue sharing



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arrangements. In the event of a liability arising from a bad debt from a customer, we are required to indemnify RBC CS against any loss. This potential
liability is uninsured.

Commissions

As a securities
broker, we act as agent for our customers in the purchase and sale of common and preferred stocks, options, warrants and debt securities traded on securities exchanges or in the over-the-counter (OTC) market. A portion of our revenue is
derived from commissions from customers on these transactions. In the OTC market, transactions with customers in securities may be effected as principal, rather than agent, primarily in securities for which we are a market maker. Customer
transactions in securities are effected either on a cash or margin basis.

We also enter into dealer agreements with mutual fund management companies and
publicly registered limited partnerships. Commissions on the sale of these securities are derived from the standard dealer discounts, which range from approximately 1% to 8.5% of the purchase price of the securities, depending on the terms of the
dealer agreement and the amount of the purchase. We do not generally sell interests in limited partnerships that are not publicly registered.

In the case
of corporate finance transactions, described below, a portion of the discount applicable to securities placed by our retail brokerage group is credited to securities brokerage commissions and the commission payable to the broker is recorded as
securities brokerage commission expense.

Corporate Finance

While a substantial portion of our corporate finance business consists of acting as managing underwriter of initial and follow-on public offerings for microcap and smallcap companies, we also act as a placement agent for PIPEs and private
placements for smaller companies. We underwrite the public offerings on a firm commitment basis, which means that we agree to purchase a specific amount of securities from the issuer at a discount and resell the securities to the public
at a specified price after the registration statement for the offering is declared effective by the Securities and Exchange Commission (the SEC). Managing these public offerings involves the risk of loss if we are unable to resell at a
profit the securities we are committed to purchase. This risk is usually reduced by including other stock brokerage firms as a part of an underwriting syndicate in which each member commits to purchase a specified amount of the offering. We,
and the other underwriters, may also sell a portion of our respective commitments through a selling group of other stock brokerage firms that participate in selling the offering but are not subject to an underwriters
commitment. As an underwriter, we are also subject to potential liability under federal and state securities laws if the registration statement or prospectus contains a material misstatement or omission. We do not have insurance to cover our
potential liabilities as an underwriter.

The commitment of our capital between the time a firm commitment underwriting agreement becomes effective and the
time we resell the securities constitutes a charge against our net capital. Accordingly, our participation in, or initiation of, underwritings may be limited by the financial requirements of the SEC and the Financial Industry Regulatory
Authority (FINRA). See Net Capital Requirements below.

Between June 1, 1978 and December 31, 2008, we acted as the
managing underwriter or co-managing underwriter for 164 securities offerings, raising approximately $1.2 billion for corporate finance clients. Of these, 102 were initial public offerings. We typically receive 2% to 3% of the aggregate amount of
money raised in an offering to cover nonaccountable expenses and between 7% and 9% as compensation to underwriters, selling group members and registered representatives, although these percentages may be lower for larger transactions.

As a part of our compensation for the underwriting activities, we also typically receive warrants exercisable to purchase securities similar to those
that we offer and sell to the public. The warrants generally have a five-year expiration date and vest immediately. The warrants are generally subject to a restricted period of six months to one-year in which we cannot exercise the warrants. The
exercise price is typically 120% of the price at which the securities are initially sold to the public. Accordingly, unless



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there is at least a 20% increase in the price of these securities at some time more than six months and less than five years after the offering, the warrants
will remain under water and will ultimately expire unexercised. We also receive warrants in connection with our PIPEs, which have varying terms and conditions. A portion of these underwriter warrants are typically transferred to other
co-managing underwriters in the public offering.

In 2008, we completed 1 initial public offering with gross proceeds for our client totaling $5.1 million.

Investment Income

We hold securities for investment,
which are maintained in investment accounts that are segregated from our trading accounts. Our investment portfolio principally consists of securities purchased for investment and underwriter warrants.

From time to time, we make investments as a principal in companies that are, or are expected to be, corporate finance clients. The investment may be as convertible
debt in anticipation of a public offering, in which case, if the offering is successful, the principal and interest are either converted to equity or repayable from the offering proceeds. If the offering is not successful, the debt is typically
converted to equity. We also make investments in companies that are not anticipating an immediate public offering. In such cases, the investment is typically made in the form of the purchase of restricted equity securities. Typically, these
type of investments have ranged from $50,000 to $1.0 million. At December 31, 2008, we held securities of 4 privately-held companies in our investment accounts with a fair value of $2.3 million.

Trading Income and Market Making

In addition to executing trades as
an agent, we regularly act as a principal in executing trades in equity securities, corporate debt securities and municipal bonds. At December 31, 2008, we made a market in 50 securities of 34 issuers. Of these, 31 were corporations for which
we had acted as managing or co-managing underwriter of public financings.

Our market making activities are conducted both with other dealers in the
wholesale market and with our customers. Transactions with customers are effected as principal at a net price equal to the current interdealer price plus or minus the approximate equivalent of a brokerage commission. In such
transactions, the commission is recorded as securities brokerage commissions revenue while any profit or loss attributable to a change in value of the security in our trading account is recorded as trading profit or loss. Our transactions as
principal expose us to risk because securities positions are subject to fluctuations in fair value and liquidity. Profits or losses on trading and investment positions depend upon the skills of the employees in our trading department and employees
responsible for taking investment positions. The trading department is headquartered in our Portland, Oregon office.

Limitations on Investment and
Trading Securities

The size of our investment and trading securities positions at any date may not be representative of our exposure on any other
date, because the securities positions vary substantially depending upon economic and market conditions, the allocation of capital among types of inventories, underwriting commitments, customer demands and trading volume. The aggregate value of
inventories that we may carry are limited by certain requirements under the SECs net capital rules. See Net Capital Requirements below.

Branch Offices

Our branch offices are generally run by independent contractors who assume liability for all the operating expenses of the
branch. We typically receive between 10% and 15% of the gross commission earned by the branch, with the balance retained by the branch to pay its expenses and staff. Persons in these branches are registered with us, and we assume the same compliance
and regulatory obligations as would be the case if we were fully responsible for the branchs expenses. As of March 27, 2009, we had



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40 branch offices in California, Colorado, Georgia, New Jersey, New York, North Carolina, Oregon, Utah and Washington. All of these branches, except our
offices in Oregon and Manhattan, New York, operate as independent contractor offices. We continue to be responsible for all expenses of the Oregon and Manhattan offices.

Regulation

We are registered with the SEC as a broker-dealer under the Securities Exchange Act of 1934 and are a
member of FINRA. We are also registered as a broker-dealer and investment advisor under the laws of all 50 states, Washington, D.C. and Puerto Rico.

The
securities business is subject to extensive regulation under federal and state laws. The principal purpose of regulation and discipline of broker-dealers is the protection of customers and the securities markets rather than protection of creditors
and stockholders of broker-dealers. The SEC is the federal agency charged with administration of the federal securities laws. Much of the regulation of broker-dealers, however, has been delegated to self-regulatory organizations, principally the
FINRA. These self-regulatory organizations adopt rules (subject to approval by the SEC) that govern the industry and conduct periodic examinations of member broker-dealers. Securities firms are also subject to regulation and examination by
state securities commissions in the states in which they are registered.

The regulations to which broker-dealers are subject cover all aspects of the
securities business, including sales methods, trading practices among broker-dealers, capital structure of securities firms, record keeping and the conduct of directors, officers and employees. Additional legislation, changes in
rules promulgated by the SEC and by self-regulatory bodies or changes in the interpretation or enforcement of existing laws and rules often directly affect the method of operation and profitability of broker-dealers. The SEC, FINRA and
state regulatory authorities may conduct administrative proceedings that can result in censure, fine, suspension or expulsion of a broker-dealer, its officers or employees.

Net Capital Requirements

We are required to maintain minimum net capital under the SECs net
capital rule of not less than 6.67% of our aggregate indebtedness. In general, net capital consists of the broker-dealers net worth, adjusted by numerous factors specified in the applicable regulations. In particular, the
value of securities that can be included in net capital is subject to reduction in fair value or principal amount. The amount of the required reduction, or haircut, depends on the nature of the security. As of December 31, 2008, we
had net capital of $5.1 million, which exceeded our minimum requirement of $0.1 million by $5.0 million. The ratio of aggregate indebtedness of $1.7 million to net capital of $5.1 million at December 31, 2008, was approximately 0.33 to 1.

In a public offering in which we act as an underwriter, we must have sufficient net capital to cover the amount of securities underwritten, applying the
applicable formula mandated by the SEC, during the period between effectiveness and the closing of the transaction, usually 3 business days. This results in a significant temporary increase in our required net capital. Although this has never
happened, in some cases, the amount of securities underwritten by us could be limited by our net capital. Any significant reduction in our net capital, even if we were still in compliance with the SECs net capital rule for its retail and
trading activities, could have a material adverse effect on our ability to continue our investment banking activities.

Industry and Competition

All aspects of our business are highly competitive. In our general brokerage activities, we compete directly with numerous other broker-dealers, some of
which are large well-known firms. Many of our competitors employ extensive advertising and actively solicit potential clients in order to increase business. In addition, brokerage firms compete by furnishing investment research publications to
existing clients, the quality and breadth of which are considered important in the development of new business and the retention of existing clients. We also compete with a number of smaller regional brokerage firms.



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Some commercial banks and thrift institutions offer securities brokerage services. Many commercial banks offer a variety
of investment banking services. Competition among financial services firms also exists for investment representatives and other personnel.

The securities
industry has become more concentrated and more competitive since we were founded, as numerous securities firms have either ceased operations or have been acquired by or merged into other firms. In addition, the 2008 financial crisis made an
unprecedented impact on the financial services industry. Most of the biggest investment banks, including Bear Stearns, Lehman Bros. and Merrill Lynch no longer exist, and Goldman Sachs and Morgan Stanley have become bank holding companies. These
developments have resulted in uncertainty in the securities industry and the economic crisis continues in 2009 to date.

The securities industry has
experienced substantial commission discounting by broker-dealers competing for brokerage business. In addition, specialized firms offer discount services to individual customers. These firms generally effect transactions for their
customers on an execution only basis without offering other services such as portfolio valuation, investment recommendations and research. Discount brokerage firms may offer their services over the Internet, further decreasing offered
commission rates and increasing ease of use for customers. Competition within the discount brokerage segment is fierce. Weaker online trading volumes and falling commission rates have prompted the discount brokers to merge in order to expand their
client base, achieve operating synergies, and diversify their business away from heavy reliance on trading commissions. In addition, rapid growth in the mutual fund industry is presenting potential customers of ours with an increasing number of
alternatives to traditional stock brokerage accounts.

In our investment banking activities, we compete with other brokerage firms, venture capital firms,
banks and all other sources of capital for small, growing companies. Since we generally manage offerings smaller than $45 million, we do not typically compete with the investment banking departments of large, well-known national brokerage firms.
Nevertheless, we occasionally manage larger offerings. In addition, large national and regional investment banking firms occasionally manage offerings of a size that is competitive with us, typically for fees and compensation less than that charged
by us. When the market for initial public offerings is active, many small regional firms that do not typically engage in investment banking activities also begin to compete with us.

As discussed above, during 2008, the market for public offerings slowed significantly as a result of the downturn in the overall global economy. We cannot predict when the market for public offerings will improve.

Employees

At March 27, 2009, we had 71 employees
(of which 69 were full-time). Of these, 42 were executives and support staff and 29 were involved in brokerage activities and compensated primarily on a commission basis. We also had independent contractor arrangements with 67 independent
contractors, all of whom are compensated solely on a commission basis.



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|ITEM 1A. | RISK FACTORS
|-------- | ------------

As a Smaller Reporting Company, this information is
not required.



|ITEM 1B. | UNRESOLVED STAFF COMMENTS
|-------- | -------------------------

Not applicable as there are no
outstanding comment letters.



|ITEM 2. | PROPERTIES
|------- | ----------

We lease approximately 17,100 square feet of office
space in Portland, Oregon under a lease expiring January 2011. The base monthly rental rate on this lease is currently $28,560. The rental rate increases January 2010 to $29,560 through the expiration of the lease. Our Salem, Oregon office leases
3,759 square feet of space under a lease that expires in October 2011 at a monthly rent of $4,393, with rent subject to increases based upon inflation. We also lease approximately 2,500 square feet of space for our office in Manhattan, New York
under a lease expiring in September 2010. The base monthly rental rate on this lease is currently $13,019. Our operating leases are accounted for on a straight-line basis. We believe the existing leased space in Portland, Salem and Manhattan is
adequate for our business for the foreseeable future. The other branch offices lease space but, under the terms of the relationship between us and these offices, we are not responsible for these leasing costs.



|ITEM 3. | LEGAL PROCEEDINGS
|------- | -----------------

We are named in and subject to various
proceedings and claims arising primarily from our securities business activities, including lawsuits, arbitration claims, class actions and regulatory matters. Some of these claims seek substantial compensatory, punitive or indeterminate damages. We
are also involved in other reviews, investigations and proceedings by governmental and self-regulatory agencies regarding our business, certain of which may result in adverse judgments, settlements, fines, penalties, injunctions or other relief.
Because litigation is inherently unpredictable, particularly in cases where claimants seek substantial or indeterminate damages or when investigations and proceedings are in the early stages, we cannot predict with certainty the losses or range of
losses related to such matters, how such matters will be resolved, when they will ultimately be resolved, or what the eventual settlement, fine, penalty or other relief might be. Consequently, we cannot estimate losses or ranges of losses for
matters where there is only a reasonable possibility that a loss may have been incurred. Although the ultimate outcome of these matters cannot be ascertained at this time, it is the opinion of management, after consultation with counsel, that the
resolution of the foregoing matters will not have a material adverse effect on our Consolidated Financial Statements, taken as a whole; such resolution may, however, have a material effect on the operating results in any future period, and,
depending on the outcome and timing of any particular matter, may be material to the operating results for any period depending on the operating results for that period. We have provided loss allowances for such matters in accordance with Statement
of Financial Accounting Standards (SFAS) No. 5, Accounting for Contingencies. The ultimate resolution may differ materially from the amounts provided. For the twelve-month periods ended December 31, 2008 and 2007,
the recording of legal losses did not have a material impact on our results of operations.



|ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
|------- | ---------------------------------------------------

None.



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PART II



|ITEM 5. | MARKET FOR THE REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
|------- | ----------------------------------------------------------------------------------------------------------------

Stock Prices and Dividends

Our common stock trades on the
Nasdaq Capital Market under the symbol PLCC, but it is not actively traded. The following table sets forth the high and low closing sale prices of our common stock for each quarter in the two years ended December 31, 2008.



|                             |  |      |      |     |   |     
|---------------------------- |  | ---- | ---- | --- | - | ----
|Year Ended December 31, 2007 |  | High |      | Low
|Quarter 1                    |  | $    | 5.34 |     | $ | 4.50
|Quarter 2                    |  |      | 6.05 |     |   | 4.60
|Quarter 3                    |  |      | 6.01 |     |   | 4.48
|Quarter 4                    |  |      | 5.85 |     |   | 4.35
|                             |  |     
|Year Ended December 31, 2008 |  | High |      | Low
|Quarter 1                    |  | $    | 5.52 |     | $ | 4.61
|Quarter 2                    |  |      | 5.29 |     |   | 3.80
|Quarter 3                    |  |      | 4.36 |     |   | 2.25
|Quarter 4                    |  |      | 2.55 |     |   | 1.00

As of December 31, 2008, we had 55 shareholders of record and approximately 410 beneficial shareholders.

No dividends were declared or paid in 2007 or 2008. Net capital requirements may limit our ability to pay future dividends to our shareholders.

Issuer Purchases of Equity Securities

We
repurchased the following shares of our common stock during the fourth quarter of 2008:



|                          |  |                                |  |                            |      |                                                                  |        |                                                                |        
|------------------------- |  | ------------------------------ |  | -------------------------- | ---- | ---------------------------------------------------------------- | ------ | -------------------------------------------------------------- | -------
|                          |  | Total numberof sharespurchased |  | Averageprice paidper share |      | Total number ofshares purchasedas part of publiclyannounced plan |        | Maximum numberof shares that mayyet be purchasedunder the plan
|October 1 to October 31   |  |                               |  |                            |     |                                                                  |       |                                                                |       
|November 1 to November 30 |  |                               |  |                            |     |                                                                  |       |                                                                |       
|December 1 to December 31 |  | 13,865                         |  | $                          | 1.05 |                                                                  | 13,865 |                                                                | 243,011
|                          |  |                                |  |                            |      |                                                                  |        |                                                                |        
|Total                     |  | 13,865                         |  | $                          | 1.05 |                                                                  | 13,865 |                                                                | 243,011
|                          |  |                                |  |                            |      |                                                                  |        |                                                                |        

A plan to repurchase up to a total of 600,000 shares of our common stock was approved by our Board of Directors in
September 2001 and does not have an expiration date. In addition, in June 2008, our Board of Directors approved the repurchase of up to a total of an additional 200,000 shares of our common stock. This authorization also does not have an expiration
date.

Equity Compensation Plan Information

See
Item 12. for Equity Compensation Plan Information.



|ITEM 6. | SELECTED FINANCIAL DATA
|------- | -----------------------

As a Smaller Reporting Company, this
information is not required.



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|ITEM 7. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------

OVERVIEW

Substantially all of our business consists of the securities brokerage and corporate finance activities of
our wholly-owned subsidiary, Paulson Investment Company, Inc., which has operations in four principal categories, all of them in the financial services industry. These categories are:



| |  |  | securities brokerage activities for which we earn commission revenues;
| | - |  | ----------------------------------------------------------------------



| |  |  | corporate finance revenues consisting principally of underwriting discounts and underwriter warrants;
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | securities trading from which we record profit or loss, depending on trading results; and
| | - |  | -----------------------------------------------------------------------------------------



| |  |  | investment income resulting from earnings on, and increases or decreases in the value of, our investment portfolio.
| | - |  | -------------------------------------------------------------------------------------------------------------------

In addition, in the third quarter of 2008, we formed a new 100% owned subsidiary for the purpose of purchasing, improving and remarketing undervalued real estate. Through
December 31, 2008, we had not purchased any real estate.

Because we operate in the financial services industry, our revenues and earnings are
substantially affected by general conditions in financial markets. Further, past performance is not necessarily indicative of results to be expected in future periods. In our securities brokerage business, the amount of our revenues depends on
levels of market activity requiring the services we provide. Our corporate finance activity, which consists of acting as the managing underwriter of initial and follow-on public offerings, private investments in public equity (PIPEs) and
private placements for smaller companies, is similarly affected by the strength of the market for new equity offerings, which has historically experienced substantial cyclical fluctuation. The number of initial public offerings (IPOs) in
the U.S. has declined as volatility in the U.S. economy continues. During 2008, 43 companies completed IPOs in the U.S., with proceeds totaling $28 billion. This compares to 272 IPOs in 2007, with proceeds totaling $59.7 billion. With the VISA IPO
excluded from the 2008 results, the IPOs in 2008 raised $10 billion. 2008 was the slowest year for U.S. IPOs since 1978. The low demand for IPOs was also evidenced by the 101 companies that filed to withdraw proposed offerings with the SEC, almost
double the 51 that did so in 2007. Although we attempt to match operating costs with activity levels, many of our expenses are either fixed or difficult to change on short notice. Accordingly, fluctuations in brokerage and corporate finance revenues
tend to result in sharper fluctuations, on a percentage basis, in net income or loss.

Our investment and trading income or loss is affected by changes in
market valuation of securities generally and, in particular, by changes in valuation of the equity securities of microcap companies in which our investments and trading activities tend to be concentrated. Equity markets in general, and microcap
equity markets in particular, have always experienced significant volatility and this volatility has, in recent years, been extreme. The result of this volatility on the value of our investment portfolio and securities held in connection with our
trading and investment activities include large quarterly fluctuations in income or loss from these operations and substantial increases or decreases in our net worth as our securities holdings are marked to market.

A substantial portion of our corporate finance business consists of acting as managing underwriter of initial and follow-on public offerings for microcap and smallcap
companies. As a part of our compensation for these activities, we typically receive warrants exercisable to purchase securities similar to those that we offer and sell to the public. The warrants generally have a five-year expiration date and
vest immediately. The warrants are generally subject to a restricted period of six months to one-year during which we cannot exercise. The exercise price is typically 120% of the price at which the securities were initially sold to the public.
Accordingly, unless there is at least a 20% increase in the price of these securities at some time more than six months and less than five years after the offering, the warrants will remain under water and will ultimately expire
unexercised. We also receive warrants in connection with PIPEs, which have varying terms and conditions.



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CURRENT EVENTS

As a
result of the continuing global economic turmoil and our poor operating results, in February 2009, we terminated 15% of our back office staff, discontinued the 401(k) matching contribution and implemented 10% pay cuts for all salaried employees
effective April 1, 2009. In addition, we suspended the summer 2009 investment banking conference and the November 2009 Westergaard Conference, as well as eliminated other non-essential business expenditures. We anticipate that these actions
will result in annualized cost savings of approximately $1.5 million. Costs associated with these actions were primarily for severance and related costs and were immaterial.

CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES

The following discussion and analysis of our financial condition
and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. In preparing our consolidated financial statements, we must
make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our financial statements. Actual results are likely to differ
from these estimates under different assumptions and conditions.

As a result of the factors described below, our revenues and earnings are subject to
substantial fluctuation from period to period based on a variety of circumstances, many of which are beyond our control. An increase in financial market activity generally, and/or an increase in equity valuations generally, will normally result in
increases in our revenues, earnings and net worth as our activity levels and the value of our investment portfolio increase. Conversely, a general market retrenchment will typically lead to decreased revenues, earnings and net worth as a result of
both decreased activity and the need to adjust high investment portfolio values to lower levels. Accordingly, results for any historical period are not necessarily indicative of similar results for any future period.

The critical accounting policies described below include those that reflect significant judgments and uncertainties, which potentially could produce materially different
results under different assumptions and conditions. We believe our critical accounting policies are limited to those described below.

Revenue
Recognition

Securities transactions and related revenue are recorded on a trade date basis. Managers fees, underwriters fees, and other
underwriting revenues are recognized at the time the underwriting is completed. Tax deferred revenue is recognized at the time individual tax deferred units are sold. Revenue from the receipt of underwriter warrants is recognized on the date the
warrants are received based on the fair value of the securities received as estimated using the Black-Scholes option-pricing model taking into account the exercise price, remaining life of the warrant, the current price of the underlying stock and
its expected volatility, expected dividends on the stock and the risk-free interest rate for the remaining term of the warrant.

SFAS No. 157

Effective January 1, 2008, we adopted the provisions of SFAS No. 157, Fair Value Measurements, for our financial assets and
liabilities. SFAS No. 157 applies to our underwriter warrants as well as to our trading and investment securities.

Value of Underwriter
Warrants

We are required to estimate the value of all derivative securities that we hold at the date of any financial statements and to include
that value, and changes in such value, in those financial statements. Accordingly, the aggregate fair value of our underwriter warrants is recorded as an asset on our balance sheet. When a new warrant is received, its fair value is included in
corporate finance revenue on the date on which it is earned. Subsequently, any change in fair value is recorded as investment income or loss. When a warrant is exercised, the book value is adjusted to reflect the value of the securities purchased,
net of the exercise price, and the adjustment amount is recorded as income or loss for the relevant



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period. If a warrant expires unexercised, the book value is adjusted to zero and the decrease is recorded as a loss in the relevant period. In addition, we
have recorded a liability related to underwriter warrants that were previously held by certain employees. We are obligated to pay a bonus to these employees equal to the gain recognized by us when the warrants are exercised and the related stock is
sold.

We estimate the value of our underwriter warrants using the Black-Scholes Option Pricing Model. The Black-Scholes model requires us to use five
inputs including: price, risk free rate, exercise price, time remaining on the warrant and price volatility. After stock price, the most influential factor in this model is price volatility, which we calculate for each companys warrants based
on each companys own historical stock closing prices as well as an index of historical prices for comparable companies. When we initially receive a new underwriter warrant from an initial public offering, its calculated volatility factor is
entirely based on the volatility of an index of comparable companies, since there is no price history for a new publicly traded company. As each underwriter warrant approaches its expiration date, its volatility factor is derived primarily from the
historical prices of its underlying common stock. We cannot assure you that we will ultimately be able to exercise any of our warrants in a way that will realize the value that we attribute to them in our financial statements based on this model. At
December 31, 2008, the value of underwriter warrants was $1.7 million, which is included as a separate line item on our consolidated balance sheet.

Fair Value of Investments

In addition to our underwriter warrants, we hold other securities, some of which have very limited
liquidity and some of which do not have a readily ascertainable fair value. According to accounting principles generally accepted in the United States of America (U.S. GAAP), we are required to carry these securities at fair value. The
fair value of not readily marketable securities is estimated by management using available information including the following: quoted market prices of similar securities (i.e., unrestricted shares of the same company); price of recent known trades
of the same or similar securities; the cost of the security, if recently purchased, adjusted for changes in the financial condition of the issuer; all other information available from review of available documents related to the issuer or
discussions with management of the issuer. Changes in the value of these securities are reflected currently in our results of operations as a component of investment income. Our estimates regarding the fair value of securities that are not readily
marketable are significant estimates and these estimates could change in the near term. At December 31, 2008, the value of investments which do not have a readily ascertainable fair value was $2.3 million and was included as a component of
trading and investment securities on our consolidated balance sheet.

Legal Reserves

We record reserves related to legal proceedings resulting from lawsuits and arbitrations, which arise from our business activities. Some of these lawsuits and
arbitrations claim substantial amounts, including punitive damage claims. Management has determined that it is likely that ultimate resolution in favor of the claimant will result in losses to us on certain of these claims. We have, after
consultation with outside legal counsel and consideration of facts currently known by management, recorded estimated losses to the extent we believe certain claims are probable of loss and the amount of the loss can be reasonably estimated. Factors
considered by management in estimating our liability are the loss and damages sought by the claimant/plaintiff, the merits of the claim, the amount of loss in the clients account, the possibility of wrongdoing on the part of our employee, the
total cost of defending the litigation, the likelihood of a successful defense against the claim, and the potential for fines and penalties from regulatory agencies. Results of litigation and arbitration are inherently uncertain, and
managements assessment of risk associated therewith is subject to change as the proceedings evolve. After discussion with legal counsel, management, based on its understanding of the facts, accrues what they consider appropriate to reserve
against probable loss for certain claims, which is included in the Consolidated Balance Sheets under the caption Accounts payable and accrued expenses.

Income Taxes

Financial Accounting Standards Board (FASB) Interpretation No. 48 (FIN 48),
Accounting for Uncertainty in Income Taxes, defines the threshold for recognizing the benefits of tax return positions in the financial statements as more-likely-than-not to be sustained by the taxing authority. FIN 48
applies to all tax positions accounted for under SFAS No. 109, Accounting for Income Taxes. Accordingly, our



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financial statements reflect those tax positions that are more-likely-than-not to be sustained. At December 31, 2008, we had unrecognized tax benefits
of $272,000, all of which would have an impact on the effective tax rate if recognized. Interest and penalties accrued on unrecognized tax benefits were $43,000. We do not believe it is reasonably possible that the total amount of unrecognized
benefits will significantly increase or decrease within the next 12 months.

Stock-Based Compensation

We account for stock-based compensation pursuant to Statement of Financial Accounting Standards (SFAS) No. 123R, Share-Based Payment, which
prescribes accounting for equity instruments exchanged for employee services. Under the provisions of SFAS No. 123R, stock-based compensation cost for equity classified awards is measured at the grant date, based on the fair value of the award,
and is recognized as an expense over the employees requisite service period (generally the vesting period of the equity award). The provisions of SFAS No. 123R apply to all awards granted or modified after January 1, 2006, the date
of adoption. We did not have any unrecognized expense related to awards outstanding at the date of adoption since they were all fully vested. For future awards, expense calculated pursuant to SFAS No. 123R will be recognized as compensation
expense using the Black-Scholes option pricing model over the requisite service period.

RESULTS OF OPERATIONS

Our revenues and operating results are influenced by fluctuations in the equity markets as well as general economic and market conditions, particularly conditions in the
over-the-counter market, where our investment and trading positions and the underlying stock for the underwriter warrants are heavily concentrated. Significant fluctuations can occur in our revenues and operating results from one period to another.
Our results of operations depend upon many factors, such as the number of companies that are seeking financing, the quality and financial condition of those companies, market conditions in general, the performance of our previous underwritings and
interest in certain industries by investors. As a result, revenues and income derived from these activities may vary significantly from period to period. Our revenues include the following:



| |  |  | Commissions, which represent amounts earned from our retail securities brokerage activities;
| | - |  | --------------------------------------------------------------------------------------------



| |  |  | Corporate finance revenues, which are a function of total proceeds from offerings done during the period, compensation per offering and the fair value of
underwriter warrants received;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Investment income (loss), which includes (i) the unrealized appreciation and depreciation of securities held based on quoted market prices, (ii) the
unrealized appreciation and depreciation of securities held that are not readily marketable, based upon our estimate of their fair value, (iii) realized gains and losses on the sale of securities with quoted market prices and securities that
are not readily marketable, (iv) income on the exercise of underwriter warrants, and (v) the unrealized appreciation and depreciation of underwriter warrants held; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Trading income (loss), which is the gain or loss from trading positions before commissions paid to the representatives in the trading department.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------



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The following table sets forth the changes in our operating results in 2008 compared to 2007 (dollars in thousands):



|                                       |  |                         |         |                    |      |   |                      |  |   |         |   |  |       |   
|-------------------------------------- |  | ----------------------- | ------- | ------------------ | ---- | - | -------------------- |  | - | ------- | - |  | ----- | --
|                                       |  | Year Ended December 31, |         | Increase(Decrease) |      |   | % Increase(Decrease) | 
|                                       |  | 2008                    |         |                    | 2007 |   |                     
|Revenues:                              |  |                         |         |                    |      |   |                      |  |   |         |   |  |       |   
|Commissions                            |  | $                       | 14,390  |                    |      | $ | 17,008               |  | $ | (2,618  | ) |  | (15.4 | )%
|Corporate finance                      |  |                         | 395     |                    |      |   | 6,032                |  |   | (5,637  | ) |  | (93.5 | ) 
|Investment income (loss)               |  |                         | (17,729 | )                  |      |   | 3,108                |  |   | (20,837 | ) |  | *     |   
|Trading income (loss)                  |  |                         | (5,232  | )                  |      |   | 3,535                |  |   | (8,767  | ) |  | *     |   
|Interest and dividends                 |  |                         | 53      |                    |      |   | 101                  |  |   | (48     | ) |  | (47.5 | ) 
|Other                                  |  |                         | 108     |                    |      |   | 257                  |  |   | (149    | ) |  | (58.0 | ) 
|                                       |  |                         |         |                    |      |   |                      |  |   |         |   |  |       |   
|Total revenues                         |  |                         | (8,015  | )                  |      |   | 30,041               |  |   | (38,056 | ) |  | *     |   
|Expenses:                              |  |                         |         |                    |      |   |                      |  |   |         |   |  |       |   
|Commissions and salaries               |  |                         | 13,362  |                    |      |   | 15,774               |  |   | (2,412  | ) |  | (15.3 | ) 
|Underwriting expenses                  |  |                         | 429     |                    |      |   | 451                  |  |   | (22     | ) |  | (4.9  | ) 
|Rent, telephone and quotation services |  |                         | 1,174   |                    |      |   | 1,209                |  |   | (35     | ) |  | (2.9  | ) 
|Professional fees                      |  |                         | 808     |                    |      |   | 772                  |  |   | 36      |   |  | 4.7   |   
|Bad debt expense                       |  |                         | 21      |                    |      |   | 219                  |  |   | (198    | ) |  | (90.4 | ) 
|Travel and entertainment               |  |                         | 252     |                    |      |   | 244                  |  |   | 8       |   |  | 3.3   |   
|Advertising and promotion expense      |  |                         | 202     |                    |      |   | 240                  |  |   | (38     | ) |  | (15.8 | ) 
|Settlement expense                     |  |                         | 51      |                    |      |   | 605                  |  |   | (554    | ) |  | (91.6 | ) 
|Depreciation and amortization          |  |                         | 107     |                    |      |   | 115                  |  |   | (8      | ) |  | (7.0  | ) 
|Other                                  |  |                         | 1,599   |                    |      |   | 2,706                |  |   | (1,107  | ) |  | (40.9 | ) 
|                                       |  |                         |         |                    |      |   |                      |  |   |         |   |  |       |   
|Total expenses                         |  |                         | 18,005  |                    |      |   | 22,335               |  |   | (4,330  | ) |  | (19.4 | ) 
|                                       |  |                         |         |                    |      |   |                      |  |   |         |   |  |       |   
|Income (loss) before income taxes      |  | $                       | (26,020 | )                  |      | $ | 7,706                |  | $ | (33,726 | ) |  | *     |   
|                                       |  |                         |         |                    |      |   |                      |  |   |         |   |  |       |   



|* | Not meaningful.
|- | ---------------

The global economic turmoil, which worsened significantly in the third and fourth quarters of 2008, had a negative impact on our results of operations in 2008. For example, for the period from December 31, 2007 to December 31,
2008, the Dow Jones Industrial average and the NASDAQ composite indices decreased 33.8% and 40.5%, respectively.

Commissions decreased 15.4% in 2008
compared to 2007, primarily as a result of poor market conditions. We had 96 registered representatives at December 31, 2008 compared to 95 at December 31, 2007.

Corporate finance income in 2008 included underwriting discounts earned from the following:



| |  |  | an initial public offering in which we raised $5.1 million for Healthy Fast Foods, Inc., as well as the Black-Scholes value of the underwriter warrants received in
connection with that offering.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Corporate finance income in 2007 included underwriting discounts earned from the following:



| |  |  | an initial public offering in the first quarter of 2007 in which we raised $9.8 million for Converted Organics Inc., as well as the Black-Scholes value of the
underwriter warrants received in connection with that offering;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | one private transaction completed during the first quarter of 2007 in which we raised $2.2 million for our client;
| | - |  | ------------------------------------------------------------------------------------------------------------------



| |  |  | an initial public offering in the second quarter of 2007 in which we raised $14.0 million for Vaughan Foods Inc., as well as the Black-Scholes value of the
underwriter warrants received in connection with that offering;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | one private offering during the second quarter of 2007 in which we raised $2.8 million for our client;
| | - |  | ------------------------------------------------------------------------------------------------------



| |  |  | a follow-on public offering in the fourth quarter of 2007 in which we raised $13.2 million for The Quantum Group, Inc.; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------



| |  |  | we were a co-underwriter in the fourth quarter of 2007 for Rodman & Renshaw Capital Group, Inc., in which we raised $6.0 million.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------



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Investment income (loss) included the following (in thousands):



|                                                                                                                                                                                 |  |                         |         |   |      |   |        |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------ | -
|                                                                                                                                                                                 |  | Year Ended December 31, |        
|                                                                                                                                                                                 |  | 2008                    |         |   | 2007 |  
|Net unrealized appreciation (depreciation) related to underwriter warrants                                                                                                       |  | $                       | (15,160 | ) |      | $ | 6,575  |  
|Net unrealized depreciation of underwriter warrantsemployee and independent contractor                                                                                          |  |                         | 527     |   |      |   |       |  
|Net unrealized appreciation (depreciation) of securities held based on quoted market prices or, for securities that are not readily
marketable, our estimate of their fair value |  |                         | 4,089   |   |      |   | (8,142 | )
|Net realized gains (losses) on the sale of securities with quoted market prices, securities that are not readily marketable and gains from the
exercise of underwriter warrants  |  |                         | (7,185  | ) |      |   | 4,675  |  
|                                                                                                                                                                                 |  |                         |         |   |      |   |        |  
|                                                                                                                                                                                 |  | $                       | (17,729 | ) |      | $ | 3,108  |  
|                                                                                                                                                                                 |  |                         |         |   |      |   |        |  

We exercised two underwriter warrants in 2008 compared to three in 2007. Generally, when we exercise a warrant to
obtain the underlying common stock, the common stock is subsequently sold in the near term and the related gain is reflected as a component of investment income.

Investment income (loss) is volatile from period to period due to the fact that it is driven by the fair value or fair value of the securities and underwriter warrants held. In addition, the performance of the securities in which we have a
concentration can significantly affect our investment income from period to period.

Trading income decreased to a loss of $5.2 million in 2008 compared to
income of $3.5 million in 2007. In 2008, trading income was negatively affected by difficult conditions in the market, especially the significant downturn in the third and fourth quarters of 2008. Trading income results were positively affected in
2007 by highly favorable results for certain securities that we were holding in our trading inventories. Our focus is on very small capitalization issues, especially those tied to our corporate finance clients. Trading income (loss) can be volatile
from period to period because it is driven by the fair value of the securities in which we make a market.

Other income in both 2008 and 2007 included
$100,000 of amortization of deferred revenue related to our clearing firm agreement. In addition, other income in 2007 included $120,000 in insurance recovery related to legal and settlement expense in prior years.

Expenses

Total expenses decreased $4.3 million in 2008
compared to 2007, primarily due to decreases in commissions and salaries, bad debt expense and settlement expense as described in more detail below.

Commissions and salaries decreased $2.4 million in 2008 compared to 2007. The decrease was primarily due to lower commissions earned on lower commission revenue and lower compensation as a result of fewer investment banking transactions.
Retail commissions as a percentage of retail sales were comparable between 2008 and 2007.

Bad debt expense is recorded for specific amounts when they are
determined by management to be uncollectible. Bad debt expense in 2007 included a $104,000 write-off of a loan to a potential corporate finance client.

Settlement expense of $51,000 in 2008 was related to legal matters that were resolved during 2008. Settlement expense of $0.6 million in 2007 included $0.2 million for a claim that was settled in the fourth quarter of 2007 and $0.2 million
for a claim that was settled in the third quarter of 2007. In addition, there was a net $60,000 adjustment for insurance recovery in 2007.

LIQUIDITY
AND CAPITAL RESOURCES

Our primary sources of liquidity include our cash and receivables from our clearing organization, offset by payables to our
clearing organization. In addition, during the fourth quarter of 2008, we sold certain securities at a loss. The sale of these securities increased our income taxes receivable as we are able to carry back the losses to prior years. We received $0.7
million of the income tax receivable during the first quarter of 2009 and expect to receive approximately $5.6 million in the second quarter of 2009.



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In addition, our sources of liquidity include our trading positions, investment positions, borrowings on those positions
and profits realized upon the sale of the securities underlying underwriter warrants exercised. The liquidity of the market for many of our securities holdings, however, varies with trends in the stock market. Since many of the securities we hold
are thinly traded, and we are, in many cases, a primary market maker in the issues held, any significant sales of our positions could adversely affect the liquidity of the issues held. In general, falling prices in NASDAQ securities (which make up
most of our trading positions) lead to decreased liquidity in the market for these issues, while rising prices in NASDAQ issues tend to increase the liquidity of the market for these securities.

We believe our cash and receivable from clearing organization and income taxes receivable at December 31, 2008 are sufficient to meet our cash and regulatory net
capital needs for at least the next twelve-month period from December 31, 2008, which allows us to hold our investment securities for the long-term. Our liquidity could be negatively affected by protracted unfavorable market conditions. As
discussed above, the major market indices have declined significantly during 2008.

As a securities broker-dealer, we are required by SEC regulations to
meet certain liquidity and capital standards. We believe we were in compliance with these standards at December 31, 2008.

Following the lapse of
restrictions upon issuance, capital available from the sale of the underlying securities of underwriter warrants exercised can fluctuate significantly from period to period as the value of the underlying securities fluctuates with overall market and
individual company financial condition or performance. There is no public market for the underwriter warrants. The securities receivable upon exercise of the underwriter warrants cannot be resold unless the issuer has registered these securities
with the SEC and with the states in which the securities will be sold unless exemptions are available. Any delay or other problem in the registration of these securities would have an adverse impact upon our ability to obtain funds from the exercise
of the underwriter warrants and the resale of the underlying securities.

At December 31, 2008, we owned 14 underwriter warrants from 13 issuers, all
but one of which were exercisable. None of the warrants had an exercise price below the December 31, 2008 market price of the securities receivable upon exercise. There is little or no direct relationship between the intrinsic value of our
underwriter warrants at the end of any given period and the fair value calculated using the Black-Scholes option pricing model. The prices of the securities underlying the underwriter warrants are very volatile, and substantial fluctuations in our
estimate of their value can be expected in the future.

Cash provided by operating activities totaled $0.8 million in 2008, primarily due to our net loss
of $17.1 million being offset by net non-cash expense items of $11.1 million and changes in our operating assets and liabilities as discussed in more detail below.

Our net receivable from our clearing organization decreased $4.2 million to $5.0 million at December 31, 2008 from $9.2 million at December 31, 2007, primarily due to the results of the activity in our trading and investment
accounts, reduced broker commissions, as well as the timing of general corporate expenditures.

Notes and other receivables decreased $1.0 million to $0.6
million at December 31, 2008 from $1.6 million at December 31, 2007, due to repayment of a $1.1 million note from one of our corporate finance clients, partially offset by amounts loaned to other corporate finance clients.

Income taxes receivable, current increased $7.9 million to $6.5 million at December 31, 2008 from a payable of $1.4 million at December 31, 2007, primarily due
to realized losses in the current period and our ability to carry back the losses for a refund of taxes paid in previous periods.

Deferred income tax
assets increased $3.2 million to $1.4 million at December 31, 2008 from a liability of $1.8 million at December 31, 2007, primarily due to the decrease in the value of our underwriter warrants, as well as unrealized losses on our
investment securities.



16



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##### Table of Contents

Changes in our trading and investment securities are dependent on the purchase and sale of securities during the period,
as well as changes in their fair values during the period.

A summary of activity related to the value of our underwriter warrants was as follows (in
thousands):



|                                         |  |   |         |  
|---------------------------------------- |  | - | ------- | -
|Balance, December 31, 2007               |  | $ | 16,373  |  
|Fair value of warrants received          |  |   | 462     |  
|Net unrealized loss on value of warrants |  |   | (14,100 | )
|Value of warrants exercised or expired   |  |   | (1,060  | )
|                                         |  |   |         |  
|Balance, December 31, 2008               |  | $ | 1,675   |  
|                                         |  |   |         |  

Accounts payable and accrued liabilities decreased $2.5 million to $0.7 million at December 31, 2008 from
$3.2 million at December 31, 2007, primarily due to a decrease in amounts payable to certain employees as a result of a decrease in the fair value of stock related to the exercise of underwriter warrants.

Compensation, employee benefits and payroll taxes decreased $1.6 million to $0.5 million at December 31, 2008 from $2.1 million at December 31, 2007, primarily
due to the exercise of employee underwriter warrants and the sale of the related stock in December 2007 with no similar event in December 2008.

Deferred
revenue of $0.4 million at December 31, 2008 related to amounts received from our clearing firm based on the execution of a five-year agreement and a one-year extension of the agreement, and is being amortized at the rate of $8,333 per month
through September 2012.

Underwriter warrants  employee and independent contractor of $0.1 million at December 31, 2008 represented the fair
value of underwriter warrants held for which the gain from the sale of the related stock upon exercise is due to certain employees.

In September 2001, our
Board of Directors approved a stock repurchase program pursuant to which we are authorized to repurchase up to 600,000 shares of our common stock. In addition, in June 2008, our Board of Directors approved the repurchase of up to a total of an
additional 200,000 shares of our common stock. During 2008, we repurchased a total of 108,865 shares for $497,000 and, at December 31, 2008, 243,011 shares remained available for repurchase. These repurchase programs do not have an expiration
date.

OFF-BALANCE SHEET ARRANGEMENTS

We do not have
any off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital
expenditures or capital resources.

NEW ACCOUNTING PRONOUNCEMENTS

See Note 19. of Notes to Consolidated Financial Statements included under Part II, Item 8 of this Annual Report on Form 10-K.

CONTRACTUAL PAYMENT OBLIGATIONS

Tabular disclosure of contractual payment obligations is not required for Smaller Reporting Companies.



|ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|-------- | ----------------------------------------------------------

As a
Smaller Reporting Company, this information is not required.



17



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##### Table of Contents

|ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
|------- | -------------------------------------------

The financial
statements and notes thereto required by this item begin on page F-1 of this document, as listed in Item 15 of Part IV. The Supplementary Data is not included as it is not required for a Smaller Reporting Company.



|ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
|------- | ------------------------------------------------------------------------------------

None.



|ITEM 9A(T). | CONTROLS AND PROCEDURES
|----------- | -----------------------

Disclosure Controls and Procedures

Our management has evaluated, under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer, the
effectiveness of our disclosure controls and procedures as of the end of the period covered by this report as defined in Rule 13a-15(e) or Rule 15d-15(e) under the Securities Exchange Act of 1934 (the Exchange Act). Based on that
evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures are effective in ensuring that information required to be
disclosed in our Exchange Act reports is (1) recorded, processed, summarized and reported in a timely manner, and (2) accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as
appropriate, to allow timely decisions regarding required disclosure.

There are inherent limitations to the effectiveness of any system of disclosure
controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving
their control objectives, and management necessarily is required to use its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Managements Report on Internal Control Over Financial Reporting

Our management is responsible for
establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a 15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer
and our Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control  Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on our evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2008.

This Annual Report on Form 10-K does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Managements report was not subject to
attestation by our registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit us to provide only managements report in this Annual Report on Form 10-K.

Changes in Internal Controls

There has been no change in our
internal control over financial reporting that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.



|ITEM 9B. | OTHER INFORMATION
|-------- | -----------------

None.



18



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##### Table of Contents

PART III



|ITEM 10. | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
|-------- | ------------------------------------------------------

The
information required by this item is incorporated by reference to the information under the captions Election of Directors, Executive Officers, Meetings and Committees of the Board of Directors, Audit
Committee Financial Expert and Section 16(a) Beneficial Ownership Reporting Compliance in our Proxy Statement for our 2009 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days
after the end of our fiscal year.

We have adopted a code of ethics that applies to our officers (including our principal executive, financial and
accounting officers), directors, employees and consultants. The text of our code of ethics is posted at our Internet website, located at www.paulsoninvestment.com. Furthermore, if disclosure of an amendment or waiver to our code of
ethics is required by Item 5.05 of Form 8-K, we intend to satisfy such disclosure either by timely filing a Form 8-K or by posting such information at the same Internet website.



|ITEM 11. | EXECUTIVE COMPENSATION
|-------- | ----------------------

The information required by this item is
incorporated by reference to the information under the captions Director Compensation and Executive Compensation in our Proxy Statement for our 2009 Annual Meeting of Shareholders to be filed with the Securities and Exchange
Commission within 120 days after the end of our fiscal year.



|ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
|-------- | ----------------------------------------------------------------------------------------------

Equity Compensation Plan Information

The following table summarizes equity securities
authorized for issuance pursuant to compensation plans as of December 31, 2008.



|                                                       |  |                                                                                             |  |                                                                              |  |                                                                                                                                           
|------------------------------------------------------ |  | ------------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------
|Plan Category                                          |  | Number of securitiesto be issued uponexercise
ofoutstanding options,warrants and rights (a) |  | Weighted averageexercise price ofoutstanding options,warrants and rights (b) |  | Number of securitiesremaining available for futureissuance under equitycompensation plans(excluding securities reflectedin column (a)) (c)
|Equity compensation plans approved by shareholders(1)  |  |                                                                                            |  |                                                                             |  | 532,000                                                                                                                                   
|                                                       |  |                                                                                             | 
|Equity compensation plans not approved by shareholders |  |                                                                                            |  |                                                                             |  |                                                                                                                                          
|                                                       |  |                                                                                             |  |                                                                              |  |                                                                                                                                           
|Total                                                  |  |                                                                                            |  |                                                                             |  | 532,000                                                                                                                                   
|                                                       |  |                                                                                             |  |                                                                              |  |                                                                                                                                           



|(1) | Includes our 1999 Stock Option Plan.
|--- | ------------------------------------

Additional information required by
this item is incorporated by reference to the information under the caption Stock Ownership of Principal Owners and Management in our Proxy Statement for our 2009 Annual Meeting of Shareholders to be filed with the Securities and
Exchange Commission within 120 days after the end of our fiscal year.



|ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
|-------- | -------------------------------------------------------------------------

Information required by this item is incorporated by reference to the information under the caption Director Independence in our Proxy Statement for our 2009 Annual Meeting of Shareholders to be filed with the Securities and
Exchange Commission within 120 days after the end of our fiscal year.



19



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##### Table of Contents

|ITEM 14. | PRINCIPAL ACCOUNTANT FEES AND SERVICES
|-------- | --------------------------------------

The information required by
this item is incorporated by reference to the information under the caption Independent Registered Public Accountants in our Proxy Statement for our 2009 Annual Meeting of Shareholders to be filed with the Securities and Exchange
Commission within 120 days after the end of our fiscal year.

PART IV



|ITEM 15. | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
|-------- | ------------------------------------------

Financial Statements and Schedules

The Consolidated Financial Statements and Schedules, together with the report
thereon of McGladrey & Pullen, LLP, are included on the pages indicated below:



|                                                                                               |  |     
|---------------------------------------------------------------------------------------------- |  | ----
|                                                                                               |  | Page
|Report of McGladrey & Pullen, LLP, Independent Registered Public Accounting Firm               |  | F-1 
|                                                                                               | 
|Consolidated Balance Sheets as of December 31, 2008 and 2007                                   |  | F-2 
|                                                                                               | 
|Consolidated Statements of Operations for the years ended December 31, 2008 and 2007           |  | F-3 
|                                                                                               | 
|Consolidated Statements of Shareholders Equity for the years ended December 31, 2008 and
2007 |  | F-4 
|                                                                                               | 
|Consolidated Statements of Cash Flows for the years ended December 31, 2008 and 2007           |  | F-5 
|                                                                                               | 
|Notes to Consolidated Financial Statements                                                     |  | F-6 
|                                                                                               | 
|Supplementary Schedule of Warrants Owned                                                       |  | F-18
|                                                                                               | 
|Schedule II  Valuation and Qualifying Accounts                                                |  | F-19

Exhibits

The
following exhibits are filed herewith and this list is intended to constitute the exhibit index. Exhibit numbers marked with an asterisk (*) represent management or compensatory arrangements.



|       |  |                                                                                                                                                                                                              
|------ |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Number |  | Description                                                                                                                                                                                                  
|3.1    |  | Articles of Incorporation (incorporated by reference to Exhibit 3.1 to our Registration Statement on Form 10 filed with the Securities and Exchange Commission on December 18, 1989
).                       
|       | 
|3.2    |  | Amended and Restated Bylaws (incorporated by reference to Exhibit 3.1 to Form 8-K filed December 18, 2007).                                                                                                  
|       | 
|10.1   |  | Office Lease renewal for the period from June 1, 1997 to May 31, 2001, dated as of May 6, 1997 (incorporated by reference to Exhibit 10.4 to Form 10-QSB for the quarter ended June 30,
1997).               
|       | 
|10.2   |  | Amendment 1 to Office Lease dated as of May 6, 1997 (incorporated by reference to Exhibit 10.5 to Form 10-KSB for the year ended December 31, 2001).                                                         
|       | 
|10.3   |  | Amendment 2 to Office Lease dated as of May 6, 1997.                                                                                                                                                         
|       | 
|10.4*  |  | 1999 Stock Option Plan (incorporated by reference to Exhibit 10.5 to Form 10-KSB for the year ended December 31, 1999).                                                                                      
|       | 
|10.5   |  | Fully Disclosed Clearing Agreement between RBC Dain Correspondent Services and Paulson Investment Company, Inc. (incorporated by reference to Exhibit 10.1 to Form 10-Q for the quarter ended June
30, 2006).
|       | 
|21     |  | Subsidiaries of Paulson Capital Corp.                                                                                                                                                                        
|       | 
|23     |  | Consent of McGladrey & Pullen, LLP.                                                                                                                                                                          
|       | 
|31.1   |  | Certification of Principal Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934.                                                                            
|       | 
|31.2   |  | Certification of Principal Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934.                                                                            
|       | 
|32.1   |  | Certification of Principal Executive Officer pursuant to Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.                                                 
|       | 
|32.2   |  | Certification of Principal Financial Officer pursuant to Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.                                                 



20



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##### Table of Contents

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Paulson Capital Corp. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized on March 27, 2009:



PAULSON CAPITAL CORP.(Registrant)By

/s/ CHESTER L. F. PAULSONChester L. F. PaulsonPresident and Chief Executive Officer(Principal Executive Officer)


Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by
the following persons on behalf of the Registrant and in the capacities indicated on March 27, 2009.



|                          |  |  |  |                                  
|------------------------- |  |  |  | ---------------------------------
|SIGNATURE                 |  |  |  | TITLE                            
|                          |  | 
|/s/ CHESTER L. F. PAULSON |  |  |  | Chairman of the Board, President 
|Chester L. F. Paulson     |  |  |  | and Chief Executive Officer      
|                          |  |  |  | (Principal Executive Officer)    
|                          |  | 
|/s/ KAREN L. JOHANNES     |  |  |  | Chief Financial Officer          
|Karen L. Johannes         |  |  |  | (Principal Financial Officer)    
|                          |  | 
|/s/ JACQUELINE M. PAULSON |  |  |  | Secretary, Treasurer and Director
|Jacqueline M. Paulson     |  |  |  |                                  
|                          |  | 
|/s/ DENIS R. BURGER       |  |  |  | Director                         
|Denis R. Burger           |  |  |  |                                  
|                          |  | 
|/s/ STEVE H. KLEEMANN     |  |  |  | Director                         
|Steve H. Kleemann         |  |  |  |                                  
|                          |  | 
|/s/ CHARLES L.F. PAULSON  |  |  |  | Director                         
|Charles L.F. Paulson      |  |  |  |                                  
|                          |  | 
|/s/ SHANNON P. PRATT      |  |  |  | Director                         
|Shannon P. Pratt          |  |  |  |                                  
|                          |  | 
|/s/ PAUL F. SHOEN         |  |  |  | Director                         
|Paul F. Shoen             |  |  |  |                                  



21



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##### Table of Contents

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders

Paulson Capital Corp. and
Subsidiaries

We have audited the accompanying consolidated balance sheets of Paulson Capital Corp. and Subsidiaries as of December 31, 2008 and 2007,
and the related consolidated statements of operations, shareholders equity and cash flows for the years then ended. Our audits also included the financial statement schedules of Paulson Capital Corp. and Subsidiaries listed in Item 15.
These financial statements and financial statement schedules are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant estimates made by management, 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Paulson
Capital Corp. and Subsidiaries as of December 31, 2008 and 2007, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the
related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.

We were not engaged to examine managements assessment of the effectiveness of Paulson Capital Corp. and Subsidiaries internal control over financial
reporting as of December 31, 2008 included in the accompanying Managements Report on Internal Control Over Financial Reporting and, accordingly, we do not express an opinion thereon.



|                           
|---------------------------
|/s/ McGladrey & Pullen, LLP
|                           
|Chicago, Illinois          
|March 31, 2009             



F-1



---

##### Table of Contents

Paulson Capital Corp. and Subsidiaries

Consolidated Balance Sheets



|                                                                                                                 |  |              |            |      |   |           
|---------------------------------------------------------------------------------------------------------------- |  | ------------ | ---------- | ---- | - | ----------
|                                                                                                                 |  | December 31,
|                                                                                                                 |  | 2008         |            | 2007
|Assets                                                                                                           |  |              |            |      |   |           
|Cash                                                                                                             |  | $            | 318,810    |      | $ | 43,619    
|Receivable from clearing organization                                                                            |  |              | 7,469,811  |      |   | 11,702,341
|Notes and other receivables                                                                                      |  |              | 635,027    |      |   | 1,563,530 
|Income taxes receivable                                                                                          |  |              | 6,480,699  |      |   |          
|Deferred tax asset                                                                                               |  |              | 1,409,000  |      |   |          
|Trading and investment securities, at fair value                                                                 |  |              | 6,611,097  |      |   | 20,194,914
|Underwriter warrants, at fair value                                                                              |  |              | 1,675,000  |      |   | 16,373,000
|Prepaid and deferred expenses                                                                                    |  |              | 885,136    |      |   | 939,371   
|Furniture and equipment, at cost, net of accumulated depreciation and amortization of $881,621 and $862,616      |  |              | 94,991     |      |   | 196,333   
|                                                                                                                 |  |              |            |      |   |           
|Total Assets                                                                                                     |  | $            | 25,579,571 |      | $ | 51,013,108
|                                                                                                                 |  |              |            |      |   |           
|                                                                                                                 |  |             
|Liabilities and Shareholders Equity                                                                             |  |              |            |      |   |           
|Accounts payable and accrued liabilities                                                                         |  | $            | 675,491    |      | $ | 3,240,877 
|Payable to clearing organization                                                                                 |  |              | 2,490,075  |      |   | 2,463,413 
|Compensation, employee benefits and payroll taxes                                                                |  |              | 497,791    |      |   | 2,065,972 
|Securities sold, not yet purchased, at market value                                                              |  |              |           |      |   | 36,259    
|Income taxes payablecurrent                                                                                     |  |              |           |      |   | 1,369,710 
|Income taxes payablelong-term                                                                                   |  |              | 315,000    |      |   | 297,000   
|Deferred revenue                                                                                                 |  |              | 375,000    |      |   | 375,000   
|Underwriter warrantsemployee and independent contractor, at fair value                                          |  |              | 124,000    |      |   | 651,000   
|Deferred income taxes                                                                                            |  |              |           |      |   | 1,821,000 
|                                                                                                                 |  |              |            |      |   |           
|Total Liabilities                                                                                                |  |              | 4,477,357  |      |   | 12,320,231
|                                                                                                                 |  |             
|Commitments and Contingencies                                                                                    |  |              |           |      |   |          
|                                                                                                                 |  |             
|Shareholders Equity                                                                                             |  |              |            |      |   |           
|Preferred stock, no par value; 500,000 shares authorized; none issued                                            |  |              |           |      |   |          
|Common stock, no par value; 20,000,000 shares authorized; shares issued and outstanding: 5,928,285 and 6,037,150 |  |              | 1,947,280  |      |   | 1,972,319 
|Retained earnings                                                                                                |  |              | 19,154,934 |      |   | 36,720,558
|                                                                                                                 |  |              |            |      |   |           
|Total Shareholders Equity                                                                                       |  |              | 21,102,214 |      |   | 38,692,877
|                                                                                                                 |  |             
|                                                                                                                 |  |              |            |      |   |           
|Total Liabilities and Shareholders Equity                                                                       |  | $            | 25,579,571 |      | $ | 51,013,108
|                                                                                                                 |  |              |            |      |   |           

See accompanying Notes to Consolidated Financial Statements.



F-2



---

##### Table of Contents

Paulson Capital Corp. and Subsidiaries

Consolidated Statements of Operations



|                                       |  |                                 |             |   |      |   |           
|-------------------------------------- |  | ------------------------------- | ----------- | - | ---- | - | ----------
|                                       |  | For the Year Ended December 31,
|                                       |  | 2008                            |             |   | 2007
|Revenues                               |  |                                 |             |   |      |   |           
|Commissions                            |  | $                               | 14,390,079  |   |      | $ | 17,007,481
|Corporate finance                      |  |                                 | 395,389     |   |      |   | 6,032,172 
|Investment income (loss)               |  |                                 | (17,728,748 | ) |      |   | 3,108,278 
|Trading income (loss)                  |  |                                 | (5,232,435  | ) |      |   | 3,535,042 
|Interest and dividends                 |  |                                 | 52,792      |   |      |   | 100,430   
|Other                                  |  |                                 | 107,692     |   |      |   | 257,265   
|                                       |  |                                 |             |   |      |   |           
|                                       |  |                                 | (8,015,231  | ) |      |   | 30,040,668
|                                       |  |                                
|Expenses                               |  |                                 |             |   |      |   |           
|Commissions and salaries               |  |                                 | 13,362,807  |   |      |   | 15,773,679
|Underwriting expenses                  |  |                                 | 428,440     |   |      |   | 451,601   
|Rent, telephone and quotation services |  |                                 | 1,173,426   |   |      |   | 1,209,065 
|Professional fees                      |  |                                 | 807,426     |   |      |   | 771,894   
|Bad debt expense                       |  |                                 | 20,727      |   |      |   | 218,692   
|Travel and entertainment               |  |                                 | 252,094     |   |      |   | 244,285   
|Advertising and promotion expense      |  |                                 | 202,098     |   |      |   | 239,942   
|Settlement expense                     |  |                                 | 51,300      |   |      |   | 604,712   
|Depreciation and amortization          |  |                                 | 107,206     |   |      |   | 114,857   
|Other                                  |  |                                 | 1,599,145   |   |      |   | 2,706,177 
|                                       |  |                                 |             |   |      |   |           
|                                       |  |                                 | 18,004,669  |   |      |   | 22,334,904
|                                       |  |                                 |             |   |      |   |           
|                                       |  |                                
|Income (loss) before income taxes      |  |                                 | (26,019,900 | ) |      |   | 7,705,764 
|                                       |  |                                
|Income tax expense (benefit):          |  |                                 |             |   |      |   |           
|Current                                |  |                                 | (5,696,000  | ) |      |   | 2,773,000 
|Deferred                               |  |                                 | (3,230,000  | ) |      |   | 151,000   
|                                       |  |                                 |             |   |      |   |           
|                                       |  |                                 | (8,926,000  | ) |      |   | 2,924,000 
|                                       |  |                                 |             |   |      |   |           
|                                       |  |                                
|Net income (loss)                      |  | $                               | (17,093,900 | ) |      | $ | 4,781,764 
|                                       |  |                                 |             |   |      |   |           
|                                       |  |                                
|Basic net income (loss) per share      |  | $                               | (2.86       | ) |      | $ | 0.78      
|                                       |  |                                 |             |   |      |   |           
|                                       |  |                                
|Diluted net income (loss) per share    |  | $                               | (2.86       | ) |      | $ | 0.78      
|                                       |  |                                 |             |   |      |   |           
|                                       |  |                                
|Shares used in per share calculations: |  |                                 |             |   |      |   |           
|Basic                                  |  |                                 | 5,966,676   |   |      |   | 6,114,636 
|                                       |  |                                 |             |   |      |   |           
|Diluted                                |  |                                 | 5,966,676   |   |      |   | 6,124,490 
|                                       |  |                                 |             |   |      |   |           

See accompanying Notes to Consolidated Financial Statements.



F-3



---

##### Table of Contents

Paulson Capital Corp. and Subsidiaries

Consolidated Statements of Shareholders Equity

For the Years Ended December 31, 2008 and 2007



|                                                                           |  |              |   |  |          |           |   |                    |   |             |        |  |   |             |  
|-------------------------------------------------------------------------- |  | ------------ | - |  | -------- | --------- | - | ------------------ | - | ----------- | ------ |  | - | ----------- | -
|                                                                           |  | Common Stock |   |  | Retained |           |   | TotalShareholders |  
|                                                                           |  | Shares       |   |  | Amount   |           |   | Earnings           |   |             | Equity | 
|Balance at December 31, 2006                                               |  | 6,179,011    |   |  | $        | 1,920,293 |   |                    | $ | 32,855,725  |        |  | $ | 34,776,018  |  
|                                                                           |  |              |   | 
|Effect of adoption of FIN 48 on January 1, 2007                            |  |             |   |  |          |          |   |                    |   | (90,000     | )      |  |   | (90,000     | )
|Stock options exercised and income tax benefit from stock option exercises |  | 22,000       |   |  |          | 88,710    |   |                    |   |            |        |  |   | 88,710      |  
|Redemption of common stock                                                 |  | (163,861     | ) |  |          | (36,684   | ) |                    |   | (826,931    | )      |  |   | (863,615    | )
|Net income                                                                 |  |             |   |  |          |          |   |                    |   | 4,781,764   |        |  |   | 4,781,764   |  
|                                                                           |  |              |   |  |          |           |   |                    |   |             |        |  |   |             |  
|Balance at December 31, 2007                                               |  | 6,037,150    |   |  |          | 1,972,319 |   |                    |   | 36,720,558  |        |  |   | 38,692,877  |  
|                                                                           |  |              |   | 
|Redemption of common stock                                                 |  | (108,865     | ) |  |          | (25,039   | ) |                    |   | (471,724    | )      |  |   | (496,763    | )
|Net loss                                                                   |  |             |   |  |          |          |   |                    |   | (17,093,900 | )      |  |   | (17,093,900 | )
|                                                                           |  |              |   |  |          |           |   |                    |   |             |        |  |   |             |  
|Balance at December 31, 2008                                               |  | 5,928,285    |   |  | $        | 1,947,280 |   |                    | $ | 19,154,934  |        |  | $ | 21,102,214  |  
|                                                                           |  |              |   |  |          |           |   |                    |   |             |        |  |   |             |  

See accompanying Notes to Consolidated Financial Statements.



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Paulson Capital Corp. and Subsidiaries

Consolidated Statements of Cash Flows



|                                                                                               |  |                                 |             |   |      |   |            |  
|---------------------------------------------------------------------------------------------- |  | ------------------------------- | ----------- | - | ---- | - | ---------- | -
|                                                                                               |  | For the Year Ended December 31, |            
|                                                                                               |  | 2008                            |             |   | 2007 |  
|Cash flows from operating activities:                                                          |  |                                 |             |   |      |   |            |  
|Net income (loss)                                                                              |  | $                               | (17,093,900 | ) |      | $ | 4,781,764  |  
|Adjustments to reconcile net income (loss) to net cash flows provided by operating activities: |  |                                 |             |   |      |   |            |  
|Receipt of underwriter warrants                                                                |  |                                 | (462,320    | ) |      |   | (4,185,731 | )
|Unrealized (appreciation) depreciation/expiration of underwriter warrants                      |  |                                 | 15,160,320  |   |      |   | (6,574,996 | )
|Unrealized depreciation of underwriter warrantsemployee and independent contractor            |  |                                 | (527,000    | ) |      |   |           |  
|Non-cash compensation associated with underwriter warrants                                     |  |                                 |            |   |      |   | 688,727    |  
|Depreciation and amortization                                                                  |  |                                 | 107,205     |   |      |   | 114,857    |  
|Deferred income taxes                                                                          |  |                                 | (3,230,000  | ) |      |   | 162,600    |  
|Deferred revenue                                                                               |  |                                 |            |   |      |   | (100,000   | )
|Bad debt expense                                                                               |  |                                 | 20,727      |   |      |   | 218,692    |  
|Change in assets and liabilities:                                                              |  |                                 |             |   |      |   |            |  
|Receivable from/payable to clearing organization                                               |  |                                 | 4,259,192   |   |      |   | (1,489,960 | )
|Notes and other receivables                                                                    |  |                                 | 907,776     |   |      |   | (131,220   | )
|Income tax receivable                                                                          |  |                                 | (6,480,699  | ) |      |   | 304,695    |  
|Trading and investment securities                                                              |  |                                 | 13,583,817  |   |      |   | 1,711,553  |  
|Prepaid and deferred expenses                                                                  |  |                                 | 54,235      |   |      |   | (227,544   | )
|Accounts payable, accrued liabilities and compensation payables                                |  |                                 | (4,133,567  | ) |      |   | 3,781,045  |  
|Securities sold, not yet purchased                                                             |  |                                 | (36,259     | ) |      |   | 19,015     |  
|Income taxes payablecurrent                                                                   |  |                                 | (1,369,710  | ) |      |   | 1,369,710  |  
|Income taxes payablelong term                                                                 |  |                                 | 18,000      |   |      |   | 207,000    |  
|                                                                                               |  |                                 |             |   |      |   |            |  
|Net cash provided by operating activities                                                      |  |                                 | 777,817     |   |      |   | 650,207    |  
|                                                                                               |  |                                
|Cash flows from investing activities:                                                          |  |                                 |             |   |      |   |            |  
|Additions to furniture and equipment                                                           |  |                                 | (5,863      | ) |      |   | (39,424    | )
|                                                                                               |  |                                 |             |   |      |   |            |  
|Net cash used in investing activities                                                          |  |                                 | (5,863      | ) |      |   | (39,424    | )
|                                                                                               |  |                                
|Cash flows from financing activities:                                                          |  |                                 |             |   |      |   |            |  
|Proceeds from stock option exercise                                                            |  |                                 |            |   |      |   | 77,110     |  
|Payments to retire common stock                                                                |  |                                 | (496,763    | ) |      |   | (863,615   | )
|                                                                                               |  |                                 |             |   |      |   |            |  
|Net cash used in financing activities                                                          |  |                                 | (496,763    | ) |      |   | (786,505   | )
|                                                                                               |  |                                 |             |   |      |   |            |  
|                                                                                               |  |                                
|Increase (decrease) in cash                                                                    |  |                                 | 275,191     |   |      |   | (175,722   | )
|                                                                                               |  |                                
|Cash:                                                                                          |  |                                 |             |   |      |   |            |  
|Beginning of year                                                                              |  |                                 | 43,619      |   |      |   | 219,341    |  
|                                                                                               |  |                                 |             |   |      |   |            |  
|                                                                                               |  |                                
|End of year                                                                                    |  | $                               | 318,810     |   |      | $ | 43,619     |  
|                                                                                               |  |                                 |             |   |      |   |            |  
|                                                                                               |  |                                
|Supplemental cash flow information:                                                            |  |                                 |             |   |      |   |            |  
|Cash paid during the period for income taxes                                                   |  | $                               | 2,260,953   |   |      | $ | 1,427,736  |  
|                                                                                               |  |                                
|Supplemental non-cash information:                                                             |  |                                 |             |   |      |   |            |  
|Deferred tax benefit from stock option exercise                                                |  | $                               |            |   |      | $ | 11,600     |  
|Effect of adoption of FIN 48                                                                   |  |                                 |            |   |      |   | 90,000     |  

See accompanying Notes to Consolidated Financial Statements.



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PAULSON CAPITAL CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE
1ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization

Paulson Capital Corp. is a holding company whose wholly-owned subsidiary, Paulson Investment Company, Inc., is a registered broker-dealer in securities under the Securities Exchange Act of 1934, as amended, and is a
member of the Financial Industry Regulatory Authority (FINRA). We provide broker-dealer services in securities on both an agency and a principal basis to our customers who are introduced to RBC Correspondent Services, a division of
RBC Capital Markets Corporation (RBC CS), our clearing organization, on a fully-disclosed basis. We also act as lead underwriter or participating selling group member for securities offerings. We conduct business throughout the
United States.

We operate under the provision of paragraph (k)(2)(ii) of rule 15c3-3 of the Securities and Exchange Act of 1934 and, accordingly, are
exempt from the remaining provisions of that rule. Essentially, the requirements of paragraph (k)(2)(ii) provide that we clear all transactions on behalf of our customers on a fully disclosed basis with a clearing broker-dealer and promptly transmit
all customer funds and securities to the clearing broker-dealer. The clearing broker-dealer carries all of the accounts of the customers and maintains and preserves all related books and records as are customarily kept by a clearing broker-dealer.

During 2008, Paulson Capital Corp. formed a new 100% owned subsidiary, Paulson Capital Properties, LLC, for the purpose of purchasing, improving and
remarketing undervalued real estate. Through December 31, 2008, we had not purchased any real estate.

Summary of Significant Accounting Policies

Principles of Consolidation

The
accompanying consolidated financial statements include the accounts of Paulson Capital Corp. and its wholly-owned subsidiaries, Paulson Investment Company, Inc. and Paulson Capital Properties, LLC. All significant intercompany balances and
transactions have been eliminated in consolidation.

Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities
and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Our estimates regarding the fair value of underwriter warrants, not
readily marketable securities and legal reserves are significant estimates and these estimates could change in the near term. Actual results could differ from those estimates.

Revenue Recognition

Securities transactions and related revenue are recorded on a trade date basis.
Managers fees, underwriters fees, and other underwriting revenues are recognized at the time the underwriting is completed. Tax deferred revenue is recognized at the time individual tax deferred units are sold. Revenue from the receipt
of underwriter warrants is recognized on the date the warrants are received based on the fair value of the securities received as estimated using the Black-Scholes option-pricing model taking into account the exercise price, remaining life of the
warrant, the current price of the underlying stock and its expected volatility, expected dividends on the stock and the risk-free interest rate for the remaining term of the warrant.



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Value of Underwriter Warrants

We are required to estimate the value of all derivative securities that we hold at the date of any financial statements and to include that value, and changes in such value, in those financial statements. Accordingly,
the aggregate fair value of our underwriter warrants is recorded as an asset on our balance sheet. When a new warrant is received, its fair value is included in corporate finance revenue on the date on which it is earned. Subsequently, any change in
fair value is recorded as investment income or loss. When a warrant is exercised, the book value is adjusted to reflect the value of the securities purchased, net of the exercise price, and the adjustment amount is recorded as income or loss for the
relevant period. If a warrant expires unexercised, the book value is adjusted to zero and the decrease is recorded as a loss in the relevant period. In addition, we have recorded a liability related to underwriter warrants that were previously held
by certain employees. We are obligated to pay a bonus to these employees equal to the gain recognized by us when the warrants are exercised and the related stock is sold. We estimate the value of our underwriter warrants using the Black-Scholes
Option Pricing Model. The Black-Scholes model requires us to use five inputs including: price, risk free rate, exercise price, time remaining on the warrant and price volatility. See also Notes 4 and 7 and Supplementary Schedule of Warrants Owned.

Fair Value of Marketable Securities

Marketable
securities and not readily marketable securities are valued at fair value. Changes in the value of these securities are reflected currently in our results of operations as a component of investment income. See also Note 4.

Cash

Cash includes cash on hand and cash on deposit with
banks.

Balances maintained within accounts on deposit with banks, at times, may exceed federally insured limits. We have not experienced any losses
in such accounts.

Fair Value of Financial Instruments

Substantially all of our financial instruments are carried at fair value or amounts that approximate fair value. The carrying amounts reflected in the financial statements for cash, receivables and payables approximate their respective fair
values due to the short-term nature of these items. The fair values of securities owned and securities sold, not yet purchased are equal to the carrying value. Changes in the fair value of these securities are reflected currently in our results of
operations. Other than those separately disclosed in the Notes to Consolidated Financial Statements, our remaining financial instruments are generally short-term in nature and their carrying values approximate fair value.

Furniture and Equipment

Depreciation of furniture and
equipment is generally computed using the straight-line method over their estimated useful lives (5 years). Leasehold improvements are amortized over the lesser of their estimated useful life or the remaining lives of their related leases.

Income Taxes

Income taxes are accounted for
under the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities
and their respective tax basis and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in results of operations in the period that includes the enactment date.



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We follow the guidance of Financial Accounting Standards Board (FASB) Interpretation No. 48 (FIN
48), Accounting for Uncertainty in Income Taxes, which defines the threshold for recognizing the benefits of tax return positions in the financial statements as more-likely-than-not to be sustained by the taxing
authority. FIN 48 applies to all tax positions accounted for under Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes. We adopted the provisions of FIN 48 on January 1, 2007. In
accordance with paragraph 19, we elected to treat interest and penalties accrued on unrecognized tax benefits as tax expense within our financial statements. Upon adoption, we adjusted our financial statements to reflect those tax positions that are
more-likely-than-not to be sustained as of the adoption date. The adjustment totaled $90,000 and was recorded directly as a reduction to our retained earnings balance on January 1, 2007.

Earnings Per Share

Basic earnings per share is computed based
on the weighted average number of common shares outstanding during the year. Diluted earnings per share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the year. Common equivalent
shares from stock options are excluded from the computation when their effect is antidilutive.

Advertising

Advertising costs are charged to expense when incurred. Advertising expense for the years ended December 31, 2008 and 2007 totaled $202,000 and $131,000,
respectively.

Stock-Based Compensation

We
account for stock-based compensation in accordance with SFAS No. 123R, Share-Based Payment, which establishes accounting for equity instruments exchanged for employee services. Under the provisions of SFAS No. 123R, stock-based
compensation cost for equity classified awards is measured at the grant date, based on the fair value of the award, and is recognized as an expense over the employees requisite service period (generally the vesting period of the equity award).
We utilize the Black-Scholes option pricing model for determining the fair value of awards.

Comprehensive Income

We had no comprehensive income items; accordingly, net income and comprehensive income are the same.

NOTE 2RECEIVABLE FROM AND PAYABLE TO CLEARING ORGANIZATION

We introduce all customer transactions in
securities traded on U.S. securities markets to RBC CS on a fully-disclosed basis. The agreement with our clearing broker provides that we are obligated to assume any exposure related to nonperformance by customers or counterparties. We monitor
clearance and settlement of all customer transactions on a daily basis. The exposure to credit risk associated with the nonperformance of customers and counterparties in fulfilling their contractual obligations pursuant to these securities
transactions can be directly impacted by volatile trading markets which may impair the customers or counterpartys ability to satisfy their obligations. In the event of nonperformance, we may be required to purchase or sell financial
instruments at unfavorable market prices resulting in a loss. We have not experienced in the past, and we do not anticipate experiencing in the future, significant nonperformance by our customers and counterparties.



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NOTE 3NOTES AND OTHER RECEIVABLES

Notes and other receivables consisted of the following (in thousands):



|                    |  |              |     |      |   |      
|------------------- |  | ------------ | --- | ---- | - | -----
|                    |  | December 31,
|                    |  | 2008         |     | 2007
|Officers            |  | $            | 68  |      | $ | 77   
|Employees           |  |              | 43  |      |   | 38   
|Independent brokers |  |              | 72  |      |   | 38   
|Other               |  |              | 452 |      |   | 1,411
|                    |  |              |     |      |   |      
|                    |  | $            | 635 |      | $ | 1,564
|                    |  |              |     |      |   |      

Employee and independent broker receivables relate principally to advances and expenses in excess of commission
earnings and inventory losses charged to our employees and registered representatives. Other receivables are primarily related to advances to underwriting clients, as well as to commissions receivable and amounts receivable from insurance companies
as reimbursement for insured losses. An allowance is recorded for specific amounts when they are determined by management to be uncollectible. For the years ended December 31, 2008 and 2007, receivables of $21,000 and $219,000,
respectively, were determined by management to be uncollectible and written off to bad debt expense.

NOTE 4FAIR VALUE MEASUREMENTS

Effective January 1, 2008, we adopted the provisions of SFAS No. 157, Fair Value Measurements, for our financial assets and
liabilities. The adoption of this portion of SFAS No. 157 did not have any effect on our financial position or results of operations and we do not expect the adoption of the provisions of SFAS No. 157 related to non-financial assets and
liabilities to have an effect on our financial position or results of operations.

Various inputs are used in determining the fair value of our financial
assets and liabilities and are summarized into three broad categories:



| |  |  | Level 1  quoted prices in active markets for identical securities;
| | - |  | -------------------------------------------------------------------



| |  |  | Level 2  other significant observable inputs, including quoted prices for similar securities, interest rates, prepayment speeds, credit risk, etc.; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Level 3  significant unobservable inputs, including our own assumptions in determining fair value.
| | - |  | ---------------------------------------------------------------------------------------------------

The inputs or methodology used for valuing securities are not necessarily an indication of the risk associated with investing in those securities.

Following are the disclosures related to our financial assets and (liabilities) pursuant to SFAS No. 157 (in thousands):



|                                                         |  |                   |       |   |             |        
|-------------------------------------------------------- |  | ----------------- | ----- | - | ----------- | -------
|                                                         |  | December 31, 2008
|                                                         |  | Fair Value        |       |   | Input Level
|Trading securities                                       |  | $                 | 4,028 |   |             | Level 1
|Investment securities, marketable                        |  |                   | 307   |   |             | Level 1
|Investment securities, not readily marketable            |  |                   | 2,276 |   |             | Level 3
|Underwriter warrants                                     |  |                   | 1,675 |   |             | Level 3
|Underwriter warrantsemployee and independent contractor |  |                   | (124  | ) |             | Level 3



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Following is a summary of activity related to our Level 3 financial assets and liabilities (in thousands):



|                                                                                             |  |                     |         |   |                                                        |   |      |                                           |  |   |      
|-------------------------------------------------------------------------------------------- |  | ------------------- | ------- | - | ------------------------------------------------------ | - | ---- | ----------------------------------------- |  | - | -----
|                                                                                             |  | UnderwriterWarrants |         |   | UnderwriterWarrants Employee andIndependentContractor |   |      | Not ReadilyMarketableInvestmentSecurities
|Balance, December 31, 2007                                                                   |  | $                   | 16,373  |   |                                                        | $ | (651 | )                                         |  | $ | 1,946
|Fair value of warrants received, included as a component of corporate finance revenue        |  |                     | 462     |   |                                                        |   |     |                                           |  |   |     
|Net unrealized gain (loss), included as a component of investment income (loss)              |  |                     | (14,100 | ) |                                                        |   | 483  |                                           |  |   | 330  
|Value of warrants exercised and expired, included as a component of investment income (loss) |  |                     | (1,060  | ) |                                                        |   | 44   |                                           |  |   |     
|                                                                                             |  |                     |         |   |                                                        |   |      |                                           |  |   |      
|Balance, December 31, 2008                                                                   |  | $                   | 1,675   |   |                                                        | $ | (124 | )                                         |  | $ | 2,276
|                                                                                             |  |                     |         |   |                                                        |   |      |                                           |  |   |      

Valuation of Trading Securities and Marketable Investment Securities

The fair value of our trading and our marketable investment securities is determined based on quoted market prices. Securities traded on a national exchange are stated at
the last reported sales price on the day of valuation; other securities traded in the over-the-counter market and listed securities for which no sale was reported on that date are stated at the last quoted bid price.

Valuation of Not Readily Marketable Investment Securities

Securities not readily marketable include investment securities (a) for which there is no market on a securities exchange or no independent publicly quoted market, (b) that cannot be publicly offered or sold unless registration
has been effected under the Securities Act of 1933, or (c) that cannot be offered or sold because of other arrangements, restrictions or conditions applicable to the securities or to us. The fair value of not readily marketable securities
is estimated by management using available information including the following: quoted market prices of similar securities (i.e., unrestricted shares of the same company); price of recent known trades of the same or similar securities; the cost of
the security, if recently purchased, adjusted for changes in the financial condition of the issuer; all other information available from review of available documents related to the issuer or discussions with management of the issuer.

Valuation of Underwriter Warrants

We estimate the value of
our underwriter warrants using the Black-Scholes Option Pricing Model. The Black-Scholes model requires us to use five inputs including: stock price, risk free rate, exercise price, time remaining on the warrant and price volatility. After stock
price, the most influential factor in this model is price volatility, which we calculate for each companys warrants based on each companys own historical closing stock prices as well as an index of historical prices for comparable
companies. When we initially receive a new underwriter warrant from an initial public offering, its calculated volatility factor is entirely based on the volatility of an index of comparable companies, since there is no price history for a new
publicly traded company. As each underwriter warrant approaches its expiration date, its volatility factor is derived primarily from the historical prices of its underlying common stock. We cannot assure you that we will ultimately be able to
exercise any of our warrants in a way that will realize the value that we attribute to them in our financial statements based on this model.



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NOTE 5TRADING SECURITIES AND SECURITIES SOLD, NOT YET PURCHASED

Trading securities and securities sold, not yet purchased, represent the fair value of securities held long and short by us. The categories of trading securities and
their related fair values were as follows (in thousands):



|                                |  |                   |       |                        |   |       |  |                        |        |  |   |   
|------------------------------- |  | ----------------- | ----- | ---------------------- | - | ----- |  | ---------------------- | ------ |  | - | --
|                                |  | December 31, 2008 |       | December 31, 2007     
|                                |  | Owned             |       | Sold, Not YetPurchased |   | Owned |  | Sold, Not YetPurchased
|Corporate equities              |  | $                 | 3,488 |                        | $ |      |  | $                      | 9,809  |  | $ | 36
|State and municipal obligations |  |                   |      |                        |   |      |  |                        | 83     |  |   |  
|Corporate options/warrants      |  |                   | 540   |                        |   |      |  |                        | 2,145  |  |   |  
|                                |  |                   |       |                        |   |       |  |                        |        |  |   |   
|                                |  | $                 | 4,028 |                        | $ |      |  | $                      | 12,037 |  | $ | 36
|                                |  |                   |       |                        |   |       |  |                        |        |  |   |   

As a securities broker-dealer, we are engaged in various securities trading and brokerage activities as
principal. In the normal course of business, we sometimes sell securities that we do not currently own and will therefore be obligated to purchase such securities at a future date. This obligation is recorded on our balance sheet at the
fair value of the related securities and will result in a trading loss on the securities if the fair value increases and a trading gain if the fair value decreases between the balance sheet date and the purchase date.

NOTE 6INVESTMENT SECURITIES

Investment securities which are
readily marketable are stated at fair value with unrealized gains and losses included currently in earnings as a component of investment income (loss) on our consolidated statements of operations.

Included in investment securities are also certain securities which are not readily marketable. Securities not readily marketable include investment securities
(a) for which there is no market on a securities exchange or no independent publicly quoted market, (b) that cannot be publicly offered or sold unless registration has been effected under the Securities Act of 1933, or (c) that cannot
be offered or sold because of other arrangements, restrictions or conditions applicable to the securities or to us. Securities that are not readily marketable are stated at fair value with unrealized gains and losses included currently in
earnings as a component of investment income (loss) on our consolidated statements of operations.

The cost basis related to our investment security
portfolio was $8.6 million and $17.2 million as of December 31, 2008 and 2007, respectively.

The fair value of our investment securities was as
follows (in thousands):



|                           |  |              |       |      |   |      
|-------------------------- |  | ------------ | ----- | ---- | - | -----
|                           |  | December 31,
|                           |  | 2008         |       | 2007
|Corporate equities         |  | $            | 2,505 |      | $ | 7,905
|Corporate options/warrants |  |              | 78    |      |   | 253  
|                           |  |              |       |      |   |      
|                           |  | $            | 2,583 |      | $ | 8,158
|                           |  |              |       |      |   |      

Realized gains (losses) related to our investment securities included in the determination of net earnings was
$(10.6) million and $0.5 million, respectively, in 2008 and 2007.



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NOTE 7UNDERWRITER WARRANTS

The fair value of underwriter warrants is determined by management using the Black-Scholes option-pricing model (see Notes 1 and 4). The warrants generally have a five-year expiration date and vest
immediately. The warrants are generally subject to a restriction period of six months to one-year in which we cannot exercise the warrants. Underwriter warrant activity was as follows (in thousands):



|                                                              |  |   |         |  
|------------------------------------------------------------- |  | - | ------- | -
|Fair value at December 31, 2006                               |  | $ | 5,650   |  
|Fair value of warrants received, net of employee compensation |  |   | 3,497   |  
|Employee and independent contractor warrant obligation        |  |   | 651     |  
|Net unrealized gain in value of warrants                      |  |   | 7,660   |  
|Value of warrants exercised                                   |  |   | (1,085  | )
|                                                              |  |   |         |  
|Fair value at December 31, 2007                               |  |   | 16,373  |  
|Fair value of warrants received                               |  |   | 462     |  
|Net unrealized loss in value of warrants                      |  |   | (14,100 | )
|Value of warrants exercised or expired                        |  |   | (1,060  | )
|                                                              |  |   |         |  
|Fair value at December 31, 2008                               |  | $ | 1,675   |  
|                                                              |  |   |         |  

The fair value of the underwriter warrants received is reflected currently in earnings as a component of corporate
finance income. The unrealized appreciation (depreciation) in the fair value of underwriter warrants is reflected currently in earnings as a component of investment income (loss). The gain recognized from the exercise of underwriter warrants and the
sale of the related stock is reflected currently in earnings as a component of investment income (loss).

As a result of a change in regulations regarding
deferred compensation under Section 409A of the Internal Revenue Code, underwriter warrants received after January 1, 2005 and held by employees and independent contractors are considered non-qualified deferred compensation. On
October 17, 2007, in order to avoid adverse tax consequences, all affected employees and independent contractors waived their rights to their underwriter warrants in return for payment of their pro rata share of the gain when we exercise the
warrants and sell the corresponding stock. The fair value of such underwriter warrants was $0.1 million and $0.7 million, respectively, at December 31, 2008 and 2007 and was included as a liability on our consolidated balance sheet. Previously,
the fair value of underwriter warrants given to employees and independent contractors was recognized currently as a component of compensation expense. With respect to future underwriter warrants, we have no obligation to share any portion of the
proceeds with any employee or independent contractor.

NOTE 8FURNITURE AND EQUIPMENT, NET

Furniture and equipment are stated at cost and consisted of the following (in thousands):



|                              |  |              |      |   |      |   |       |  
|----------------------------- |  | ------------ | ---- | - | ---- | - | ----- | -
|                              |  | December 31, |     
|                              |  | 2008         |      |   | 2007 |  
|Office equipment              |  | $            | 846  |   |      | $ | 930   |  
|Leasehold improvements        |  |              | 131  |   |      |   | 129   |  
|                              |  |              |      |   |      |   |       |  
|                              |  |              | 977  |   |      |   | 1,059 |  
|Less accumulated depreciation |  |              | (882 | ) |      |   | (863  | )
|                              |  |              |      |   |      |   |       |  
|                              |  | $            | 95   |   |      | $ | 196   |  
|                              |  |              |      |   |      |   |       |  

NOTE 9INCOME TAXES

Income tax expense (benefit) consisted of the following (in thousands):



|                                |  |                         |        |   |      |   |      
|------------------------------- |  | ----------------------- | ------ | - | ---- | - | -----
|                                |  | Year Ended December 31,
|                                |  | 2008                    |        |   | 2007
|Current tax expense (benefit):  |  |                         |        |   |      |   |      
|Federal                         |  | $                       | (5,536 | ) |      | $ | 2,480
|State and local                 |  |                         | (160   | ) |      |   | 293  
|                                |  |                         |        |   |      |   |      
|                                |  |                         | (5,696 | ) |      |   | 2,773
|Deferred tax expense (benefit): |  |                         |        |   |      |   |      
|Federal                         |  |                         | (2,938 | ) |      |   | 134  
|State and local                 |  |                         | (292   | ) |      |   | 17   
|                                |  |                         |        |   |      |   |      
|                                |  |                         | (3,230 | ) |      |   | 151  
|                                |  |                         |        |   |      |   |      
|                                |  | $                       | (8,926 | ) |      | $ | 2,924
|                                |  |                         |        |   |      |   |      



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##### Table of Contents

Income tax expense (benefit) for each year varies from the amount computed by applying the statutory federal income tax
rate to earnings before income taxes as follows (in thousands):



|                                                        |  |                         |        |   |      |   |       |  
|------------------------------------------------------- |  | ----------------------- | ------ | - | ---- | - | ----- | -
|                                                        |  | Year Ended December 31, |       
|                                                        |  | 2008                    |        |   | 2007 |  
|Income tax (benefit) at statutory federal tax rate      |  | $                       | (8,847 | ) |      | $ | 2,620 |  
|State and local taxes, net of federal benefit           |  |                         | (867   | ) |      |   | 353   |  
|Change in valuation allowance on net deferred tax asset |  |                         | 709    |   |      |   | (1    | )
|Other, net                                              |  |                         | 79     |   |      |   | (48   | )
|                                                        |  |                         |        |   |      |   |       |  
|                                                        |  | $                       | (8,926 | ) |      | $ | 2,924 |  
|                                                        |  |                         |        |   |      |   |       |  

The deferred income tax asset (liability) consisted of the following (in thousands):



|                                                   |  |              |       |   |      |   |        |  
|-------------------------------------------------- |  | ------------ | ----- | - | ---- | - | ------ | -
|                                                   |  | December 31, |      
|                                                   |  | 2008         |       |   | 2007 |  
|Accrued expenses                                   |  | $            | 20    |   |      | $ | 139    |  
|Fixed asset depreciation                           |  |              | 46    |   |      |   | 24     |  
|Deferred revenue                                   |  |              | 140   |   |      |   | 144    |  
|Unrealized depreciation on securities              |  |              | 1,667 |   |      |   |       |  
|State net operating loss carryforwards and credits |  |              | 226   |   |      |   | 60     |  
|State net capital loss carryforwards               |  |              | 212   |   |      |   |       |  
|Charitable contribution carryforwards and other    |  |              | 20    |   |      |   |       |  
|                                                   |  |              |       |   |      |   |        |  
|                                                   |  |              | 2,331 |   |      |   | 367    |  
|Valuation allowance                                |  |              | (769  | ) |      |   | (60    | )
|                                                   |  |              |       |   |      |   |        |  
|                                                   |  |              | 1,562 |   |      |   | 307    |  
|                                                   |  |             
|Unrealized appreciation on securities              |  |              |      |   |      |   | (1,974 | )
|Prepaid expense                                    |  |              | (153  | ) |      |   | (154   | )
|                                                   |  |              |       |   |      |   |        |  
|                                                   |  |              | (153  | ) |      |   | (2,128 | )
|                                                   |  |              |       |   |      |   |        |  
|                                                   |  | $            | 1,409 |   |      | $ | (1,821 | )
|                                                   |  |              |       |   |      |   |        |  

We recorded an increase (decrease) to our valuation allowance for 2008 and 2007 in the amount of $709,000 and
$(1,000), respectively, based upon managements assessment that it is more likely than not that a portion of the net deferred tax asset related to certain state net operating loss carryforwards will not be fully realized. Management will
continue to review the net deferred tax asset and may adjust the valuation allowance in future periods based upon its assessment.

State net operating loss
carryforwards of approximately $5.3 million at December 31, 2008 expire from 2009 through 2028. State net capital loss carryforwards of approximately $4.3 million at December 31, 2008 expire if not utilized by December 31, 2013.

Following is a roll-forward of our unrecognized tax benefits (in thousands):



|                                                      |  |   |    
|----------------------------------------------------- |  | - | ---
|Balance at January 1, 2007                            |  | $ | 174
|Additions for tax positions taken in prior years      |  |   | 18 
|Additions for tax positions taken in the current year |  |   | 80 
|                                                      |  |   |    
|Balance at December 31, 2007                          |  |   | 272
|Additions for tax positions taken in prior years      |  |   |   
|Additions for tax positions taken in the current year |  |   |   
|                                                      |  |   |    
|Balance at December 31, 2008                          |  | $ | 272
|                                                      |  |   |    

All of our unrecognized tax benefits would have an impact on the effective tax rate if recognized. Interest and
penalties accrued on unrecognized tax benefits were $43,000 and $25,000 at December 31, 2008 and 2007, respectively. We do not believe it is reasonably possible that the total amount of unrecognized tax benefits will significantly increase or
decrease within the next 12 months.

The tax years which remain open to examination in the U.S., our only major taxing jurisdiction, were 2005 through
2008. An IRS examination for the 2004 and 2005 tax years was completed during the second quarter of 2007 resulting in a benefit, including interest, of $154,000 that was received in July 2007.



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NOTE 10STOCK-BASED COMPENSATION PLANS

1999 Stock Option Plan

Our 1999 Stock Option Plan (the Plan) reserves 1.0 million shares of
our common stock for issuance upon exercise of options granted under the Plan. At December 31, 2008, 532,000 options were available for grant and reserved for issuance related to the Plan. The Plan provides for the grant of incentive
stock options and nonqualified stock options. Activity under the Plan in 2008 was as follows:



|                                 |  |                    |   |  |                               |     
|-------------------------------- |  | ------------------ | - |  | ----------------------------- | ----
|                                 |  | OptionsOutstanding |   |  | WeightedAverageExercise Price
|Outstanding at December 31, 2007 |  | 95,000             |   |  | $                             | 4.20
|Granted                          |  |                   |   |  |                               |    
|Exercised                        |  |                   |   |  |                               |    
|Expired                          |  | (95,000            | ) |  |                               | 4.20
|                                 |  |                    |   |  |                               |     
|Outstanding at December 31, 2008 |  |                   |   |  |                               |    
|                                 |  |                    |   |  |                               |     

As of December 31, 2008, there was no unrecognized stock-based compensation.

Stock-Based Compensation

We estimate the fair value of stock
options using the Black-Scholes option pricing model. This valuation model takes into account the exercise price of the award, as well as a variety of significant assumptions. We believe that the valuation technique and the approach utilized to
develop the underlying assumptions are appropriate in calculating the fair values of our stock options. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by persons who receive equity awards.

Our options are fully vested upon the date of grant. Accordingly, we recognize the related stock-based compensation expense at that time. There were no
stock options granted during 2008 or 2007. Therefore, we did not have any stock-based compensation expense in either year. Shares to be issued upon the exercise of stock options will come from newly issued shares.

Certain information regarding our stock-based compensation plan was as follows (in thousands):



|                                                          |  |                         |   |      |   |   
|--------------------------------------------------------- |  | ----------------------- | - | ---- | - | --
|                                                          |  | Year Ended December 31,
|                                                          |  | 2008                    |   | 2007
|Total intrinsic value of share options exercised          |  | $                       |  |      | $ | 30
|Cash received from options exercised                      |  |                         |  |      |   | 77
|Tax deduction realized related to stock options exercised |  |                         |  |      |   | 30

NOTE 11EARNINGS PER SHARE

Following is a reconciliation of our shares used for our basic net income (loss) per share and our diluted net income (loss) per share:



|                                                                                                                    |  |                         |  |          
|------------------------------------------------------------------------------------------------------------------- |  | ----------------------- |  | ---------
|                                                                                                                    |  | Year Ended December 31,
|                                                                                                                    |  | 2008                    |  | 2007     
|Shares used for basic net income (loss) per share                                                                   |  | 5,966,676               |  | 6,114,636
|Effect of dilutive stock options                                                                                    |  |                        |  | 9,854    
|                                                                                                                    |  |                         |  |          
|Shares used for diluted net income (loss) per share                                                                 |  | 5,966,676               |  | 6,124,490
|                                                                                                                    |  |                         |  |          
|                                                                                                                    |  |                        
|Stock options not included in diluted net income (loss) per share because their effect would have been antidilutive |  |                        |  |         
|                                                                                                                    |  |                         |  |          



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##### Table of Contents

NOTE 12COMMITMENTS AND CONTINGENCIES

Leases

We lease office space under the terms of various non-cancellable operating leases. The future
minimum payments for each of the next five years and thereafter required for leases were as follows at December 31, 2008 (in thousands):



|                         |  |   |      
|------------------------ |  | - | -----
|Year Ending December 31, |  |  
|2009                     |  | $ | 582  
|2010                     |  |   | 556  
|2011                     |  |   | 88   
|2012                     |  |   |     
|2013                     |  |   |     
|Thereafter               |  |   |     
|                         |  |   |      
|                         |  | $ | 1,226
|                         |  |   |      

The leases are accounted for on a straight-line basis and provide for payment of taxes and other expenses by
us. Rent expense for the years ended December 31, 2008 and 2007 was approximately $544,000 and $553,000, respectively.

Legal

We are named in and subject to various proceedings and claims arising primarily from our securities business activities, including lawsuits,
arbitration claims, class actions and regulatory matters. Some of these claims seek substantial compensatory, punitive or indeterminate damages. We are also involved in other reviews, investigations and proceedings by governmental and
self-regulatory agencies regarding our business, certain of which may result in adverse judgments, settlements, fines, penalties, injunctions or other relief. Because litigation is inherently unpredictable, particularly in cases where claimants seek
substantial or indeterminate damages or when investigations and proceedings are in the early stages, we cannot predict with certainty the losses or range of losses related to such matters, how such matters will be resolved, when they will ultimately
be resolved, or what the eventual settlement, fine, penalty or other relief might be. Consequently, we cannot estimate losses or ranges of losses for matters where there is only a reasonable possibility that a loss may have been incurred. Although
the ultimate outcome of these matters cannot be ascertained at this time, it is the opinion of management, after consultation with counsel, that the resolution of the foregoing matters will not have a material adverse effect on our Consolidated
Financial Statements, taken as a whole; such resolution may, however, have a material effect on the operating results in any future period, and, depending on the outcome and timing of any particular matter, may be material to the operating results
for any period depending on the operating results for that period. We have provided loss allowances for such matters in accordance with SFAS No. 5, Accounting for Contingencies. The ultimate resolution may differ materially from the
amounts provided. For the years ended December 31, 2008 and 2007, the recording of legal losses did not have a material impact on our results of operations.

Underwriter Commitments

In the normal course of business, we enter into underwriting commitments. Settlement of the transactions
relating to such underwriting commitments, which were open at December 31, 2008, had no material effect on our consolidated financial statements.

NOTE 13EMPLOYEE BENEFIT PLANS

Retirement benefits for our employees who have completed certain service requirements are provided by a
defined contribution profit-sharing plan. Plan contributions are determined by the Board of Directors. Contributions to the plan for the years ended December 31, 2008 and 2007 were approximately $66,000 and $198,000, respectively.



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##### Table of Contents

NOTE 14NET CAPITAL REQUIREMENT

We are subject to the Securities and Exchange Commission Uniform Net Capital rule (Rule 15c3-1), which requires the maintenance of minimum net capital and requires that the ratio of aggregate indebtedness to net
capital, both as defined, shall not exceed 15 to 1. The rule also provides that equity capital may not be withdrawn or cash dividends paid if the resulting net capital ratio would exceed 10 to 1. At December 31, 2008, we had net capital of $5.1
million, which was $5.0 million in excess of our required net capital of $0.1 million. Our net capital ratio was 0.33 to 1 at December 31, 2008. The minimum requirements may effectively restrict the payment of cash dividends.

NOTE 15SHARE REPURCHASE PLAN

In September 2001, our Board of
Directors approved a stock repurchase program pursuant to which we are authorized to repurchase up to 600,000 shares of our common stock. In addition, in June 2008, our Board of Directors approved the repurchase of up to a total of an additional
200,000 shares of our common stock. During 2008, we repurchased a total of 108,865 shares for $497,000 and, at December 31, 2008, 243,011 shares remained available for repurchase. These repurchase programs do not have an expiration date.

NOTE 16CONCENTRATION OF RISK AND GEOGRAPHIC INFORMATION

Our trading and investment securities include investments in the common stock of the following companies, which represent more than 10% of trading and investment securities at December 31, 2008 and 2007 (dollars in thousands):



|                                 |  |                         |       |                    |      |  
|-------------------------------- |  | ----------------------- | ----- | ------------------ | ---- | -
|As of December 31, 2008: Company |  | Investment atFair Value |       | Percentage ofTotal |     
|Ascent Solar Technologies, Inc.  |  | $                       | 1,766 |                    | 26.7 | %
|Shiftwise                        |  |                         | 1,300 |                    | 19.7 | %
|The Quantum Group, Inc.          |  |                         | 761   |                    | 11.5 | %
|                                 |  |                         |       |                    |      |  
|                                 |  | $                       | 3,827 |                    | 57.9 | %
|                                 |  |                         |       |                    |      |  



|                                 |  |                         |        |                    |      |  
|-------------------------------- |  | ----------------------- | ------ | ------------------ | ---- | -
|As of December 31, 2007: Company |  | Investment atFair Value |        | Percentage ofTotal |     
|The Quantum Group, Inc.          |  | $                       | 3,330  |                    | 16.5 | %
|Converted Organics, Inc.         |  |                         | 3,133  |                    | 15.5 | %
|Ascent Solar Technologies, Inc.  |  |                         | 2,610  |                    | 12.9 | %
|Charles & Colvard, Ltd.          |  |                         | 2,189  |                    | 10.8 | %
|                                 |  |                         |        |                    |      |  
|                                 |  | $                       | 11,262 |                    | 55.7 | %
|                                 |  |                         |        |                    |      |  

In 2008 and 2007, none of our revenue was from foreign sources and no customer represented 10% or more of our
total revenue. In addition, all of our long-lived assets were located within the United States.

NOTE 17RELATED PARTY TRANSACTIONS

During the years ended December 31, 2008 and 2007, we paid approximately $90,000 and $100,000, respectively, of legal costs on behalf of our officers and
employees.

NOTE 18OTHER INCOME

Other income in
2008 included $100,000 in amortization of deferred revenue related to our clearing firm agreement.

Other income in 2007 included $120,000 in insurance
recovery related to legal and settlement expense in prior years and $100,000 in amortization of deferred revenue related to our clearing firm agreement.



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##### Table of Contents

NOTE 19NEW ACCOUNTING PRONOUNCEMENTS

SFAS No. 162

In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles, which identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with
generally accepted accounting principles in the United States. SFAS No. 162 is effective 60 days following the Securities and Exchange Commissions approval of the Public Company Accounting Oversight Board amendments to AU
Section 4311, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles. We believe that our accounting principles and practices are consistent with the guidance in SFAS No. 162, and,
accordingly, we do not expect the adoption of SFAS No. 162 to have a material effect on our financial position or results of operations.

SFAS
No. 161

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, which
requires certain disclosures related to derivative instruments. SFAS No. 161 is effective prospectively for interim periods and fiscal years beginning after November 15, 2008. We do not have any derivative instruments that fall under the
guidance of SFAS No. 161 and, accordingly, the adoption of SFAS No. 161 will not have any effect on our financial position or results of operations.

SFAS No. 159

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities, which permits entities to choose to measure many financial instruments and certain other items at fair value. The adoption of the provisions of SFAS No. 159 effective January 1, 2008 did not have any effect on
our financial position or results of operations.

NOTE 20SUBSEQUENT EVENT

Conversion of Note Receivable to Equity

In February 2009, our $0.4 million note receivable from Shiftwise was
converted to 966,598 shares of Series A2 Preferred Stock of Shiftwise, which, when added to our previously existing shares, resulted in a total of 3,456,598 shares.



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##### Table of Contents

Paulson Capital Corp. and Subsidiaries

SUPPLEMENTARY SCHEDULE OF WARRANTS OWNED

As of December 31, 2008



|                                               |  |                   |  |                                               |  |                 |  |                          |       |                |         
|---------------------------------------------- |  | ----------------- |  | --------------------------------------------- |  | --------------- |  | ------------------------ | ----- | -------------- | --------
|Description                                    |  | Number ofWarrants |  | WarrantsObligated toEmployeesIncludedin Total |  | DateExercisable |  | ExercisePrice perWarrant |       | ExpirationDate
|American Mold Guard (units)                    |  | 111,000           |  | 24,976                                        |  | 04/26/07        |  | $                        | 15.60 |                | 04/26/11
|Ascent Solar Technologies (units)              |  | 112,500           |  |                                              |  | 07/10/07        |  |                          | 6.60  |                | 07/10/11
|Converted Organics, Inc. (units)               |  | 131,219           |  | 18,224                                        |  | 02/13/08        |  |                          | 6.60  |                | 02/13/12
|Healthy Fast Foods (units)                     |  | 100,000           |  |                                              |  | 03/19/09        |  |                          | 6.12  |                | 03/19/13
|ICOP Digital (units)                           |  | 99,150            |  | 23,400                                        |  | 01/04/06        |  |                          | 9.90  |                | 07/08/10
|ICOP Digital (common and warrant)              |  | 65,000            |  | 47,125                                        |  | 01/08/06        |  |                          | 5.92  |                | 07/08/10
|INX (formerly known as I-Sector Corp.) (units) |  | 29,653            |  |                                              |  | 05/07/05        |  |                          | 19.92 |                | 05/07/09
|GigOptix, Inc. (formerly Lumera Corporation)   |  | 43,260            |  |                                              |  | 07/23/05        |  |                          | 66.72 |                | 07/22/09
|Milestone Scientific (units)                   |  | 99,857            |  |                                              |  | 02/17/05        |  |                          | 7.82  |                | 02/16/09
|Nuvim (units)                                  |  | 243,000           |  | 58,050                                        |  | 12/18/05        |  |                          | 1.20  |                | 06/20/10
|The Quantum Group (units)                      |  | 84,000            |  |                                              |  | 12/12/08        |  |                          | 13.20 |                | 12/12/12
|Universal Guardian (units)                     |  | 261,668           |  | 165,868                                       |  | 06/20/06        |  |                          | 1.50  |                | 06/19/11
|Vaughan Foods (units)                          |  | 191,275           |  | 43,038                                        |  | 06/27/08        |  |                          | 7.80  |                | 06/27/12
|XELR8 Holdings, Inc.                           |  | 5,500             |  | 2,750                                         |  | 03/27/08        |  |                          | 1.50  |                | 03/27/12



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##### Table of Contents

SCHEDULE II

Paulson Capital Corp. and Subsidiaries

Valuation and Qualifying Accounts

For the Two Years in the Period Ended December 31, 2008



|                                     |  |                              |   |                             |   |                                    |  |                          |          |  |                        |          |   |  |   |  
|------------------------------------ |  | ---------------------------- | - | --------------------------- | - | ---------------------------------- |  | ------------------------ | -------- |  | ---------------------- | -------- | - |  | - | -
|Column A                             |  | Column B                     |   | Column C                    |   | Column D                           |  |                          | Column E
|Description                          |  | Balanceat Beginningof Period |   | Chargedto Costs andExpenses |   | Charged toOther Accounts -Describe |  | Deductions -Describe (a) |          |  | Balanceat Endof Period
|Year Ended December 31, 2007:        |  |                              |   |                             |   |                                    |  |                          |          |  |                        |          |   |  |   |  
|                                     |  |                              |   |                             |  
|Allowance for uncollectible accounts |  | $                            |  |                             | $ | 218,692                            |  | $                        |         |  | $                      | (218,692 | ) |  | $ | 
|                                     |  |                              |   |                             |  
|Year Ended December 31, 2008:        |  |                              |   |                             |   |                                    |  |                          |          |  |                        |          |   |  |   |  
|                                     |  |                              |   |                             |  
|Allowance for uncollectible accounts |  | $                            |  |                             | $ | 20,727                             |  | $                        |         |  | $                      | (20,727  | ) |  | $ | 



|(a) | Charges to the account included in this column are for the purpose for which the reserve was created.
|--- | -----------------------------------------------------------------------------------------------------



F-19