SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549

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Annual Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934

For the fiscal year endedDecember 31, 1999

Commission file number:0-18188


FORM 10-KSB/A(Amendment No. 3)

PAULSON CAPITAL CORP.(Name of small business issuer as specified in its charter)

|Oregon                                                                                 |  | 93-0589534                          
|-------------------------------------------------------------------------------------- |  | ------------------------------------
|(State or other jurisdiction of
incorporation or organization)                         |  | (I.R.S. Employer
Identification No.)
|811 S.W. Naito Parkway, Suite 200
Portland, OR(Address of principal
executive offices) |  | 97204(Zip Code)                     

Issuer's telephone number, including area code: (503) 243-6000

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

None

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

Common Stock, no par value(Title of class)

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Check
whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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 / /

Check
if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will be contained,
to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part II of this Form 10-KSB or any amendment to this
Form 10-KSB.

State
issuer's revenues for its most recent fiscal year:

$34,654,000

As
of March 17, 2000, 3,549,535 shares of the registrant's common stock, no par value, were outstanding and the aggregate market value of the shares of common stock of the
Registrant held by non-affiliates (based upon the average of the closing bid and asked prices of Registrant's shares in the over-the-counter market as of such date)
was $15,162,624.

DOCUMENTS
INCORPORATED BY REFERENCE

Portions
of the Registrant's definitive proxy statement for the 2000 annual meeting of shareholders to be filed with the Securities and Exchange Commission are incorporated by
reference into Part III.

Transitional
Small Business Disclosure Format: Yes /x/  No / /

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PART I

ITEM 1. DESCRIPTION OF BUSINESS



Paulson Capital Corp. ("Paulson Capital" or the "Company"), established in 1970, is a holding company whose only operating subsidiary is Paulson Investment
Company, Inc. ("PIC"), a full service brokerage firm engaged in the purchase and sale of securities from and to the public and for its own account and in investment banking activities. The
Company operates in one industry segment, the financial services industry. At December 31, 1999 PIC employed 19 brokers and had independent contractor arrangements with 86 brokers registered
with the National Association of Securities Dealers, Inc. ("NASD"). PIC also employed a support staff of 47 persons in its headquarters in Portland, Oregon and in certain of its branch offices.
At December 31, 1999 PIC had 39 branch offices throughout the United States.

The
Company's headquarters are located at 811 S.W. Naito Parkway, Suite 200, Portland, Oregon 97204. Its telephone number is (503) 243-6000.



Virtually all of Paulson Capital's business is carried on through PIC. PIC is involved in the purchase and sale of most investment securities but is not
involved in commodities or futures. Three broad categories of securities activities contribute to revenues of PIC: general securities (or retail), trading and market making (or wholesale) and
corporate finance/investment banking. PIC also receives revenues from gains and losses in investment accounts, from the exercise of underwriter warrants received in connection with its corporate
finance activities, and from other sources.

The
following table indicates the approximate percentage of revenues that were accounted for by each of these categories and from investment income (including underwriter warrants) in
the last three fiscal years:

1999

1998

1997General Securities

43
%
124
%
42
%Trading

1

6

4Corporate Finance

15

54

32Investment Income

40

(85
)
21Other

1

1

1


In
this table, "Trading" includes only the net profit or loss from PIC's trading activities. See "Trading and Market Making."



As a securities broker, PIC acts as agent for its customers in the purchase and sale of common and preferred stocks, options and debt securities traded on
securities exchanges or in the over-the-counter ("OTC") market. A major portion of its revenues is derived from commissions from customers on these transactions. In the OTC
market, transactions with customers in securities not listed on an exchange may be effected as principal, rather than agent, primarily where PIC is a market maker in that security. Customer
transactions in securities are effected either on a cash or margin basis.

PIC
enters 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 dealers discounts, which range from approximately 1 percent to 8.5 percent of the purchase

2

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price of the securities, depending on the terms of the dealer agreement and the amount of the purchase. PIC does not generally sell interests in limited partnerships which are not publicly registered.

Pursuant
to an agreement between PIC and Correspondent Services Corporation ("CSC"), a subsidiary of PaineWebber Group, Inc., CSC carries all of PIC's customer securities
accounts and performs the following services: (1) preparation and mailing of monthly statements to PIC customers; (2) settlement of contracts and transactions in securities between PIC
and other broker-dealers and between PIC and its 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. PIC determines the amount of commission to be charged to its customers on agency transactions and
the price of securities purchased or sold in principal transactions. CSC receives compensation based on the size of the transaction, subject to certain minimum and maximum amounts. The agreement
between PIC and CSC may be canceled by either party upon 60 days written notice, which period may be reduced in certain events. In the event of a liability arising from a bad debt from a
customer, PIC is required to indemnify CSC against any loss. This potential liability is uninsured.

In
addition to providing clearing services for PIC, CSC loans money to PIC in the ordinary course of PIC's business, pursuant to an arrangement under which CSC agrees to finance PIC's
trading accounts. At December 31, 1999, no net loans were outstanding pursuant to this arrangement. See "Item 6Management's Discussion and Analysis or Plan of Operation."



In addition to executing trades as an agent, PIC regularly acts as a principal in executing trades in equity securities, corporate debt securities and
municipal bonds. The amount of trading by PIC in the high yield bond market has not been material. At December 31, 1999, PIC made a market in approximately 34 securities of 25 issuers. Of
these, 18 were corporations for which PIC has acted as managing or co-managing underwriter of public financings. In addition, at December 31, 1999, PIC held securities of 38
companies in its investment account. In 1999, the value of securities held in the trading accounts and investment account ranged between $7,870,602 and $16,439,565. The level of positions carried in
PIC's trading and investment accounts fluctuates significantly. The size of the securities positions at any date may not be representative of PIC's 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 PIC may carry is limited by certain requirements under the SEC's net capital rules. See "Net Capital Requirements."

PIC's
market making activities are conducted both with other dealers in the "wholesale market" and with PIC's 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. Securities are purchased primarily to provide an inventory for customers who wish to
buy, and short sales are likewise made primarily to serve customers. PIC's transactions as principal expose PIC to risk because securities positions are subject to fluctuations in market value and
liquidity. Profits or losses on trading and investment positions depend upon the skills of the employees in PIC's trading department and employees responsible for taking investment positions. The
trading department is headquartered in PIC's Portland, Oregon office.



PIC raises capital through public offerings of securities for corporations that are engaged in a variety of businesses. PIC participates in underwritings of
corporate securities as managing underwriter and as a syndicate member. Management of an underwriting account is generally more profitable than

3

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participation as a member of an underwriting syndicate. Revenues generated by syndicate participations have not been material.

PIC
generally underwrites public offerings of securities in the range of $5 million to $20 million on a "firm commitment" basis, which means that it agrees to purchase a
specific amount of securities from the issuer at a discount after the registration statement for the offering is declared effective by the Securities and Exchange Commission (the "SEC") and resells
the securities to the public at a specified price. The underwriting involves risk of loss if PIC is unable to resell at a profit the securities it is committed to purchase. This risk is usually
reduced by accepting other stock brokerage firms as a part of an underwriting syndicate in which each member commits to purchase a specified amount of the offering. PIC and other underwriters may also
sell a portion of their commitment 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, PIC is also subject to potential liability under federal and state securities laws and other laws if the registration statement or prospectus contains a material misstatement or omission.
PIC's potential liability as an underwriter is uninsured.

The
commitment of capital by PIC between the time a firm commitment underwriting agreement becomes effective and the time PIC resells the securities constitutes a charge against its
net capital.
Accordingly, PIC's participation in or initiation of underwritings may be limited by the financial requirements of the SEC and NASD. See "Net Capital Requirements."

Between
June 1, 1978 and December 31, 1999 PIC acted as the managing underwriter or co-managing underwriter for 135 securities offerings, raising
approximately $807 million for corporate finance clients. Of these, 84 were initial public offerings. PIC typically receives 2 to 3 percent of the aggregate amount of money raised in an
offering to cover nonaccountable expenses and between 7 and 9 percent as compensation to underwriters, selling group members and registered representatives, although these percentages may be
lower for larger transactions. PIC also typically receives warrants to purchase securities, equal to 10 percent of the securities sold in the offering, for a period of five years at a price
equal to 120 percent of the public offering price, although a portion of these warrants are typically transferred as compensation to persons associated with PIC and, in certain cases, to other
major underwriters in the public offering. See "Item 6Management's Discussion and Analysis or Plan of OperationLiquidity and Capital Resources."



PIC branch offices are generally run by independent contractors that assume liability for all the operating expenses of the branch. PIC typically receives
between 15 and 20 percent 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 PIC,
and PIC assumes the same compliance and regulatory obligations as would be the case if PIC were fully responsible for the branch's expenses. As of December 31, 1999, PIC had 39 branch offices
in California, Connecticut, District of Columbia, Georgia, Hawaii, Idaho, Nevada, New Jersey, New York, Oregon, Utah and Washington. All of these branches except one in Salem, Oregon are operating as
independent contractor offices. PIC continues to be responsible for all expenses of the Salem office.



PIC employs three persons that devote a majority of their time to gathering and analyzing information which is intended to provide PIC with an adequate basis
for performing its investment banking activities and to provide customers with a regular flow of information on the companies for which PIC has in the past provided investment banking services.

4

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PIC is registered with the SEC as a broker-dealer under the Securities Exchange Act of 1934. It is also registered as a broker-dealer under the laws of 45
states and Washington, D.C. PIC is a member of the NASD.

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 NASD. These self-regulatory organizations adopt rules
(subject to approval by the SEC) which 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 affect directly the method of operation and profitability of broker-dealers. The SEC, NASD and state regulatory
authorities may conduct administrative proceedings which can result in censure, fine, suspension or expulsion of a broker-dealer, its officers or employees.



PIC is required to maintain minimum "net capital" under the SEC's net capital rule of not less than 6.67 percent of its aggregate indebtedness. As of
December 31, 1999, PIC had net capital of $17,506,585, which exceeded its minimum requirement of $273,057 by $17,233,528. The ratio of aggregate indebtedness of $4,095,864 to net capital of
$17,506,585 on December 31, 1999 was approximately 0.23 to 1. In a public offering in which PIC acts as an underwriter, PIC must have sufficient net capital to cover the amount of securities
underwritten, applying applicable formulae mandated by the SEC, during the period between effectiveness and the closing of the transaction (usually about one week). This results in a significant
temporary increase in PIC's required net capital. In many cases, the amount of securities underwritten by PIC has been limited by its net capital. Any significant reduction in PIC's net capital, even
if PIC were still in compliance with the SEC's net capital rule for its retail and trading activities, could have a material adverse impact on PIC's ability to continue its investment banking
activities.



All aspects of PIC's business are highly competitive. In its general brokerage activities, PIC competes directly with numerous other broker-dealers, many of
which are large well known firms with substantially greater financial and personnel resources than PIC. Many of PIC's 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. PIC also competes with a number of smaller regional brokerage firms.

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.

5

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The securities industry has become considerably more concentrated and more competitive since the Company was founded, as numerous securities firms have either ceased operations or
have been acquired by or merged into other firms. This trend has been particularly pronounced among firms similar in size and business mix to PIC. In addition, companies not engaged primarily in the
securities business, but with substantial financial resources, have acquired leading securities firms. These developments have increased competition from firms with greater capital resources than
those of the Company. Various legislative and regulatory developments have tended to increase competition within the industry or reduced profits for the industry. In particular, various recent
developments have tended to increase competition from commercial banks.

The
securities industry has experienced substantial commission discounting by broker-dealers competing for brokerage business. In addition, an increasing number of specialized firms
now 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. A growing number of discount brokerage firms offer their services over the Internet, further decreasing offered commission rates and increasing ease
of use for customers. The continuation of such discounting and an increase in the number of new and existing firms offering discounts could adversely affect the Company. In addition, rapid growth in
the mutual fund industry is presenting potential customers of PIC with an increasing number of alternatives to traditional stock brokerage accounts.

In
its investment banking activities, PIC competes with other brokerage firms, venture capital firms, banks and all other sources of capital for small, growing companies. Since PIC
generally manages offerings smaller than $20 million, it does not typically compete with the investment banking
departments of large, well-known national brokerage firms. Nevertheless, PIC occasionally manages larger offerings. In addition, large national and regional investment banking firms
occasionally manage offerings of a size that is competitive with PIC, typically for fees and compensation less than that charged by PIC. 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 PIC.



At December 31, 1999, PIC had 66 employees, of whom 47 were executives and support staff and 19 were involved in brokerage activities and compensated
primarily on a commission basis. PIC also had independent contractor arrangements with 86 independent contractors, all of whom are compensated solely on a commission basis. Paulson Capital had no
employees separate from PIC.

ITEM 2. DESCRIPTION OF PROPERTY

PIC leases approximately 17,100 square feet of space for its office in Portland, Oregon under a lease expiring May 31, 2002 at a monthly rent of
$22,848. PIC's Salem office leases space under a lease expiring on October 31, 2002 at a monthly rent of $2,921.69, with rent subject to increases based upon inflation. The Company believes the
existing leased space is suitable and adequate for its business for the foreseeable future.

ITEM 3. LEGAL PROCEEDINGS

The Company and PIC are defendants inHolly Millar and Bertram Ostrau v. Pearce Systems International, Inc., et
al., filed in San Francisco Superior Court, State of California, in March 1996. An asserted class action, plaintiffs allege violations of the California securities law,
deceit, negligent misrepresentation and unfair business practices relating to alleged misstatements in the prospectus used in connection with a February 1994, $5 million public offering
in which PIC acted as the managing underwriter. Plaintiffs seek rescission of the offering as well as actual damages, interest, attorney fees

6

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and punitive damages. No class has been certified. No date for a trial has been set. Pursuant to a tolling agreement with the plaintiff, the Company (but not PIC) expects to be dismissed without
prejudice from the lawsuit. PIC and plaintiffs have reached a settlement of this matter. The settlement is subject to final court approval. The total payment by PIC under the settlement would depend
upon the number of purchasers in the public offering who file valid claims. PIC believes the maximum total
payment by PIC under the settlement would be approximately $900,000, but the actual payment could be less, depending upon the number of valid claims filed.

In
October 1998, Russell W. Cummings, a former PIC customer, filed a lawsuit in California state court asserting claims against PIC and a former PIC registered representative
alleging violations of the California Consumers Legal Remedies Act, fraud, negligent misrepresentation, breach of contract, tortious breach of the implied covenant of good faith and fair dealing,
breach of fiduciary duty and negligence. Prior to filing the complaint, plaintiff demanded payment of $250,000. The complaint seeks damages in excess of $100,000 in connection with options and short
sales transactions beginning in 1996. Plaintiff has agreed to arbitrate the matter before the NASD. PIC has not had an opportunity to fully investigate this claim, but believes it has meritorious
defenses and intends to defend this matter vigorously. Discovery has not yet commenced.

In
October 1998, Masood Asif and Bobbie Sierra, former PIC customers, filed an arbitration against PIC, an officer and director of PIC, and a former PIC registered
representative alleging breach of fiduciary duty, negligent misrepresentation, suppression of facts and churning. Plaintiff seeks damages of $100,000 and punitive damages of $100,000. PIC has not had
an opportunity to fully investigate this claim, but believes it has meritorious defenses and intends to defend this matter vigorously.

In
January 1999, Shahid and Lita Choudhry and Iqbal Waraich, former customers of PIC, filed an NASD arbitration claim against PIC and a former PIC registered representative
alleging that the registered representative managed their account improperly, failed to follow claimant's instructions on particular transactions and failed to provide ongoing investment advice.
Claimants allege negligence, fraud, unsuitability, breach of fiduciary duty, violations of the federal securities laws, failure to supervise and violation of NASD rules, seeking damages of $115,000,
plus punitive damages and interest. PIC has not had an opportunity to fully investigate this claim, but believes it has meritorious defenses and intends to defend this matter vigorously.

In
April 1999, Philip Cutler, a former PIC customer, filed an NASD arbitration claim asserting claims against PIC for alleged misrepresentations, excessive commissions and a
failure to supervise. Claimant alleges damages in excess of $100,000. PIC has not had an opportunity to investigate this matter fully, but believes it has meritorious defenses and intends to defend
this matter vigorously. This matter is set for arbitration on May 30, 2000.

In
January of 2000, Paulson received notice that Paul Monka, as trustee for the Urantia Corporation defined benefit pension plan, filed an arbitration against PIC and a former PIC
registered representative alleging violations of NASD rules, misrepresentation, fraud, breach of contract, and breach of fiduciary duty. Claimant seeks compensatory damages in excess of $460,000 and
punitive damages. PIC has not had an opportunity to fully investigate this claim, but believes it has meritorious defenses and intends to defend this matter vigorously.

In
December of 1999, Francis Hoffman, a former PIC customer, sent a written complaint to PIC alleging that PIC and one of its registered representatives churned her account, placed
her in unsuitable investments, and violated its duty of care and loyalty, the Oregon Securities Law, the NASD Rules and the Oregon Administrative Rules. The customer claims she has lost in excess of
$220,000. PIC has not had an opportunity to fully investigate this claim, but believes it has meritorious defenses and intends to defend this matter vigorously.

7

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An adverse outcome in certain of the matters described above could have a material adverse effect on PIC or the Company. PIC has been named in certain other legal proceedings and has
received notice that certain customers may commence legal proceedings against PIC. The Company believes, based upon information received to date and, where the Company believes it appropriate,
discussions with legal counsel, that resolution of this additional pending or threatened litigation will have no material adverse effect on the consolidated financial condition, results of operations,
or business of the Company.

8

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

None

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

The Company's common stock trades in the over-the-counter market. The Company's stock has not been actively traded. The Company's stock
is quoted on the Nasdaq SmallCap Market under the symbol "PLCC." The following are high and low sales prices for the common stock for the periods shown, as obtained from the Nasdaq Stock Market.

1999 Prices

1998 Prices

1997 PricesHigh

Low

High

Low

High

Low1st Quarter

$
7.000

$
2.625

$
6.750

$
4.625

$
3.188

$
2.5002nd Quarter


5.125


3.500


5.625


4.125


5.250


2.5623rd Quarter


5.250


3.688


4.125


2.312


6.875


3.5004th Quarter


5.500


3.688


3.875


2.000


6.562


4.625


The
high and low closing prices for the first quarter of 2000 through March 10 were $9.250 and $5.062, respectively.

As
of March 10, 2000, there were 3,549,535 shares of the Company's common stock outstanding and held of record by 134 holders. The number of record holders includes as single
holders various institutions (such as brokerage firms) that hold shares in "street name" for multiple shareholders. Based on the number of requests for the Company's proxy materials for its 1999
annual meeting, the Company believes there are approximately 520 beneficial holders of its common stock. The Company
repurchased 257,400 shares of common stock during 1999. Additional shares of common stock may be repurchased from time to time in the future.

The
Company has never paid a dividend on its common stock. Regulatory net capital requirements may limit the ability of PIC to pay dividends to the Company, which would affect the
Company's ability to pay dividends to its shareholders. The Company anticipates that, for the foreseeable future, earnings will be retained for use in its business and does not anticipate the payment
of dividends.

In
1999 the Company issued an aggregate of 1,783 unregistered Shares of the Company's stock as compensation to persons attending meetings of its board of directors. Such persons
include directors, executive officers of the Company, and a director of PIC who is neither an officer of the Company or PIC. These issuances are exempt from registration under Section 4(2) of
the Securities Act of 1933, as amended.

9

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ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

SELECTED FINANCIAL DATA    (in thousands except per share amounts)    Income Statement Information

Years Ended December 31,1999
(restated)

1998
(restated)

1997
(restated)Revenues

$
34,654

$
9,176

$
30,136Commissions and Salaries


15,693


10,371


12,552Other Expenses


4,183


4,109


4,003Total Expenses


19,876


14,480


16,555Pretax Income (loss)


14,778


(5,304
)

13,581Net Income (loss)


8,916


(3,356
)

8,461Diluted Earnings (loss) Per share

$
2.41

($
0.86
)
$
2.11Average number of common shares outstanding


3,704


3,918


4,005


Balance Sheet Information  (restated)

December 31,1999

1998

1997Total Assets

$
46,707

$
31,341

$
43,836Working Capital


29,360


22,783


23,028Short-Term Debt


0


0


100Long-Term Debt


0


0


0Shareholders' Equity


31,121


23,313


27,387


Overview

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



Because
we operate in the financial services industry, our revenues and earnings are substantially affected by conditions in financial markets generally. In our securities brokerage
and corporate finance businesses, the amount of our revenues depends substantially on levels of market activity requiring the services we provide. For example, our investment banking activity, which
consists primarily of acting as managing or participating underwriter of initial and follow-on public offerings for smaller companies, depends on the market for new equity offerings, which
has historically experienced substantial cyclical

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fluctuation. 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
investment banking revenues tend to result in sharper fluctuations, on a percentage basis, in net income or loss.

Our
investment income or loss and, to a lesser extent, our 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 results 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 investment banking business consists of acting as managing underwriter of initial and follow-on public offerings for microcap companies. As a
part of our underwriter compensation for this activity, we typically receive warrants exercisable to purchase securities identical to those that we offer and sell to the public. The warrants are not
exercisable for the first year after the offering in which they are earned and are thereafter exercisable for four years, after which they expire. The exercise price is typically 120% of the price at
which we initially sold the securities to the public. Accordingly, unless there is at least a 20% increase in the price of these securities at some time more than one and less than five years after
the offering, the warrants will remain "under water" and will ultimately expire unexercised.

Under
Statement of Financial Accounting Standards No. 133, as amended by SFAS 137 and 138, 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. The warrants described above are derivative securities for the purpose
of SFAS 133. Accordingly, the aggregate estimated value of our warrants as of the date of any balance sheet is recorded as an asset on that balance sheet. When a new warrant is earned as a
result of our investment banking activity, its estimated value is included in corporate finance revenue for the period in which it is earned. In
subsequent periods, any change in estimated value is recorded as investment income or loss for the period. If, and 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 the warrant expires unexercised, the book value is adjusted to zero
and the decrease is recorded as a loss in the relevant period.

In
order to comply with SFAS 133, we have changed our method of estimating the value of our underwriter warrants from the "intrinsic value' method to the Black-Scholes Option
Pricing Model. We have restated our financial results for the years ending 1997, 1998, and 1999 using this new model. The model requires us to use historical price data combined with various
assumptions and judgments to develop the inputs for the model. In particular, we have calculated a volatility factor for each company's warrants that is based on its own stock price movements as well
as an index: as our warrants get closer to their expiration date their individual volatility factors are almost entirely based on the historical price volatility of each company's 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.

As
a result of the factors described above, our revenues and earnings are subject to substantial fluctuation from period to period based on 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 revenue, 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

11

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decreased revenue, earnings and net worth as a result both of 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.

Results of Operations

PIC's revenues and operating results are influenced by fluctuations in the equity underwriting markets as well as general economic and market conditions,
particularly conditions in the over-the-counter market, where PIC's investment account, trading inventory positions and underwriter warrants are heavily concentrated.
Significant fluctuations can occur in PIC's revenues and operating results from one period to another. PIC's results of operations depend upon many factors, such as the number of companies that are
seeking public financing, the quality and financial condition of those companies, market conditions in general, the performance of previous PIC underwritings and interest in certain industries by
investors. As a result, revenues and income derived from these activities may vary significantly from year to year. In the tables below, "Trading Income" is the net gain or loss from trading positions
before commissions paid to the representatives in the trading department. "Investment Income" includes amounts received, if any, from the exercise of PIC's underwriter warrants and unrealized
appreciation or depreciation in the value of PIC's unexercised underwriter warrants.

12

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Summary of Changes in Major Categories  of Revenues and Expense  (restated)

1999 vs. 1998

1998 vs. 1997Revenues:Sales Commissions

$
3,751,155

33.1
%
($
1,404,382
)
(11.0
%)Corporate Finance


365,928

7.3
%

(4,878,823
)
(49.5
%)Investment Income


21,663,542

N/A


(14,097,273
)
(223.4
%)Trading Income


(272,663
)
(46.2
%)

(605,763
)
(50.7
%)Other


(29,912
)
(44.1
%)

25,712

61.0
%Total


25,478,050

277.7
%

(20,960,529
)
(69.6
%)Expenses:Commissions and Salaries

$
5,321,954

51.3
%
($
2,180,827
)
(17.4
%)Underwriting Expenses


619,337

84.7
%

(31,282
)
(4.1
%)Rent, Telephone & Quotes


48,271

5.7
%

6,965

0.8
%Other


(593,665
)
(23.4
%)

129,260

5.4
%Total

$
5,395,897

37.3
%
($
2,075,884
)
(12.5
%)Pretax Income

$
20,082,153

N/A

($
18,884,645
)
(139.1
%)


1999 Compared to 1998

Total revenues for 1999 rose 277.7 percent from 1998, from $9,175,532 to $34,653,582. As shown in the table above, sales commissions increased
$3,751,155, or 33.1 percent, from $11,324,412 in 1998 to $15,075,567 in 1999. This increase resulted primarily from the more favorable price movements and trading levels in smaller
capitalization OTC issues in 1999 compared to 1998. The Nasdaq Industrial Average rose less in 1999 (11.37 percent) than in 1998 (17.97 percent), but PIC's focus is on very small
capitalization issues, especially those tied to PIC's corporate finance clients, which experienced a more favorable market in 1999. Corporate finance revenues rose 7.6 percent, or $365,928, in
1999 compared to 1998. Four transactions were completed in 1998, raising a total of $37 million for the issuers; 4 transactions were also completed in 1999, raising an aggregate of
$43 million for corporate finance clients. Investment income increased $21,663,542, from a loss of $7,786,262 in 1998 to income of $13,877,280 in 1999, due to unrealized appreciation of
underwriter warrants held by the Company, based upon the Company's estimate of their fair value, gains in the value of the underwriter warrants sold and greater profits on other investment securities
held in response to significant increases in OTC prices, particularly the technology sector. No underwriter warrants were exercised in 1998 while four warrants were exercised in 1999. The profits from
investments sold in the investment account in 1999 were greater than in 1998. Trading income fell $272,663, or 46.2 percent, from $589,822 in 1998 to $317,159 in 1999. This decline was
primarily due to losses on one large holding late in 1999 offsetting the more favorable markets in smaller capitalization OTC issues in 1999 compared to 1998.

Total
expenses rose $5,395,897 in 1999 from 1998, an increase of 37.3 percent from $14,479,189 to $19,875,086. Commissions and salaries rose $5,321,954, or 51.3 percent,
from $10,370,979 in 1998 to $15,692,933 in 1999. This increase was primarily due to increased commission revenues resulting in a higher level of commissions paid and higher accruals for PIC's profit
sharing plan. Higher commission rates are generally paid to employee registered representatives at higher production levels as an incentive. Underwriting expenses increased by $619,337, or
84.7 percent. While the same number of transactions was completed in 1999 as in 1998, the 1999 transactions incurred somewhat higher legal and other expenses. In addition, expenses were
incurred on transactions that were not completed. Rent,

13

---

telephone and quote expenses increased from $842,437 in 1998 to $890,708 in 1999, an increase of 5.7 percent. Other expenses decreased 23.4 percent, from $2,534,738 in 1998 to $1,941,073
in 1999, with decreased settlements and advertising/promotion expenses more than offsetting increases in conference, travel and entertainment, depreciation and other expenses.

The
Company had a pretax loss of $5,303,657 in 1998 compared to pretax income of $14,778,496 in 1999. The primary reason for this increase was the significant increase in investment
income. Independent of investment income, the Company would have had pretax income of $901,216 in 1999 compared to pretax income of $2,482,605 in 1998. Investment income in 1999 was significantly
higher than in any other year in the Company's history, due to unrealized appreciation of underwriter warrants held by the Company, based upon the Company's estimate of their fair value, gains in the
value of the underwriter warrants sold and greater profits on other investment securities held in response to significant increases in OTC prices, particularly the technology sector. This source of
income cannot be expected to regularly recur. Significant fluctuations can occur in PIC's revenues and operating results from one period to another. The Company also incurred a benefit of $1,948,017
from income taxes in 1998, compared to an expense of $5,862,260 in 1999.

On
September 30, 1999, the Company's board of directors approved the Company's 1999 Stock Option Plan. The plan reserves 500,000 shares of the Company's common stock for
issuance upon exercise of the options. Also effective September 30, 1999, the board of directors approved the grant of 128,000 options to directors and employees of the Company. The approved
grant price of the options was $4.44 per share, the September 30, 1999 market value. However, the plan is subject to shareholder approval at the Company's June 2000 shareholder meeting.
Because approval is not virtually certain, the options have not been included in the diluted earnings per share calculation for the year ended December 31, 1999. If the market value of the
stock, on the date of approval, is greater than the grant price, the Company will incur compensation expense equal to the price per share differential times the number of shares granted.

1998 Compared to 1997

Total revenues for 1998 fell 69.6 percent from 1997, to $9,175,532 from $30,136,061. As shown in the table above, sales commissions fell $1,404,382, or
11.0 percent, to $11,324,412 in 1998 from $12,728,794 in 1997. This decrease resulted primarily from the less favorable price movements and trading levels in smaller capitalization OTC issues
in 1998 compared to 1997. The Nasdaq Industrial Average rose more in 1997 (11.17 percent) than in 1998 (6.55 percent), and PIC's focus is on very small capitalization issues, especially
those tied to PIC's corporate finance clients, which experienced a less favorable market in 1998. Corporate finance revenues fell 49.5 percent, or $4,878,823, in 1998 compared to 1997. Four
transactions were completed in 1998, raising a total of $37 million for the issuers; 6 transactions were completed in 1997, raising an aggregate of $93 million for corporate finance
clients. Investment income decreased $14,097,273, to a loss of $7,786,262 in 1998 from income of $6,311,011 in 1997, primarily as a result of unrealized depreciation of the value of underwriter
warrants held by the Company, based upon the Company's estimate of their fair value. No underwriter warrants were exercised in 1998 while one warrant was exercised in 1997, and the profits from
investments sold in the investment account in
1997 were significantly greater than in 1998. Trading income fell $605,763, or 50.7 percent, to $589,822 in 1998 from $1,195,585 in 1997. This decline was due to lower trading levels in 1998
and the generally more favorable markets in smaller capitalization OTC issues in 1997 compared to 1998.

Total
expenses fell $2,075,884 in 1998 from 1997, a decrease of 12.5 percent to $14,479,189 from $16,555,073. Commissions and salaries fell $2,180,827, or 17.4 percent,
to $10,370,979 in 1998 from $12,551,806 in 1997. This decrease was primarily due to decreased commission revenues resulting in a lower level of commissions paid. Higher commission rates are generally
paid to employee registered representatives at higher production levels as an incentive. Underwriting expenses decreased by $31,282

14

---

or 4.1 percent. While fewer transactions were completed in 1998, PIC was the sole manager for all transactions and bore all the expenses. In addition, expenses were incurred on transactions
that were not completed. Rent, telephone and quote expenses increased to $842,437 in 1998 from $835,472 in 1997, an increase of 0.8 percent. Other expenses increased 5.4 percent, to
$2,534,738 in 1998 from $2,405,478 in 1997, with increased settlements and travel and entertainment expenses more than offset by declines in professional fees and other expenses.

The
Company had a pretax loss of $5,303,657 in 1998 compared to pretax income of $13,580,988 in 1997. The primary reasons for this decrease were the significant decreases in
investment income, corporate finance revenues and trading income. Independent of investment income, the Company would have had pretax income of $7,269,977 in 1997 compared to pretax income of
$2,482,605 in 1998. Investment income in 1995 through 1997 was significantly higher than in any previous year in the Company's history, primarily as a result of increases in unrealized appreciation of
underwriter warrants held by the Company, based upon the Company's estimate of their fair value, gains in the value of the underwriter warrants sold and greater profits on other investment securities
held in response to significant increases in OTC prices, particularly the technology sector. This source of income cannot be expected to regularly recur. Significant fluctuations can occur in PIC's
revenue and operating results from one period to another. The Company also incurred a benefit of $1,948,017 from income taxes in 1998, compared to an expense of $5,119,593 in 1997.

Liquidity and Capital Resources

Conducting business as a dealer in securities requires that a substantial inventory of securities be maintained and that a large amount of liquid assets be
readily available. PIC is also required to maintain net capital as described in "Item 1Description of BusinessNet Capital Requirements" above. The Company's working capital
at December 31, 1999 was $29,359,590. Of PIC's total assets (net of intercompany accounts) at December 31, 1999 of $44,895,226, approximately 81 percent consisted of securities in
PIC's investment account, trading inventory and underwriter warrant securities, at fair value, and approximately 17 percent consisted of cash, certificates of deposit and receivables from its
correspondent broker.

PIC's
securities inventory is stated at market value. The liquidity of the market for many of PIC's securities holdings, however, varies with trends in the stock market. Since many of
the securities held by PIC are thinly traded, and PIC is in many cases a primary market maker in the issues held, any significant sales of PIC's positions could adversely affect the liquidity and
prices of the issues held. In general, falling prices in OTC securities (which make up most of PIC's trading positions) lead to decreased liquidity in the market for these issues, while rising prices
in OTC issues tends to increase the liquidity of the market for these securities. The overall decline in prices for the very small capitalization OTC securities traded by PIC in 1994 and 1998 were
combined with a general reduction in the liquidity of the markets for these securities. This situation was the reverse of 1999, 1997, 1996 and 1995, when increases in prices of OTC securities
increased the liquidity of the markets for these securities. PIC's investment account and trading inventory accounts are stated at fair market value, which is at or below quoted market price. They
include shares of restricted stock recorded by PIC, with an original cost of $1,014,210, currently valued at $1,014,210, which the Company believes, based upon available evidence, approximates market
value.

PIC
borrows money from CSC in the ordinary course of its business, pursuant to an arrangement under which CSC agrees to finance PIC's trading accounts in an amount determined by the
size of those accounts and the type of securities held, with interest charged at prevailing margin rates. As of December 31, 1999, no net loans were owed by PIC to CSC pursuant to this
arrangement. PIC and the Company are generally able to meet their compensation and other obligations out of current liquid assets.

15

---

The recorded value of our underwriter's warrants is typically not readily realizable, either because the warrants are not currently exercisable or because their exercise price is more
than the price that we could realize if we exercised the warrant and sold the underlying securities. There is no public market for our underwriter warrants and the warrants themselves are transferable
only under very limited circumstances. Accordingly, their value cannot be realized by selling the underwriter warrants themselves. Underwriter's warrants exercisable to purchase securities having a
value in excess of the exercise price are liquid, subject to restrictions on liquidity applicable to OTC securities generally and discussed in the foregoing paragraph. The securities issuable on
exercise of our underwriter's warrants are registered under the Securities Act of 1933, as amended, and, in some cases, may also be resold under an exemption from registration. Accordingly, there is
no legal impediment to liquidity with respect to these securities, except during the first year following a company's public offering, as described above.

In
1999, $6,879,286 of net cash was used in operating activities. The major adjustments to reconcile this result to the Company's net income included unrealized appreciation on
investment securities and underwriter warrants of $5,793,395, receipt of underwriter warrants valued at $3,230,000, a realized gain of $8,083,884 on investment securities, an increase in receivables
of $6,082,055 and an increase in trading securities of $119,061, partially offset by an increase in accounts payable and accrued liabilities of $3,279,288, a change in deferred income taxes of
$3,157,873 income taxes payable of $1,284,859 and
depreciation and amortization of $136,274. In 1999, $7,943,963 of net cash was provided by investing activities, consisting primarily sales of investment securities exceeding purchases investment
securities and the issuance of a note receivable of $1,100,000. Net cash used in financing activities in 1999 totaled $1,116,812, resulting from payments to repurchase common stock. See "Financial
StatementsConsolidated Statements of Cash Flows."

As
a securities broker-dealer, the Company's wholly owned subsidiary, PIC, is required by SEC regulations to meet certain liquidity and capital standards. In the unlikely event that
PIC was unable to meet these regulatory standards, it would be unable to pay dividends to the Company. Since PIC is the Company's only operating business, such a failure could have a material adverse
affect on the Company.

At
December 31, 1999, the Company had no material commitments for capital expenditures.

In
general, the primary sources of PIC's, and therefore the Company's, liquidity, including PIC's trading positions, borrowings on those positions and profits realized upon the
exercise of underwriter warrants, all depend in large part on the trend in the general markets for OTC securities. Rising OTC price levels will tend to increase the value and liquidity of PIC's
trading positions, the amount that can be borrowed from CSC based upon those positions, and the value of PIC's underwriter warrants. The Company believes its liquidity is sufficient to meet its needs
for the foreseeable future.

Year 2000 Efforts

In 1998 and 1999, the Company took various steps to address the issue of computer programs and embedded computer chips being unable to distinguish between the
year 1900 and the year 2000 (the "Y2K" issue). The Company has no proprietary operating system or applications software, nor do any of its operations use mainframe or mini-computer
systems. Therefore, the Company's focus with respect to the Y2K issue was: (1) its PC hardware and software purchased from third parties; and (2) external suppliers and service
providers. While there is no assurance that associated problems may not arise in the future, to date the Company has not experienced any material problems relating to the Y2K issue.

Inflation

Because PIC's assets are primarily liquid, they are not significantly affected by inflation. The rate of inflation affects PIC's expenses, such as employee
compensation, office leasing and communications

16

---

costs. These costs may not readily be recoverable in the price of services offered by the Company. To the extent inflation results in rising interest rates and has other adverse effects in the
securities markets and the value of securities held in inventory or PIC's investment account, it may adversely affect the Company's financial position and results of operations.

17

---

ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

|(a) Financial Statements                                                                            |  | Page
|--------------------------------------------------------------------------------------------------- |  | ----
|Report of Independent Certified Public Accountants                                                  |  | F-1 
|Consolidated Balance Sheets as of December 31, 1999 and 1998                                        |  | F-2 
|Consolidated Statements of Operations for the years ended December 31, 1999, 1998 and 1997          |  | F-3 
|Consolidated Statement of Shareholders' Equity for the years ended December 31, 1999, 1998 and 1997 |  | F-4 
|Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998 and 1997          |  | F-5 
|Notes to Consolidated Financial Statements                                                          |  | F-7 
|Supplementary Schedule of Warrants Owned                                                            |  | F-19
|Schedule IIValuation and Qualifying Account                                                        |  | F-20

18

---



PART III

All information required by Items 9, 10, 11 and 12 of Part III of this Report will be included in the Company's definitive proxy statement for its 2000
annual meeting of shareholders filed or to be filed not later than 120 days after the end of the fiscal year covered by this Report and is incorporated herein by reference, other than the
information with respect to executive officers of the Company included below.

19

---

DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY

Directors of the Company are elected for a term of one year and until their successors are elected and qualify. Executive officers are appointed by the board
of directors and do not have fixed terms of office. The board of directors and executive officers as of December 31, 1999 are set forth below. The year each person became a director follows his
or her name.

|Name                         |  | Age |  | Position(s) with
Company         |  | Principal Occupation(s)
Past Five Years
During                                                                                                                                                                                                   
|---------------------------- |  | --- |  | -------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Chester L.F. Paulson (1970)  |  | 63  |  | President and Director           |  | Director of Corporate Finance of PIC                                                                                                                                                                                                             
|Jacqueline M. Paulson (1976) |  | 60  |  | Secretary-Treasurer and Director |  | Secretary-Treasurer of PIC                                                                                                                                                                                                                       
|Glen Davis (1999)            |  | 43  |  | Director                         |  | President of PIC since February 1998 (Senior Vice President of PIC until February 1998                                                                                                                                                           
|Kenneth T. LaMear (1985)     |  | 65  |  | Director                         |  | Senior Vice President of PIC since February 1998, Chief Executive Officer of PIC until February 1998                                                                                                                                             
|Shannon P. Pratt (1998)      |  | 66  |  | Director                         |  | Managing Director, Founder  Willamette Management Associates, a business valuation firm                                                                                                                                                         
|Paul Shoen (1998)            |  | 43  |  | Director                         |  | Chairman of the Board of Directors and Chief Executive Officer of Panetechnicon Aviation, an operator and lessor of aircraft; private investor; Director  AMERCO, the parent company of U-Haul Trucking Rental, from
January 1997 to August 1998
|John Westergaard (1998)      |  | 68  |  | Director                         |  | Publisher/Editor of Westergaard Online Systems, Inc., an Internet publisher of financial "webzines"                                                                                                                                              

Chester
L.F. Paulson and Jacqueline M. Paulson are husband and wife.

20

---

(a) Exhibits

|Number |  | Description                                                                                                                                                                                                                        
|------ |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1    |  | Articles of Incorporation (incorporated by reference to Exhibit 3.1 to the Company's Registration Statement on Form 10 filed with the Commission on December 18, 1989 (the "Form 10"))                                             
|3.2    |  | Bylaws (incorporated by reference to Exhibit 3.2 to the Form 10)                                                                                                                                                                   
|10.1   |  | Office lease dated June 28, 1988 (incorporated by reference to Exhibit 10.2 to the Form 10)                                                                                                                                        
|10.3   |  | Contract with Correspondent Services Corporation, dated July 24, 1992 (Incorporated by reference to Exhibit 10.3 to the Form 10-Q for the quarter ended September 30, 1992 filed with the Commission on November 13, 1992)         
|10.4   |  | Office Lease renewal for the period from 6/1/97 to 5/31/02, dated as of May 6, 1997 (Incorporated by reference to Exhibit 10.4 to the Form 10-QSB for the quarter ended June 30, 1997 filed with the Commission on August 13, 1997)
|10.5*  |  | 1999 Stock Option Plan                                                                                                                                                                                                             
|21.1   |  | Subsidiaries  The Company's only subsidiary is Paulson Investment Company, Inc., an Oregon corporation.                                                                                                                           

---

(b) There
were no reports on Form 8-K filed during the last quarter of the period covered by this report.

21

---



SIGNATURES

Pursuant to the requirements of Section 13 or 15 of the Securities Exchange Act of 1934, the Registrant has duly caused this amendment to be signed on
its behalf by the undersigned, thereunto duly authorized.

|                        |  | PAULSON CAPITAL CORP.
|----------------------- |  | ---------------------
|Date: December 17, 2001 |  | By:                  

22

---



|Exhibit
Number |   | Description                                                                                                                                                                                                                         |  | Page
Number
|-------------- | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -----------
|3.1            |   | Articles of Incorporation (incorporated by reference to Exhibit 3.1 to the Company's Registration Statement on Form 10 filed with the Commission on December 18, 1989 (the "Form 10"))                                              |  |            
|3.2            |   | Bylaws (incorporated by reference to Exhibit 3.2 to the Form 10)                                                                                                                                                                    |  |            
|10.1           |   | Office lease dated June 28, 1988 (incorporated by reference to Exhibit 10.2 to the Form 10)                                                                                                                                         |  |            
|10.3           |   | Contract with Correspondent Services Corporation, dated July 24, 1992 (Incorporated by reference to Exhibit 10.3 to the Form 10-Q for the quarter ended September 30, 1992 filed with the Commission on November 13, 1992)          |  |            
|10.4           |   | Office Lease renewal for the period from 6/1/97 to 5/31/02, dated as of May 6, 1997 (Incorporated by reference to Exhibit 10.4 to the Form 10-QSB for the quarter ended June 30, 1997 filed with the Commission on August 13, 1997) |  |            
|10.5           | * | 1999 Stock Option Plan                                                                                                                                                                                                              |  |            
|21.1           |   | SubsidiariesThe Company's only subsidiary is Paulson Investment Company, Inc., an Oregon corporation.                                                                                                                              |  |            

---

23

---



Report of Independent Certified Public Accountants

Board
of Directors and Shareholders
Paulson Capital Corp.

We
have audited the accompanying consolidated balance sheets of Paulson Capital Corp. (an Oregon corporation) and Subsidiary as of December 31, 1999 and 1998, and the related
consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1999. These financial statements 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 auditing standards generally accepted in the 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Paulson Capital Corp. and Subsidiary as of
December 31, 1999 and 1998, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 1999, in
conformity with accounting principles generally accepted in the United States.

As
discussed in Note N of Notes to Consolidated Financial Statements, the 1999, 1998 and 1997 financial statements have been restated.

Our
audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The accompanying Supplementary Schedule of Warrants Owned
as of
December 31, 1999 is presented for purposes of additional analysis and is not a required part of the basic consolidated financial statements. Such information has been subjected to the auditing
procedures applied in the audits of the basic consolidated financial statements and, in our opinion, is fairly stated, in all material respects, in relation to the basic consolidated financial
statements taken as a whole.

We
have also audited Schedule II for each of the three years in the period ended December 31, 1999. In our opinion, this schedule presents fairly, in all material
respects, the information required to be set forth therein.

/s/
Grant Thornton LLP

Portland,
Oregon
January 26, 2000, except for Notes E and N,
as to which the date is November 28, 2001

F1

---



Paulson Capital Corp. and Subsidiary    CONSOLIDATED BALANCE SHEETS  December 31,

|                                     |                                                                                                                          | 1999                      |            | 1998      
|------------------------------------ | ------------------------------------------------------------------------------------------------------------------------ | ------------------------- | ---------- | ----------
|
|ASSETS                               |                                                                                                                          |                           |            |           
|CURRENT ASSETS                       |                                                                                                                          |                           |            |           
|                                     | Cash and cash equivalents                                                                                                |                           | $          | 48,210    
|                                     | Receivable from broker-dealers and clearing organizations                                                                |                           |            | 7,336,562 
|                                     | Notes and other receivables                                                                                              |                           |            | 671,514   
|                                     | Trading securities                                                                                                       |                           |            | 2,238,798 
|                                     | Investment securities, at market value                                                                                   |                           |            | 14,200,767
|                                     | Underwriter warrants, at estimated fair value                                                                            |                           |            | 19,746,000
|                                     | Refundable income taxes                                                                                                  |                           |            |          
|                                     | Prepaid and deferred expenses                                                                                            |                           |            | 669,599   
|                                     |                                                                                                                          |                           |            |           
|                                     |                                                                                                                          | Total current assets      |            |           
|                                     |                                                                                                                          |                           |            |           
|NOTE RECEIVABLE                      |                                                                                                                          |                           | 1,100,000  |           
|                                     |                                                                                                                          |                           |            |           
|FURNITURE AND EQUIPMENT, net         |                                                                                                                          |                           | 525,716    |           
|                                     |                                                                                                                          |                           |            |           
|INVESTMENT IN REAL ESTATE            |                                                                                                                          |                           | 169,900    |           
|                                     |                                                                                                                          |                           |            |           
|                                     |                                                                                                                          | $                         | 46,707,066 |           
|                                     |                                                                                                                          |                           |            |           
|LIABILITIES AND SHAREHOLDERS' EQUITY |                                                                                                                          |                           |            |           
|CURRENT LIABILITIES                  |                                                                                                                          |                           |            |           
|                                     | Accounts payable and accrued liabilities                                                                                 |                           | $          | 814,935   
|                                     | Payable to broker-dealers and clearing organizations                                                                     |                           |            | 1,883,602 
|                                     | Compensation, employee benefits and payroll taxes                                                                        |                           |            | 3,312,829 
|                                     | Securities sold, not yet purchased, at market value                                                                      |                           |            | 65,794    
|                                     | Income taxes payable                                                                                                     |                           |            | 1,116,800 
|                                     | Deferred income taxes                                                                                                    |                           |            | 8,357,900 
|                                     |                                                                                                                          |                           |            |           
|                                     |                                                                                                                          | Total current liabilities |            |           
|                                     |                                                                                                                          |                           |            |           
|Deferred income taxes                |                                                                                                                          |                           | 34,600     |           
|SHAREHOLDERS' EQUITY                 |                                                                                                                          |                           |            |           
|                                     | Preferred stock, no par value; authorized, 500,000 shares; issued and outstanding, no shares                             |                           |            |          
|                                     | Common stock, no par value; authorized, 10,000,000 shares; issued and outstanding, 3,541,235 and 3,796,852, respectively |                           |            | 732,343   
|                                     | Retained earnings                                                                                                        |                           |            | 30,388,263
|                                     |                                                                                                                          |                           |            |           
|                                     |                                                                                                                          |                           | 31,120,606 |           
|                                     |                                                                                                                          |                           |            |           
|                                     |                                                                                                                          | $                         | 46,707,066 |           
|                                     |                                                                                                                          |                           |            |           

The
accompanying notes are an integral part of these statements.

F2

---



Paulson Capital Corp. and Subsidiary        CONSOLIDATED STATEMENTS OF OPERATIONS        Year ended December 31,

|                                  |                                        | 1999                                |            | 1998       |            | 1997      
|--------------------------------- | -------------------------------------- | ----------------------------------- | ---------- | ---------- | ---------- | ----------
|
|Revenues                          |                                        |                                     |            |            |            |           
|                                  | Commissions                            |                                     | $          | 15,075,567 |            | $         
|                                  | Corporate finance                      |                                     |            | 5,345,619  |            |           
|                                  | Investment income (loss)               |                                     |            | 13,877,280 |            |           
|                                  | Trading income                         |                                     |            | 317,159    |            |           
|                                  | Interest and dividends                 |                                     |            | 16,641     |            |           
|                                  | Other                                  |                                     |            | 21,316     |            |           
|                                  |                                        |                                     |            |            |            |           
|                                  |                                        |                                     | 34,653,582 |            |            | 9,175,532 
|                                  |                                        |                                     |            |            |            |           
|Expenses                          |                                        |                                     |            |            |            |           
|                                  | Commissions and salaries               |                                     |            | 15,692,933 |            |           
|                                  | Underwriting expenses                  |                                     |            | 1,350,372  |            |           
|                                  | Rent, telephone and quotation services |                                     |            | 890,708    |            |           
|                                  | Interest expense                       |                                     |            | 1,248      |            |           
|                                  | Professional fees                      |                                     |            | 394,368    |            |           
|                                  | Bad debt expense                       |                                     |            |           |            |           
|                                  | Travel and entertainment               |                                     |            | 333,927    |            |           
|                                  | Settlements                            |                                     |            | 59,000     |            |           
|                                  | Other                                  |                                     |            | 1,152,530  |            |           
|                                  |                                        |                                     |            |            |            |           
|                                  |                                        |                                     | 19,875,086 |            |            | 14,479,189
|                                  |                                        |                                     |            |            |            |           
|                                  |                                        | Earnings (loss) before income taxes |            |            | 14,778,496 |           
|Income tax expense (benefit)      |                                        |                                     | 5,862,260  |            |            | (1,948,017
|                                  |                                        |                                     |            |            |            |           
|                                  |                                        | NET EARNINGS (LOSS)                 |            | $          | 8,916,236  |           
|                                  |                                        |                                     |            |            |            |           
|Basic earnings (loss) per share   |                                        | $                                   | 2.41       |            | $          | (.86      
|                                  |                                        |                                     |            |            |            |           
|Diluted earnings (loss) per share |                                        | $                                   | 2.41       |            | $          | (.86      
|                                  |                                        |                                     |            |            |            |           

The
accompanying notes are an integral part of these statements.

F3

---



Paulson Capital Corp. and Subsidiary    CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY  Three year period ended December 31, 1999

|                                                                 |  | Common Stock |   |   |        
|---------------------------------------------------------------- |  | ------------ | - | - | -------
|
|
|Balance at December 31, 1996, as previously reported             |  | 4,081,241    |   | $ | 733,701
|Restatement (Note N)                                             |  |             |   |   |       
|                                                                 |  |              |   |   |        
|Balance at December 31, 1996, as restated                        |  | 4,081,241    |   |   | 733,701
|Exercise of stock options                                        |  | 87,140       |   |   | 89,283 
|Issuance of common stock in lieu of directors' cash compensation |  | 2,266        |   |   | 8,000  
|Redemption of common stock                                       |  | (200,111     | ) |   | (36,568
|Net earnings for the year, as restated                           |  |             |   |   |       
|                                                                 |  |              |   |   |        
|Balance at December 31, 1997, as restated                        |  | 3,970,536    |   |   | 794,416
|Issuance of common stock in lieu of directors' cash compensation |  | 4,283        |   |   | 16,500 
|Redemption of common stock                                       |  | (177,967     | ) |   | (35,593
|Net loss for the year, as restated                               |  |             |   |   |       
|                                                                 |  |              |   |   |        
|Balance at December 31, 1998, as restated                        |  | 3,796,852    |   |   | 775,323
|Issuance of common stock in lieu of directors' cash compensation |  | 1,783        |   |   | 8,500  
|Redemption of common stock                                       |  | (257,400     | ) |   | (51,480
|Net earnings for the year, as restated                           |  |             |   |   |       
|                                                                 |  |              |   |   |        
|Balance at December 31, 1999, as restated                        |  | 3,541,235    |   | $ | 732,343
|                                                                 |  |              |   |   |        

The
accompanying notes are an integral part of these statements.

F4

---



Paulson Capital Corp. and Subsidiary    CONSOLIDATED STATEMENTS OF CASH FLOWS  Year ended December 31,

|                                                 |                                                                                                     | 1999                                                                                     |                                          | 1998                                                |            | 1997       |            
|------------------------------------------------ | --------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------- | ---------------------------------------- | --------------------------------------------------- | ---------- | ---------- | -----------
|
|Increase (Decrease) in Cash and Cash Equivalents |                                                                                                     |                                                                                          |                                          |                                                     |            |            |            
|Cash flows from operating activities             |                                                                                                     |                                                                                          |                                          |                                                     |            |            |            
|                                                 | Net earnings (loss)                                                                                 |                                                                                          | $                                        | 8,916,236                                           |            | $          | (3,355,640 
|                                                 | Adjustments to reconcile net earnings (loss) to net cash provided by (used in) operating activities |                                                                                          |                                          |                                                     |            |            |            
|                                                 |                                                                                                     | Receipt of underwriter warrants                                                          |                                          |                                                     | (3,230,000 | )          |            
|                                                 |                                                                                                     | Unrealized (appreciation) depreciation on investment securities and underwriter warrants |                                          |                                                     | (5,793,395 | )          |            
|                                                 |                                                                                                     | Realized (gain) loss on investment securities                                            |                                          |                                                     | (8,083,884 | )          |            
|                                                 |                                                                                                     | Deferred income taxes                                                                    |                                          |                                                     | 3,157,873  |            |            
|                                                 |                                                                                                     | Common stock issued for compensation of directors                                        |                                          |                                                     | 8,500      |            |            
|                                                 |                                                                                                     | Depreciation and amortization                                                            |                                          |                                                     | 136,274    |            |            
|                                                 |                                                                                                     | (Gain) loss from sale of furniture and equipment                                         |                                          |                                                     |           |            |            
|                                                 |                                                                                                     | Write-down of notes receivable, net of recoveries                                        |                                          |                                                     | (267,193   | )          |            
|                                                 |                                                                                                     | Changes in assets and liabilities                                                        |                                          |                                                     |            |            |            
|                                                 |                                                                                                     |                                                                                          | Receivables                              |                                                     |            | (6,082,055 | )          
|                                                 |                                                                                                     |                                                                                          | Trading securities                       |                                                     |            | (119,061   | )          
|                                                 |                                                                                                     |                                                                                          | Income taxes receivable/payable          |                                                     |            | 1,284,859  |            
|                                                 |                                                                                                     |                                                                                          | Prepaid and deferred expenses            |                                                     |            | (91,043    | )          
|                                                 |                                                                                                     |                                                                                          | Accounts payable and accrued liabilities |                                                     |            | 3,279,288  |            
|                                                 |                                                                                                     |                                                                                          | Securities sold, not yet purchased       |                                                     |            | 4,315      |            
|                                                 |                                                                                                     |                                                                                          |                                          |                                                     |            |            |            
|                                                 |                                                                                                     |                                                                                          |                                          | Net cash provided by (used in) operating activities |            |            | (6,879,286 
|                                                 |                                                                                                     |                                                                                          |                                          |                                                     |            |            |            
|Cash flows from investing activities             |                                                                                                     |                                                                                          |                                          |                                                     |            |            |            
|                                                 | Purchases of investment securities                                                                  |                                                                                          |                                          | (41,501,353                                         | )          |            | (27,439,553
|                                                 | Proceeds from sale of investment securities                                                         |                                                                                          |                                          | 50,636,252                                          |            |            | 25,400,567 
|                                                 | Proceeds from repayment of notes receivable                                                         |                                                                                          |                                          | 211,725                                             |            |            | 500,000    
|                                                 | Issuance of note receivable                                                                         |                                                                                          |                                          | (1,100,000                                          | )          |            | (534,385   
|                                                 | Additions to furniture and equipment                                                                |                                                                                          |                                          | (302,661                                            | )          |            | (254,652   
|                                                 | Purchase of real estate                                                                             |                                                                                          |                                          |                                                    |            |            |           
|                                                 | Proceeds from sale of furniture and equipment                                                       |                                                                                          |                                          |                                                    |            |            | 2,300      
|                                                 |                                                                                                     |                                                                                          |                                          |                                                     |            |            |            
|                                                 |                                                                                                     |                                                                                          |                                          | Net cash provided by (used in) investing activities |            |            | 7,943,963  
|                                                 |                                                                                                     |                                                                                          |                                          |                                                     |            |            |            

F5

---



|                                                      |                                         | 1999 |                                                      | 1998       |   | 1997       |         
|----------------------------------------------------- | --------------------------------------- | ---- | ---------------------------------------------------- | ---------- | - | ---------- | --------
|
|Cash flows from financing activities                  |                                         |      |                                                      |            |   |            |         
|                                                      | Proceeds from exercise of stock options |      | $                                                    |           |   | $          |        
|                                                      | Payments to retire common stock         |      |                                                      | (1,116,812 | ) |            | (486,916
|                                                      |                                         |      |                                                      |            |   |            |         
|                                                      |                                         |      | Net cash used in financing activities                |            |   | (1,116,812 | )       
|                                                      |                                         |      |                                                      |            |   |            |         
|                                                      |                                         |      | Net Increase (Decrease) in Cash and Cash Equivalents |            |   | (52,135    | )       
|Cash and cash equivalents at beginning of year        |                                         |      | 100,345                                              |            |   | 73,220     |         
|                                                      |                                         |      |                                                      |            |   |            |         
|Cash and cash equivalents at end of year              |                                         | $    | 48,210                                               |            | $ | 100,345    |         
|                                                      |                                         |      |                                                      |            |   |            |         
|Cash paid during the year for                         |                                         |      |                                                      |            |   |            |         
|                                                      | Interest                                |      | $                                                    | 1,248      |   | $          | 61,389  
|                                                      |                                         |      |                                                      |            |   |            |         
|                                                      | Income taxes                            |      | $                                                    | 1,441,715  |   | $          | 901,408 
|                                                      |                                         |      |                                                      |            |   |            |         
|Noncash investing and financing activity              |                                         |      |                                                      |            |   |            |         
|Repayment of secured demand note collateral agreement |                                         | $    |                                                     |            | $ | 100,000    |         
|                                                      |                                         |      |                                                      |            |   |            |         

The
accompanying notes are an integral part of these statements.

F6

---



Paulson Capital Corp. and Subsidiary        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE AORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Paulson Capital Corp. (the Company) is a holding company whose wholly-owned subsidiary, Paulson Investment Company, Inc. (Subsidiary) is a registered
broker-dealer in securities under the Securities and Exchange Act of 1934, as amended. The Subsidiary renders broker-dealer services in securities on both an agency and principal basis to its
customers who are fully introduced to Correspondent Services Corporation (CSC), a subsidiary of Paine Webber Group, Inc. The Subsidiary also acts as lead or participating underwriter for
over-the-counter securities offerings. The Subsidiary conducts business throughout the United States. The Subsidiary is exempt from the reserve requirements under SEC
Rule 15c3-3(k)(2)(ii), since it does not handle or carry customer securities and cash.

A
summary of the significant accounting policies consistently applied in the preparation of the accompanying financial statements follows.

1.  Principles of Consolidation

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

2.  Securities Transactions

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 shelter revenue is recognized at the time individual tax shelter units are sold. Revenue from the receipt of underwriter warrants, received in
corporate finance transactions, is recognized based on the estimated fair value of the securities received as estimated using the Black-Scholes option-pricing model.

Marketable
securities are valued at market value, and securities not readily marketable are valued at fair value as determined by management. 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. Underwriter warrants are valued at estimated fair value 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. Changes in the value of these securities are reflected currently in the results of operations.

3.  Fair Value of Financial Instruments

The carrying amounts reflected in the balance sheet for cash, cash equivalents, notes and other receivables and payables approximate their respective fair
values due to the short maturities of these instruments. The fair values of trading and investing securities owned and securities sold, not yet purchased are recorded primarily at quoted prices for
those or similar instruments. Underwriter warrants are recorded at estimated fair value as determined by management. Changes in the market value of these securities are reflected currently in the
results of operations.

F7

---

4.  Furniture and Equipment

Depreciation of furniture and equipment is computed generally by 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 lives of their respective leases (2.5 years).

5.  Cash Flows

For purposes of reporting cash flows, cash and cash equivalents include cash on hand, cash due from banks and brokerage accounts, certificates of deposit and
highly liquid debt instruments purchased with a maturity of three months or less.

6.  Use of Estimates

In preparing the Company's financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.

7.  Earnings Per Share

The Company adopted Financial Accounting Standard No. 128, "Earnings Per Share" in 1997. Earnings (loss) per share are computed based on the weighted
average number of common and dilutive common equivalent shares outstanding during the year (Note I).

8.  Income taxes

The Company provides for income taxes under the liability method. Deferred tax assets and liabilities are determined based on differences between financial
reporting and tax bases of assets and liabilities as measured by the enacted tax rates which are expected to be in effect when these differences reverse. Income tax expense is the tax payable for the
period and the change during the period in net deferred tax assets and liabilities.

9.  Recently Issued Accounting Pronouncements

In 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 133 ("SFAS 133"), Accounting
for Derivative Instruments and Hedging Activities. SFAS 133 will require the Company to record all derivatives on the balance sheet at fair value. The new standard, as amended by
SFAS 137 and SFAS 138, is effective for fiscal years beginning after June 15, 2000. As part of certain underwriting agreements, the Company receives underwriter warrants. These
warrants are derivatives under the definition of SFAS 133. The Company does not have any hedging activities. The Company believes the impact of adopting this standard will not be material to
its results of operations or equity since it currently marks all investments to fair value.

F8

---

NOTE BRECEIVABLE FROM AND PAYABLE TO BROKER-DEALERS AND CLEARING ORGANIZATIONS

The Subsidiary introduces all customer transactions in securities traded on U.S. securities markets to CSC on a fully-disclosed basis. The agreement between
the Subsidiary and its clearing broker provides that the Subsidiary is obligated to assume any exposure related to nonperformance by customers or counterparties. The Subsidiary monitors 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 to the Subsidiary. In the event of nonperformance, the
Subsidiary may be required to purchase or sell financial instruments at unfavorable market prices resulting in a loss. Management does not anticipate nonperformance by customers and counterparties in
the above situations.

In
addition to the clearing services provided, CSC also loans money to the Subsidiary to finance trading accounts.

At
December 31, the above clearing services and trading account financing resulted in the following:

1999

1998Receivable from CSC

$
7,336,562

$
1,430,586Payable to CSC


(1,883,602
)

(753,413
)Net receivable

$
5,452,960

$
677,173


NOTE CNOTES AND OTHER RECEIVABLES

Notes and other receivables consist of the following:

1999

1998Underwriting

$


$
267,191Employees


558,131


49,493Independent brokers


59,045


69,909Other


54,338


53,374$
671,514

$
439,967


In
connection with an underwriting, the Subsidiary accepted a note receivable on December 18, 1997 in the amount of $500,000. On February 6, 1998 the note was paid.
Three additional notes totaling $534,385 were accepted during 1998. These notes were uncollateralized and the Subsidiary recorded an allowance of $267,193 against them. During 1999, collection was
received on one of the notes and the remainder of the other two were written off.

Employee
and independent broker receivables relate principally to advances, expenses inventory losses and settlements charged to the registered representatives of the Subsidiary in
excess of commission earnings.. For the years ended December 31, 1999, 1998, and 1997, receivables from

F9

---

employees and independent brokers of $80,379, $85,448, and $17,206, respectfully, were determined by management to be uncollectible and written off to other operating expense.

At
December 31, 1999 the Company had a $1,100,000 unsecured note receivable from a company that was subordinated to the interest of another creditor. This note has an interest
rate of 6% and is due October 21, 2001.

NOTE DTRADING AND INVESTMENT SECURITIES

Trading securities and securities sold not yet purchased represent the market value of securities held long and short by the Company's subsidiary.

The
categories of trading securities and their related market values follow:

1999

1998Long

Short

Long

ShortCommon stock

$
1,895,409

$
65,794

$
1,686,731

$
50,672Preferred stock








39,008


5,511State and municipal bonds


262,082





243,055


5,296Corporate bonds


81,307





150,943


$
2,238,798

$
65,794

$
2,119,737

$
61,479


As
a securities broker-dealer, the Subsidiary is engaged in various securities trading and brokerage activities as principal. In the normal course of business, the Subsidiary has sold
securities that it does not currently own and will therefore be obligated to purchase such securities at a future date. This obligation is recorded in the financial statements at the market value of
the related securities. A trading loss will occur on the securities if the market price increases and a trading gain will occur if the market price decreases.

F10

---

Investment securities held by the Subsidiary which are readily marketable are stated at market value. Included in investment securities are 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 the Company. At December 31, 1999 these securities consist of corporate stocks and warrants at estimated fair value of $914,210 and a convertible
debenture valued at $100,000. At December 31, 1998 these securities consisted of corporate stocks at estimated fair value of $325,475. A summary of the investment security portfolio follows:

|     |                    | Cost |            | Market
Value |   | Unrealized
Gain (Loss) |            | Carrying
Value
|---- | ------------------ | ---- | ---------- | ------------ | - | ---------------------- | ---------- | --------------
|1999 |                    |      |            |              |   |                        |            |               
|     | Corporate equities |      | $          | 11,752,070   |   | $                      | 14,178,877 |               
|     | Corporate bonds    |      |            | 102,420      |   |                        | 21,890     |               
|     |                    |      |            |              |   |                        |            |               
|     |                    | $    | 11,854,490 |              | $ | 14,200,767             |            | $             
|     |                    |      |            |              |   |                        |            |               
|1998 |                    |      |            |              |   |                        |            |               
|     | Corporate equities |      | $          | 11,993,688   |   | $                      | 9,697,387  |               
|     |                    |      |            |              |   |                        |            |               

Realized
gain (loss) included in the determination of net earnings was $8,083,884, $(404,441), and $5,988,817 for the years ended December 31, 1999, 1998 and 1997,
respectively.

NOTE EUNDERWRITER WARRANTS

The estimated fair value of warrants is determined by management using the Black-Scholes option-pricing model, taking into account the exercise price,
remaining contractual 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 (see Note A2). The warrants generally have a five-year expiration date and vest immediately. The warrants are generally subject to a one-year
restriction period in which the Company cannot exercise the warrants. Significant assumptions used to estimate the fair values of the warrants included the risk-free interest rate,
expected volatility factors and an expected dividend yield for those securities that were expected to pay dividends. The expected volatility factors were determined using historical volatility of the
underlying stock if available and historical volatility of a peer group if volatility for the underlying stock is not available.

F11

---

The following table summarized activity in underwriter warrants (restated):

Estimated fair value at January 1, 1997

$
14,999,000Warrants received


5,933,000Warrants exercised


(2,375,813
)Warrants expired


(800,462
)Appreciation (depreciation) in estimated value


3,906,275Estimated fair value at December 31, 1997


21,662,000Warrants received


3,263,000Warrants exercised


0Warrants expired


(1,382,122
)Appreciation (depreciation) in estimated value


(7,265,878
)Estimated fair value at December 31, 1998


16,277,000Warrants received


3,230,000Warrants exercised


(4,220,580
)Warrants expired


(252
)Appreciation (depreciation) in estimated value


4,459,832Estimated fair value at December 31, 1999

$
19,746,000


NOTE FFURNITURE AND EQUIPMENT

Furniture and equipment are stated at cost and consist of the following:

1999

1998Office equipment

$
1,173,097

$
905,710Leasehold improvements


35,274


120,354Vehicles


65,619


65,6191,273,990


1,091,683Less accumulated depreciation and amortization


748,274


732,354$
525,716

$
359,329


F12

---

NOTE GINCOME TAXES

Income tax expense (benefit) consists of the following:

1999

1998

1997(restated)

(restated)

(restated)Current tax expenseFederal

$
1,921,593

$
724,613

$
2,364,177State


782,794


110,643


366,1162,704,387


835,256


2,730,293Deferred tax expense (benefit)Federal


2,798,507


(2,447,332
)

2,127,194State


359,366


(335,941
)

262,1063,157,873


(2,783,273
)

2,389,300$
5,862,260

$
(1,948,017
)
$
5,119,593


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

1999

1998

1997(restated)

(restated)

(restated)Income tax expense (benefit) at statutory federal tax rate

$
5,025,000

$
(1,803,000
)
$
4,618,000State taxes net of federal benefit


644,000


(231,000
)

592,000Permanent and other differences


193,260


85,983


(90,407
)$
5,862,260

$
(1,948,017
)
$
5,119,593


The
deferred income tax liability consists of the following at December 31,:

1999

1998(restated)

(restated)Unrealized appreciation on securities

$
(8,473,000
)
$
(5,343,000
)Accrued expenses


48,000


State net operating loss carryforwards


67,100


Allowance on notes receivable





105,000Fixed asset depreciation


(34,600
)

3,373$
(8,392,500
)
$
(5,234,627
)


No
valuation allowance is considered necessary. The state net operating loss carryforwards expire through 2014.

NOTE HCOMMON STOCK

Directors are compensated for their attendance at a maximum of six scheduled meetings per year. Compensation is approximately $500 of the Company's stock for
each meeting. The value of the stock is determined at the close of business the day prior to a scheduled meeting.

The
Subsidiary has a key employee stock purchase plan. Under the plan, the Subsidiary will match funds (up to $25,000) committed by key employees for the purchase of shares of the
Company's common stock. The committed and matching funds will be used by the Subsidiary to purchase stock of

F13

---

the Company in the open market or by negotiated transactions. One half of the shares will be resold to the participating employee and one half of the shares will be transferred to the employee for no
cash consideration. The named participants, the number of shares purchased in the open market and the
amount of matching funds will be at the discretion of the Board of Directors of the Subsidiary. No participants were named and no purchases of common stock under this plan were made during 1999, 1998
or 1997.

The
Company's Nonemployee Stock Option Plan had 100,000 registered shares of common stock reserved for issuance.

The
Company has adopted the disclosure only provisions of Financial Accounting Standard No. 123, "Accounting for Stock-Based Compensation" (FAS 123). It applies APB
Opinion No. 25, "Accounting for Stock Issued to Employees," in accounting for its Plans and therefore does not recognize compensation expense. Had the Company elected to recognize compensation
expense based upon the fair value at the grant date for awards under these Plans consistent with the methodology prescribed by FAS 123, the effect on the Company's pro forma net income and
earnings per share would have been immaterial. The fair value of each option grant is estimated on the date of grant using the Black-Scholes options-pricing model with the following weighted-average
assumptions: no dividends; expected volatility of 62%; risk-free interest rate of 5.9% and expected life of 2.5 years.

There
was no activity under the Nonemployee Stock Option Plan during 1999 or 1998. The following table summarizes activity under the Plan for the year ended December 31, 1997:

|                             |           | Shares
Under
Option |         | Weighted
Average
Exercise
Price
|---------------------------- | --------- | ------------------- | ------- | -------------------------------
|Balance at December 31, 1996 |           | 101,425             |         | $                              
|                             | Granted   |                     |        |                                
|                             | Exercised |                     | (87,140 | )                              
|                             | Canceled  |                     | (14,285 | )                              
|                             |           |                     |         |                                
|Balance at December 31, 1997 |           |                    |         |                                
|                             |           |                     |         |                                

On
September 30, 1999, the Board of Directors approved the 1999 Stock Option Plan. The plan reserves 500,000 shares of the Company's common stock for issuance upon exercise of
the options. Also effective September 30, 1999, the Board of Directors approved the grant of 128,000 options to directors
and employees of the Company. The approved grant price of the options was $4.44 per share, the September 30, 1999 market value. However, the plan is subject to shareholder approval at the
June 2000 shareholder meeting. Because approval is not virtually certain, the options have not been included in the diluted earnings per share calculation for the year ended December 31,
1999. If the market value of the stock, on the date of approval, is greater than the grant price, the Company will incur compensation expense equal to the price per share differential times the number
of shares granted.

F14

---

NOTE IEARNINGS PER SHARE

The following table is a reconciliation of the numerators and denominators of the basic and diluted per share computations for each of the three years in the
period ended December 31, 1999:

|                |                                 | Income
(Numerator)                             |  | Weighted
Average
Shares
(Denominator) |            | Per
Share
Amount |          
|--------------- | ------------------------------- | ---------------------------------------------- |  | ------------------------------------- | ---------- | ---------------- | ---------
|1997 (restated) |                                 |                                                |  |                                       |            |                  |          
|                | Basic earnings per share        |                                                |  |                                       |            |                  |          
|                |                                 | Income available to common stockholders        |  | $                                     | 8,461,395  |                  | 3,973,034
|                | Effect of dilutive securities   |                                                |  |                                       |            |                  |          
|                |                                 | Stock options                                  |  |                                       |           |                  | 32,344   
|                |                                 |                                                |  |                                       |            |                  |          
|                | Diluted earnings per share      |                                                |  |                                       |            |                  |          
|                |                                 | Income available to common stockholders        |  | $                                     | 8,461,395  |                  | 4,005,378
|                |                                 |                                                |  |                                       |            |                  |          
|1998 (restated) |                                 |                                                |  |                                       |            |                  |          
|                | Basic earnings (loss) per share |                                                |  |                                       |            |                  |          
|                |                                 | Income (loss) available to common stockholders |  | $                                     | (3,355,640 | )                | 3,917,788
|                |                                 |                                                |  |                                       |            |                  |          
|1999 (restated) |                                 |                                                |  |                                       |            |                  |          
|                | Basic earnings per share        |                                                |  |                                       |            |                  |          
|                |                                 | Income available to common stockholders        |  | $                                     | 8,916,236  |                  | 3,704,360
|                |                                 |                                                |  |                                       |            |                  |          

During
the years ended December 31, 1999 and 1998 there were no potentially dilutive securities outstanding. During the year ended December 31, 1997 all outstanding
stock options were included in the computation of diluted earnings per share since the options' exercise price was less than the average market price of the common shares.

F15

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NOTE JLEASES

Future minimum payments, by year and in the aggregate, required under non-cancelable operating leases with initial or remaining terms of one year
or more consist of the following:

Year ended December 31,2000

$
274,1762001


274,1762002


114,240$
662,592


The
leases provide for payment of taxes and other expenses by the Company. Rental expense for the years ended December 31, 1999, 1998 and 1997 approximated $265,000, $270,000,
and $240,000, respectively.

NOTE KEMPLOYEE BENEFIT PLANS

Retirement benefits for employees of the Company, 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, 1999, 1998 and 1997 were $600,000, $0 and $500,000, respectively.

NOTE LCONTINGENCIES

The Company and its Subsidiary have been named by individuals in certain legal actions, some of which claim state and federal securities law violations and
claim principal and punitive damages. As preliminary hearings and discovery in these cases is not complete, it is not possible to assess the degree of liability, the probability of an unfavorable
outcome or the impact on the Company's financial statements, if any. Management denies the charges in these legal actions and is vigorously defending against them. No provision for any liability that
may result from the above contingencies has been made in the financial statements.

The
Company and its Subsidiary are defendants in a class action alleging violations of California securities law and other laws relating to a public offering in which the Subsidiary
acted as the managing underwriter. The Subsidiary and the plaintiffs reached a settlement in principle during 1998, which is subject to court approval. The total payment by the Subsidiary under the
settlement depends upon the number of purchasers in the public offering who file valid claims. Management believes the range of payment possible under the settlement is between approximately $350,000
and $900,000. An accrual of $500,000 has been recorded based upon management's estimate of the most likely amount.

NOTE MNET CAPITAL REQUIREMENT

The Subsidiary is subject to the net capital rule (Rule 15c3-1) of the Securities and Exchange Commission. This rule prohibits the
Subsidiary from engaging in any securities transaction at a time when its "aggregate indebtedness" exceeds fifteen times its "net capital" as those terms are defined by the rule. At
December 31, 1999, the Subsidiary's net capital and required net capital were $17,506,585 and $273,057, respectively, and its ratio of aggregate indebtedness to net capital was .234 to 1. The
Subsidiary's absolute minimum net capital is $100,000.

F16

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NOTE NRESTATEMENT

During the fourth quarter of 2001, the Company changed its valuation methodology for underwriter warrants. Previously the Company carried these securities at
their estimated fair value once the restriction periods had lapsed. Upon reconsideration, it was determined that it is appropriate under generally accepted accounting principles to carry these
securities at their estimated fair value as soon as the securities are received. Accordingly, the financial statements for previous periods have been restated to correct this error in previously
issued financial statements that were not in compliance with accounting principles generally accepted in the United States.

The
effect of the change on the 1999 financial statement was to increase corporate finance revenue by $3,230,000, decrease investment income by $7,763,000, decrease earnings before
income taxes by
$4,533,000, decrease income tax expense by $1,738,000, decrease net earnings by $2,795,000, and decrease basic and diluted earnings per share by $.75. The effect of the change on the 1998 financial
statement was to increase corporate finance revenue by $3,263,000, increase investment loss by $5,837,000, increase loss before income taxes by $2,574,000, increase income tax benefit by $987,000,
increase net loss by $1,587,000, and increase basic and diluted loss per share by $.41. The effect of the change on the 1997 financial statement was to increase corporate finance revenue by
$5,933,000, decrease investment income by $3,481,000, increase earnings before income taxes by $2,452,000, increase income tax expense by $941,000, increase net income by $1,511,000, increase basic
earnings per share by $.38 and increase diluted earnings per share by $.37. The effect of the adjustment for periods prior to 1997 was to increase shareholders' equity by $8,577,000.

F17

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The effect of the restatement on each of the quarters for the years 1999, 1998 and 1997 is as follows (unaudited and restated):

|                                                                    |  | Three months ended |           
|------------------------------------------------------------------- |  | ------------------ | ----------
|
|1999                                                                |  |                    |           
|Net income (loss), as previously reported                           |  | $                  | 1,048,963 
|Effect of adjustment, net of income taxes                           |  |                    | (963,000  
|                                                                    |  |                    |           
|Net income (loss), as restated                                      |  | $                  | 85,963    
|                                                                    |  |                    |           
|Effect of adjustment on income before taxes                         |  | $                  | (1,563,000
|Effect of adjustment on income taxes                                |  |                    | 600,000   
|                                                                    |  |                    |           
|Effect of adjustment, net of income taxes                           |  | $                  | (963,000  
|                                                                    |  |                    |           
|Earnings (loss) per share, as previously reported                   |  | $                  | 0.28      
|Effect of adjustment, net of income taxes                           |  |                    | (0.26     
|                                                                    |  |                    |           
|Earnings (loss) per share, as restated                              |  | $                  | 0.02      
|                                                                    |  |                    |           
|1998                                                                |  |                    |           
|Net income (loss), as previously reported                           |  | $                  | 21,604    
|Effect of adjustment, net of income taxes                           |  |                    | (1,208,000
|                                                                    |  |                    |           
|Net income (loss), as restated                                      |  | $                  | (1,186,396
|                                                                    |  |                    |           
|Effect of adjustment on income before taxes                         |  | $                  | (1,960,000
|Effect of adjustment on income taxes                                |  |                    | 752,000   
|                                                                    |  |                    |           
|Effect of adjustment, net of income taxes                           |  | $                  | (1,208,000
|                                                                    |  |                    |           
|Basic and diluted earnings (loss) per share, as previously reported |  | $                  | 0.01      
|Effect of adjustment, net of income taxes                           |  |                    | (0.31     
|                                                                    |  |                    |           
|Basic and diluted earnings (loss) per share, as restated            |  | $                  | (0.30     
|                                                                    |  |                    |           
|1997                                                                |  |                    |           
|Net income, as previously reported                                  |  | $                  | 1,041,059 
|Effect of adjustment, net of on income taxes                        |  |                    | (1,825,000
|                                                                    |  |                    |           
|Net income (loss), as restated                                      |  | $                  | (783,941  
|                                                                    |  |                    |           
|Effect of adjustment on income before taxes                         |  | $                  | (2,961,000
|Effect of adjustment on income taxes                                |  |                    | 1,136,000 
|                                                                    |  |                    |           
|Effect of adjustment, net of income taxes                           |  | $                  | (1,825,000
|                                                                    |  |                    |           
|Basic earnings per share, as previously reported                    |  | $                  | 0.26      
|Effect of adjustment, net of income taxes                           |  |                    | (0.46     
|                                                                    |  |                    |           
|Basic earnings per share, as restated                               |  | $                  | (0.20     
|                                                                    |  |                    |           
|Diluted earnings per share, as previously reported                  |  | $                  | 0.26      
|Effect of adjustment, net of income taxes                           |  |                    | (0.46     
|                                                                    |  |                    |           
|Diluted earnings per share, as restated                             |  | $                  | (0.20     
|                                                                    |  |                    |           

F18

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Paulson Capital Corp. and Subsidiary        SCHEDULE OF WARRANTS OWNED        December 31, 1999

|Description                                  |  | Shares
Entitled to
Purchase |  | Exercise
Price
Per-Share |           | Expiration
Date
|-------------------------------------------- |  | --------------------------- |  | ------------------------ | --------- | ---------------
|Advantage Marketing Systems (units)          |  | 65,520                      |  | $                        | 5.40      |                
|Audiohighway (units)                         |  | 163,900                     |  | $                        | 7.80      |                
|AVI Biopharma, Inc. (units)                  |  | 112,700                     |  | $                        | 10.80     |                
|C3, Inc.                                     |  | 214,592                     |  | $                        | 18.00     |                
|Cal-Maine Foods, Inc.                        |  | 177,100                     |  | $                        | 8.40      |                
|Caring Products International, Inc. (units)  |  | 83,075                      |  | $                        | 6.00      |                
|Cell Robotics International, Inc. (units)    |  | 9.3725                      |  | $                        | 25,000.00 |                
|Cell Robotics International, Inc. (units)    |  | 29,800                      |  | $                        | 9.90      |                
|Cellegy Pharmaceuticals, Inc. (units)        |  | 18,745                      |  | $                        | 20.63     |                
|Complete Management, Inc.                    |  | 107,720                     |  | $                        | 10.80     |                
|Complete Management, Inc.                    |  | 31,377                      |  | $                        | 21.04     |                
|Cusac Industries, Ltd. (units)               |  | 11,901                      |  | $                        | 12.00     |                
|E.Com International, Inc.                    |  | 75,587                      |  | $                        | 3.50      |                
|Evergreen Resources, Inc.                    |  | 134,375                     |  | $                        | 6.90      |                
|Fortune Petroleum Corp.                      |  | 50,000                      |  | $                        | 4.00      |                
|Global Payment Technology ERC 2-6-96         |  | 103,500                     |  | $                        | 6.60      |                
|Hometown Auto Retailers NC                   |  | 120,690                     |  | $                        | 10.80     |                
|International Nursing Services, Inc. (units) |  | 15,301                      |  | $                        | 28.20     |                
|Kyzen Corporation (units)                    |  | 15,498                      |  | $                        | 14.95     |                
|Microfield Graphics, Inc.                    |  | 79,750                      |  | $                        | 7.20      |                
|Microvision Inc. (units) ERC 8-27-97         |  | 123,760                     |  | $                        | 9.60      |                
|Neotherapeutics Inc. (units) ERC 9-25-97     |  | 161,000                     |  | $                        | 9.12      |                
|Northern Bank of Commerce ERC 8-4-94         |  | 2,000                       |  | $                        | 6.60      |                
|Pacific Aerospace & Electronics (units)      |  | 146,700                     |  | $                        | 3.75      |                
|Pearce Systems International, Inc. (units)   |  | 47,722                      |  | $                        | 8.70      |                
|Premium Cigars International, Ltd.           |  | 2,000                       |  | $                        | 8.40      |                
|R-B Rubber Products, Inc.                    |  | 55,100                      |  | $                        | 5.10      |                
|Sparta Surgical Corp. (units)                |  | 11,221                      |  | $                        | 12.00     |                
|Supergen, Inc. (units) ERC 3-12-97           |  | 268,950                     |  | $                        | 7.20      |                
|Telepartners A/S (units)                     |  | 102,437                     |  | $                        | 6.00      |                
|WSG Systems, Inc.                            |  | 11.0260                     |  | $                        | 6,000.00  |                

F19

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Schedule II

Paulson Capital Corp. and Subsidiary    Valuation and Qualifying Accounts    Years ended December 31, 1999, 1998 and 1997

|Description                      |  | Balance
Beginning
of Year |         | Additions-Charges
to Cost and
Expenses |   | Deductions
Write-offs |  | Balance
at End
of Year
|-------------------------------- |  | ------------------------- | ------- | -------------------------------------- | - | --------------------- |  | ----------------------
|Allowance for doubtful accounts: |  |                           |         |                                        |   |                       |  |                       
|Year ended Dec. 31, 1999         |  | $                         | 267,193 |                                        | $ |                      |  | $                     
|Year ended Dec. 31, 1998         |  |                           |        |                                        |   | 267,193               |  |                       
|Year ended Dec. 31, 1997         |  |                           |        |                                        |   |                      |  |                       

F20

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