##### Table of Contents





UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549





FORM 10-K







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

For the Fiscal Year Ended: December 31, 2009

OR



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

Commission File Number: 000-18188





PAULSON CAPITAL
CORP.

(Exact name of registrant as specified in its charter)







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



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

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





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



|                    |  |                                          
|------------------- |  | -----------------------------------------
|Title of each class |  | Name of each exchange on which
registered
|Common Stock        |  | The NASDAQ Stock Market LLC              

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





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

Act:     Yes   ̈    No  x

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

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

Indicate
by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter)
during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   ̈    No   ̈

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

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



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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ̈    No  x

The
aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant was $2,686,957, computed by reference to the last sales price ($1.13) as reported by the Nasdaq Capital Market, as of the last business day of
the Registrants most recently completed second fiscal quarter (June 30, 2009).

The number of shares outstanding of the
registrants common stock as of March 26, 2010 was 5,893,985 shares.

Documents Incorporated by Reference

Portions of the registrants definitive Proxy Statement for its 2010 Annual Meeting of Shareholders are incorporated by reference into
Part III.









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PAULSON CAPITAL CORP.

2009 FORM 10-K ANNUAL REPORT

TABLE OF CONTENTS



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



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PART I



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

Forward-Looking Statements

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

General

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



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



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



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



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

In addition, Paulson Capital Properties, LLC, a 100% owned subsidiary, was established for the purpose of purchasing, improving and remarketing
underappreciated real estate. Through December 31, 2009, we had not purchased any real estate.

Overview

Because we operate in the financial services industry, our revenues and earnings are substantially affected by general conditions in financial markets.
Further, past performance is not necessarily indicative of results to be expected in future periods. In our securities brokerage business, the amount of our revenues depends on levels of market activity requiring the services we provide. Our
corporate finance activity, which consists of acting as the managing underwriter of initial and follow-on public offerings, private investments in public equity (PIPEs) and private placements for smaller companies, is similarly affected
by the strength of the market for new equity offerings, which has historically experienced substantial cyclical fluctuation. The number of initial public offerings (IPOs) in the U.S. has declined as volatility in the U.S. economy
continues. During 2009, there were 63 U.S. IPOs with gross proceeds totaling $21.9 billion. During 2008, 43 companies completed IPOs in the U.S., with proceeds totaling $28 billion. This compares to 272 IPOs in 2007, with proceeds totaling $59.7
billion. With the VISA IPO excluded from the 2008 results, the IPOs in 2008 raised $10 billion. 2008 was the slowest year for U.S. IPOs since 1978. The low demand for IPOs in 2008 was also evidenced by the 101 companies that filed with the SEC to
withdraw proposed offerings, almost double the 51 that did so in 2007. During 2009, aggregate IPO proceeds were still below normal levels, however, IPOs accelerated throughout the year. Although we attempt to match operating costs with activity
levels, many of our expenses are either fixed or difficult to change on short notice. Accordingly, fluctuations in brokerage and corporate finance revenues tend to result in sharper fluctuations, on a percentage basis, in net income or loss.



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

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

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



|                        |  |      |        |   |      |   |         |  
|----------------------- |  | ---- | ------ | - | ---- | - | ------- | -
|Year Ended December 31, |  | 2009 |        |   | 2008 |  
|Commissions             |  | $    | 13,475 |   |      | $ | 14,390  |  
|Corporate finance       |  |      | 564    |   |      |   | 395     |  
|Investment loss         |  |      | (313   | ) |      |   | (17,729 | )
|Trading income (loss)   |  |      | 1,236  |   |      |   | (5,232  | )
|Interest and dividends  |  |      | 179    |   |      |   | 53      |  
|Other                   |  |      | 104    |   |      |   | 108     |  
|                        |  |      |        |   |      |   |         |  
|                        |  | $    | 15,245 |   |      | $ | (8,015  | )
|                        |  |      |        |   |      |   |         |  

In 2009 and 2008, none of our revenue was from foreign sources and no customer represented 10% or more of our total revenue.
In addition, all of our long-lived assets were located within the U.S.

Current Events

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

In September 2009, half of the 10% pay cuts for the salaried employees were restored. In November 2009, the remainder of the
pay cuts were restored. For 2010, we are suspending the Summer 2010 investment banking conference and the November 2010 Westergaard Conference and we plan to continue only essential business expenditures.



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Clearing Firm

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

Commissions

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

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

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

Corporate Finance

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

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



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Between June 1, 1978 and December 31, 2009, we acted as the managing underwriter or co-managing
underwriter for 165 securities offerings, raising approximately $1.2 billion for corporate finance clients. Of these, 102 were initial public offerings. We typically receive 2% to 3% of the aggregate amount of money raised in an offering to cover
nonaccountable expenses and between 7% and 9% as compensation to underwriters, selling group members and registered representatives, although these percentages may be lower for larger transactions.

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

In 2009, we completed one bridge offering in which we raised
$450,000 and one follow-on public offering in which we raised $3.4 million.

Investment Income

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

From time to time, we make investments as a principal
in companies that are, or are expected to be, corporate finance clients. The investment may be as convertible debt in anticipation of a public offering, in which case, if the offering is successful, the principal and interest are either
converted to equity or repayable from the offering proceeds. If the offering is not successful, the debt is typically converted to equity. We also make investments in companies that are not anticipating an immediate public offering. In such cases,
the investment is typically made in the form of the purchase of restricted equity securities. Typically, these type of investments have ranged from $50,000 to $1.0 million. At December 31, 2009, we held securities of 4 privately-held
companies in our investment accounts with a fair value of $2.8 million.

Trading Income and Market Making

In addition to executing trades as an agent, we regularly act as a principal in executing trades in equity securities, corporate debt securities and
municipal bonds. At December 31, 2009, we made a market in 40 securities of 30 issuers. Of these, 15 were issuers for which we had acted as managing or co-managing underwriter of public financings.

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



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Limitations on Investment and Trading Securities

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

Branch Offices

Our branch offices are generally run by independent contractors who assume liability for all the operating
expenses of the branch. We typically receive between 10% and 15% of the gross commission earned by the branch, with the balance retained by the branch to pay its expenses and staff. Persons in these branches are registered with us, and we assume the
same compliance and regulatory obligations as would be the case if we were fully responsible for the branchs expenses. As of March 26, 2010, we had 41 branch offices in Arizona, California, Colorado, Connecticut, Florida, Georgia, New
Jersey, New York, North Carolina, Oregon, Utah and Washington. All of these branches, except our offices in Portland and Salem, Oregon and Manhattan, New York, operate as independent contractor offices. We continue to be responsible for all expenses
of the Portland and Salem, Oregon and Manhattan offices.

Regulation

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

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

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

Net Capital Requirements

We are required to maintain minimum net capital under the SECs net capital rule of not less than 6.67% of our aggregate
indebtedness. In general, net capital consists of the broker-dealers net worth, adjusted by numerous factors specified in the applicable regulations. In particular, the value of securities that can be included in net capital is subject
to reduction in fair value or principal amount. The amount of the required reduction, or haircut, depends on the nature of the security. As of December 31, 2009, we had net capital of $8.9 million, which exceeded our minimum
requirement of $0.2 million by $8.7 million. The ratio of aggregate indebtedness of $2.2 million to net capital of $8.9 million at December 31, 2009, was 0.25 to 1.



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

Industry and Competition

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

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

The securities industry has become more concentrated and more competitive since we were founded, as numerous securities firms have either ceased operations or have been acquired by or merged into other
firms. In addition, the 2008 financial crisis made an unprecedented impact on the financial services industry. Most of the biggest investment banks, including Bear Stearns, Lehman Bros. and Merrill Lynch no longer exist, and Goldman Sachs and Morgan
Stanley have become bank holding companies. These developments resulted in uncertainty in the securities industry that abated in late 2009. The surviving investment banks reported strong earnings in 2009, which was driven by fixed income activity
and the reduction of competition.

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

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



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Employees

At March 26, 2010, we had 70 employees (of which 67 were full-time). Of these, 44 were executives and support staff and 26 were involved in brokerage activities and compensated primarily on a
commission basis. We also had independent contractor arrangements with 81 independent contractors, all of whom are compensated solely on a commission basis.



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

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



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

Not applicable
as there are no outstanding comment letters.



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

We lease 17,100 square feet
of office space in Portland, Oregon under a lease expiring January 2011. The base monthly rental rate on this lease is currently $29,560. Our Salem, Oregon office leases 3,759 square feet of space under a lease that expires in October 2011 at a
monthly rent of $4,393, with rent subject to increases based upon inflation. We also lease 2,500 square feet of space for our office in Manhattan, New York under a lease expiring in September 2010. The base monthly rental rate on this lease is
currently $13,264. Our operating leases are accounted for on a straight-line basis. We believe the existing leased space in Salem is adequate for our business for the foreseeable future. Based on the upcoming expiration of the leases in Portland and
Manhattan, we are currently evaluating our office space needs and options in these markets. The other branch offices lease space but, under the terms of the relationship between us and these offices, we are not responsible for these leasing costs.



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

We are named in and
subject to various proceedings and claims arising primarily from our securities business activities, including lawsuits, arbitration claims, class actions and regulatory matters. Some of these claims seek substantial compensatory, punitive or
indeterminate damages. We are also involved in other reviews, investigations and proceedings by governmental and self-regulatory agencies regarding our business, certain of which may result in adverse judgments, settlements, fines, penalties,
injunctions or other relief. Because litigation is inherently unpredictable, particularly in cases where claimants seek substantial or indeterminate damages or when investigations and proceedings are in the early stages, we cannot predict with
certainty the losses or range of losses related to such matters, how such matters will be resolved, when they will ultimately be resolved, or what the eventual settlement, fine, penalty or other relief might be. Consequently, we cannot estimate
losses or ranges of losses for matters where there is only a reasonable possibility that a loss may have been incurred. Although the ultimate outcome of these matters cannot be ascertained at this time, it is the opinion of management, after
consultation with counsel, that the resolution of the foregoing matters will not have a material adverse effect on our consolidated financial statements, taken as a whole; such resolution may, however, have a material effect on the operating results
in any future period, and, depending on the outcome and timing of any particular matter, may be material to the operating results for any period depending on the operating results for that period. We have provided loss allowances for such matters
when the likelihood of them occurring is probable and the amount can be reasonably estimated. The ultimate resolution may differ materially from the amounts provided. Settlement expense totaled $565,000 and $51,000 in 2009 and 2008, respectively.
The 2009 amount was primarily related to a failed corporate finance transaction, partially offset by insurance recoveries on customer claims.



|ITEM 4. | RESERVED
|------- | --------



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PART II



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

Stock Prices and Dividends

Our
common stock trades on the NASDAQ Capital Market under the symbol PLCC, but it is not actively traded. The following table sets forth the high and low closing sale prices of our common stock for each quarter in the two years ended
December 31, 2009.



|                             |  |      |      |     |   |     
|---------------------------- |  | ---- | ---- | --- | - | ----
|Year Ended December 31, 2008 |  | High |      | Low
|Quarter 1                    |  | $    | 5.52 |     | $ | 4.61
|Quarter 2                    |  |      | 5.29 |     |   | 3.80
|Quarter 3                    |  |      | 4.36 |     |   | 2.25
|Quarter 4                    |  |      | 2.55 |     |   | 1.00
|                             |  |     
|Year Ended December 31, 2009 |  | High |      | Low
|Quarter 1                    |  | $    | 1.60 |     | $ | 0.88
|Quarter 2                    |  |      | 1.25 |     |   | 0.80
|Quarter 3                    |  |      | 2.51 |     |   | 1.11
|Quarter 4                    |  |      | 1.88 |     |   | 1.34

As of December 31, 2009, we had
439 shareholders of record and 382 beneficial shareholders.

No dividends were declared or paid in 2008 or 2009. Net capital requirements
may limit our ability to pay future dividends to our shareholders.

Equity Compensation Plan Information

See Item 12. for Equity Compensation Plan Information.



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

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



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

OVERVIEW

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



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



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



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



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

In addition, our wholly-owned subsidiary Paulson Capital Properties, LLC was established for the purpose of purchasing, improving and remarketing
undervalued real estate. Through December 31, 2009, we had not purchased any real estate.

Because we operate in the financial services
industry, our revenues and earnings are substantially affected by general conditions in financial markets. Further, past performance is not necessarily indicative of results to be expected in future periods. In our securities brokerage business, the
amount of our revenues depends on levels of market activity requiring the services we provide. Our corporate finance



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activity, which consists of acting as the managing underwriter of initial and follow-on public offerings, private investments in public equity (PIPEs) and private placements for
smaller companies, is similarly affected by the strength of the market for new equity offerings, which has historically experienced substantial cyclical fluctuation. The number of initial public offerings (IPOs) in the U.S. has declined
as volatility in the U.S. economy continues. During 2009, there were 63 U.S. IPOs with gross proceeds totaling $21.9 billion. During 2008, 43 companies completed IPOs in the U.S., with proceeds totaling $28 billion. This compares to 272 IPOs in
2007, with proceeds totaling $59.7 billion. With the VISA IPO excluded from the 2008 results, the IPOs in 2008 raised $10 billion. 2008 was the slowest year for U.S. IPOs since 1978. The low demand for IPOs in 2008 was also evidenced by the 101
companies that filed with the SEC to withdraw proposed offerings, almost double the 51 that did so in 2007. During 2009, aggregate IPO proceeds were still below normal levels; however, IPOs accelerated throughout the year. Although we attempt to
match operating costs with activity levels, many of our expenses are either fixed or difficult to change on short notice. Accordingly, fluctuations in brokerage and corporate finance revenues tend to result in sharper fluctuations, on a percentage
basis, in net income or loss.

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

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

CURRENT EVENTS

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

In September 2009, half of the 10% pay cuts for the salaried employees were restored. In November 2009, the remainder of the
pay cuts were restored. For 2010, we are suspending the Summer 2010 investment banking conference and the November 2010 Westergaard Conference and we plan to continue only essential business expenditures.



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CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES

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

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

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

Revenue Recognition

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

Value of Underwriter
Warrants

We are required to estimate the value of all securities that we hold at the date of any financial statements and to include
that value, and changes in such value, in those financial statements. Accordingly, the aggregate fair value of our underwriter warrants is recorded as an asset on our balance sheet. When a new warrant is received, its fair value is included in
corporate finance revenue on the date on which it is earned. Subsequently, any change in fair value is recorded as investment income or loss. When a warrant is exercised, the fair value is adjusted to reflect the value of the securities purchased,
net of the exercise price, and the adjustment amount is recorded as income or loss for the relevant period. If a warrant expires unexercised, the fair value is adjusted to zero and the decrease is recorded as a loss in the relevant period. In
addition, we have recorded a liability related to underwriter warrants that were previously held by certain employees. We are obligated to pay a bonus to these employees equal to the gain recognized by us when the warrants are exercised and the
related stock is sold.

We estimate the value of our underwriter warrants using the Black-Scholes Option Pricing Model. The Black-Scholes
model requires us to use five inputs including: price, risk free rate, exercise price, time remaining on the warrant and price volatility. After stock price, the most influential factor in this model is price volatility, which we calculate for each
companys warrants based on each companys own historical stock closing prices as well as an index of historical prices for comparable companies. When we initially receive a new underwriter warrant from an initial public offering, its
calculated volatility factor is entirely based on the volatility of an index of comparable companies, since there is no price history for a new publicly traded company. As each underwriter warrant approaches its expiration date, its volatility
factor is derived primarily from the historical prices of its underlying common stock. We cannot assure you that we will ultimately be able to exercise any of our warrants in a way that will realize the value that we attribute to them in our
financial statements based on this model. At December 31, 2009, the value of underwriter warrants was $1.3 million, which is included as a separate line item on our consolidated balance sheet.



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Fair Value of Investments

In addition to our underwriter warrants, we hold other securities, some of which have very limited liquidity and some of which do not have a readily ascertainable fair value. We are required to carry
these securities at fair value. The fair value of not readily marketable securities is estimated by management using available information including the following: quoted market prices of similar securities (i.e., unrestricted shares of the same
company); price of recent known trades of the same or similar securities; the cost of the security, if recently purchased, adjusted for changes in the financial condition of the issuer; all other information available from review of available
documents related to the issuer or discussions with management of the issuer. Changes in the value of these securities are reflected currently in our results of operations as a component of investment income. Our estimates regarding the fair value
of securities that are not readily marketable are significant estimates and these estimates could change in the near term. At December 31, 2009, the fair value of investments which do not have a readily ascertainable fair value was $2.8 million
and was included as a component of trading and investment securities owned on our consolidated balance sheet.

Legal Reserves

We record reserves related to legal proceedings resulting from lawsuits and arbitrations, which arise from our business activities. Some of
these lawsuits and arbitrations claim substantial amounts, including punitive damage claims. Management has determined that it is likely that ultimate resolution in favor of the claimant will result in losses to us on certain of these claims. We
have, after consultation with outside legal counsel and consideration of facts currently known by management, recorded estimated losses to the extent we believe certain claims are probable of loss and the amount of the loss can be reasonably
estimated. Factors considered by management in estimating our liability are the loss and damages sought by the claimant/plaintiff, the merits of the claim, the amount of loss in the clients account, the possibility of wrongdoing on the part of
our employee and/or independent contractor, the total cost of defending the litigation, the likelihood of a successful defense against the claim, and the potential for fines and penalties from regulatory agencies. Results of litigation and
arbitration are inherently uncertain, and managements assessment of risk associated therewith is subject to change as the proceedings evolve. After discussion with legal counsel, management, based on its understanding of the facts, accrues
what they consider appropriate to reserve against probable loss for certain claims, which is included in the consolidated balance sheets under the caption accounts payable and accrued expenses. At December 31, 2009, we had $48,000
accrued for pending legal matters.

Income Taxes

Benefits for uncertain tax positions are recognized when they are considered more-likely-than-not to be sustained by the taxing authority. At December 31, 2009, we had unrecognized tax
benefits of $418,000, all of which would have an impact on the effective tax rate if recognized. Interest and penalties accrued on unrecognized tax benefits were $90,000. We believe it is reasonably possible that the total amount of unrecognized tax
benefits, including interest, may decrease by approximately $270,000 within the next 12 months due to the closure of certain statutes of limitations.

Stock-Based Compensation

Stock-based compensation for equity awards is measured at the grant date, based on the fair
value of the award, and is recognized as an expense over the employees requisite service period (generally the vesting period of the equity award). Our awards typically vest on the date of grant and, accordingly, the expense would be
recognized on the date of grant. We utilize the Black-Scholes option pricing model for determining the fair value of stock option awards.

RESULTS OF OPERATIONS

Our revenues and operating results are influenced by fluctuations in the equity markets as well as
general economic and market conditions, particularly conditions in the over-the-counter market, where our investment and trading positions and the underlying stock for the underwriter warrants are heavily



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concentrated. Significant fluctuations can occur in our revenues and operating results from one period to another. Our results of operations depend upon many factors, such as the number of
companies that are seeking financing, the quality and financial condition of those companies, market conditions in general, the performance of our previous underwritings and interest in certain industries by investors. As a result, revenues and
income derived from these activities may vary significantly from period to period. Our revenues include the following:



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



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



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



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

The following table sets forth the changes in our operating results in 2009 compared to 2008 (dollars in thousands):



|                                       |  |                         |        |   |                      |   |         |                        |  |   |        |   |  |       |   
|-------------------------------------- |  | ----------------------- | ------ | - | -------------------- | - | ------- | ---------------------- |  | - | ------ | - |  | ----- | --
|                                       |  | Year Ended December 31, |        |   | Improvement(Decline) |   |         | % Improvement(Decline) | 
|                                       |  | 2009                    |        |   | 2008                 |   |         |                       
|Revenues:                              |  |                         |        |   |                      |   |         |                        |  |   |        |   |  |       |   
|Commissions                            |  | $                       | 13,475 |   |                      | $ | 14,390  |                        |  | $ | (915   | ) |  | (6.4  | )%
|Corporate finance                      |  |                         | 564    |   |                      |   | 395     |                        |  |   | 169    |   |  | 42.8  |   
|Investment loss                        |  |                         | (313   | ) |                      |   | (17,729 | )                      |  |   | 17,416 |   |  | 98.2  |   
|Trading income (loss)                  |  |                         | 1,236  |   |                      |   | (5,232  | )                      |  |   | 6,468  |   |  | *     |   
|Interest and dividends                 |  |                         | 179    |   |                      |   | 53      |                        |  |   | 126    |   |  | 237.7 |   
|Other                                  |  |                         | 104    |   |                      |   | 108     |                        |  |   | (4     | ) |  | (3.7  | ) 
|                                       |  |                         |        |   |                      |   |         |                        |  |   |        |   |  |       |   
|Total revenues                         |  |                         | 15,245 |   |                      |   | (8,015  | )                      |  |   | 23,260 |   |  | *     |   
|Expenses:                              |  |                         |        |   |                      |   |         |                        |  |   |        |   |  |       |   
|Commissions and salaries               |  |                         | 12,848 |   |                      |   | 13,362  |                        |  |   | 514    |   |  | 3.8   |   
|Underwriting expenses                  |  |                         | 209    |   |                      |   | 429     |                        |  |   | 220    |   |  | 51.3  |   
|Rent, telephone and quotation services |  |                         | 1,169  |   |                      |   | 1,174   |                        |  |   | 5      |   |  | 0.4   |   
|Professional fees                      |  |                         | 730    |   |                      |   | 808     |                        |  |   | 78     |   |  | 9.7   |   
|Travel and entertainment               |  |                         | 143    |   |                      |   | 252     |                        |  |   | 109    |   |  | 43.3  |   
|Advertising and promotion              |  |                         | 185    |   |                      |   | 202     |                        |  |   | 17     |   |  | 8.4   |   
|Settlement expense                     |  |                         | 565    |   |                      |   | 51      |                        |  |   | (514   | ) |  | *     |   
|Bad debt expense                       |  |                         | 1,214  |   |                      |   | 21      |                        |  |   | (1,193 | ) |  | *     |   
|Depreciation and amortization          |  |                         | 55     |   |                      |   | 107     |                        |  |   | 52     |   |  | 48.6  |   
|Other                                  |  |                         | 1,022  |   |                      |   | 1,599   |                        |  |   | 577    |   |  | 36.1  |   
|                                       |  |                         |        |   |                      |   |         |                        |  |   |        |   |  |       |   
|Total expenses                         |  |                         | 18,140 |   |                      |   | 18,005  |                        |  |   | (135   | ) |  | (0.8  | ) 
|                                       |  |                         |        |   |                      |   |         |                        |  |   |        |   |  |       |   
|Loss before income taxes               |  | $                       | (2,895 | ) |                      | $ | (26,020 | )                      |  | $ | 23,125 |   |  | 88.9  | % 
|                                       |  |                         |        |   |                      |   |         |                        |  |   |        |   |  |       |   



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

Revenues

The global economic turmoil that started in the fall of 2008 eased during 2009. For the period from December 31, 2008 to
December 31, 2009, the Dow Jones Industrial average increased 18.8% and the NASDAQ composite increased 43.8%.

Commissions decreased 6.4%
in 2009 compared to 2008, primarily as a result of market uncertainty beginning in the third quarter of 2008, with improvement not until late 2009. We had 92 registered representatives at December 31, 2009 compared to 96 at December 31,
2008.

Corporate finance revenue in 2009 included underwriting discounts earned from the following:



| |  |  | a bridge offering in which we raised $450,000;
| | - |  | ----------------------------------------------



| |  |  | a follow-on public offering in which we raised $3.4 million for ICOP Digital, Inc., as well as the Black-Scholes value of the underwriter warrants
received in connection with that offering; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | revenue related to our participation in closed-end mutual funds.
| | - |  | ----------------------------------------------------------------



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



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

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



|                                                                                                                                                                        |  |                         |        |   |      |   |         |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | ------ | - | ---- | - | ------- | -
|                                                                                                                                                                        |  | Year Ended December 31, |       
|                                                                                                                                                                        |  | 2009                    |        |   | 2008 |  
|Net unrealized depreciation related to underwriter warrants                                                                                                             |  | $                       | (602   | ) |      | $ | (15,160 | )
|Net unrealized depreciation of underwriter warrants  employee and independent contractor                                                                               |  |                         | 114    |   |      |   | 527     |  
|Net unrealized appreciation of securities held based on quoted market prices or, for securities that are not readily marketable,
our estimate of their fair value       |  |                         | 3,922  |   |      |   | 4,554   |  
|Net realized losses on the sale of securities with quoted market prices, securities that are not readily marketable and gains
from the exercise of underwriter warrants |  |                         | (3,747 | ) |      |   | (7,650  | )
|                                                                                                                                                                        |  |                         |        |   |      |   |         |  
|                                                                                                                                                                        |  | $                       | (313   | ) |      | $ | (17,729 | )
|                                                                                                                                                                        |  |                         |        |   |      |   |         |  

We did not exercise any underwriter warrants in 2009 and we exercised two underwriter warrants in 2008 Generally, when we
exercise a warrant to obtain the underlying common stock, the common stock is subsequently sold in the near term and the related gain is reflected as a component of investment income.

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

Trading income increased to
$1.2 million in 2009 compared to a loss of $5.2 million in 2008. In 2009, trading income was positively affected by favorable results for certain securities that we were holding in our trading inventories. In 2008, trading income was negatively
affected by difficult conditions in the market, especially the significant downturn in the third and fourth quarters of 2008. Our focus is on very small capitalization issues, especially those tied to our corporate finance clients. Trading income
(loss) can be volatile from period to period because it is driven by the fair value of the securities in which we make a market.

Expenses

Total expenses decreased $0.1 million in 2009 compared to 2008, as described in more detail below.

Commissions and salaries decreased $0.5 million in 2009 compared to 2008. The decrease was primarily due to lower commissions earned on lower commission
revenue, partially offset by $0.2 million of non-cash, stock-based compensation. The 2009 results were also positively affected by our staff reductions and salary decreases as discussed above. Retail commissions as a percentage of retail sales was
comparable period over period.

Underwriting expenses decreased $220,000 in 2009 compared to 2008 primarily as a result of lower expenditures
on fewer completed and potential investment banking deals.

Travel and entertainment expenses decreased $109,000 in 2009 compared to 2008
primarily as a result of the Westergaard investment banking conference in June 2008 with no comparable conference in 2009.

Settlement expense
of $0.6 million in 2009 was primarily related to a failed corporate finance transaction, partially offset by insurance recoveries on customer claims. Settlement expense of $51,000 in 2008 was related to various legal matters that were resolved
during 2008.

Bad debt expense is recorded when amounts are determined to be uncollectible. Bad debt expense of $1.2 million in 2009 was
mainly related to write-offs of notes receivable primarily from two corporate finance clients.



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Other expense decreased $0.6 million in 2009 compared to 2008 primarily as a result of lack of sponsorship
of certain conferences and fewer discretionary expenditures.

LIQUIDITY AND CAPITAL RESOURCES

Our primary sources of liquidity include our cash and receivables from our clearing organization, offset by payables to our clearing organization.

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

We believe our cash and receivables from our clearing organization at December 31, 2009 are sufficient to meet our cash and regulatory net capital needs for at least the next twelve-month period from
December 31, 2009. Our liquidity could be negatively affected by protracted unfavorable market conditions. The major market indices declined significantly during 2008 and this decline continued in the first quarter of 2009, with improvements in
the later part of 2009.

As a securities broker-dealer, we are required by SEC regulations to meet certain liquidity and capital standards. We
believe we were in compliance with these standards at December 31, 2009.

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

At December 31, 2009, we owned 10 underwriter warrants from 8 issuers, all but one of which was
exercisable. None of the warrants had an exercise price below the December 31, 2009 market price of the securities receivable upon exercise. There is little or no direct relationship between the intrinsic value of our underwriter warrants at
the end of any given period and the fair value calculated using the Black-Scholes option pricing model. The prices of the securities underlying the underwriter warrants are very volatile, and substantial fluctuations in their fair value can be
expected in the future.

Cash used in operating activities totaled $41,000 in 2009, primarily due to our net loss of $2.4 million being offset
by net non-cash expense items of $3.1 million and changes in our operating assets and liabilities as discussed in more detail below.

Our net
receivable from our clearing organization increased $3.2 million to $8.2 million at December 31, 2009 from $5.0 million at December 31, 2008, primarily due to the results of the activity in our trading and investment accounts and income
tax refunds, as well as the timing of general corporate expenditures and cash flow requirements.

Notes and other receivables decreased $0.1
million to $0.5 million at December 31, 2009 from $0.6 million at December 31, 2008, primarily due to additional amounts loaned to corporate finance clients, offset by the conversion of a $0.4 million corporate finance client note
receivable to an equity investment and $1.2 million of write-offs of notes receivable primarily from two of our corporate finance clients.



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Income taxes receivable, current decreased $4.3 million to $2.2 million at December 31, 2009 from $6.5
million at December 31, 2008, primarily due to refunds received, offset by receivables recorded for losses generated in 2009.

Deferred
tax assets decreased $1.4 million to zero at December 31, 2009 from an asset of $1.4 million at December 31, 2008, primarily due to sales of securities that were in a loss position plus the recording of a $0.3 million valuation allowance
against all remaining deferred tax assets.

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

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



|                                         |  |   |       |  
|---------------------------------------- |  | - | ----- | -
|Balance, December 31, 2008               |  | $ | 1,675 |  
|Receipt of underwriter warrants          |  |   | 217   |  
|Net unrealized loss on value of warrants |  |   | (592  | )
|Warrants exercised or expired            |  |   | (10   | )
|                                         |  |   |       |  
|Balance, December 31, 2009               |  | $ | 1,290 |  
|                                         |  |   |       |  

Compensation, employee benefits and payroll taxes increased $0.3 million to $0.8 million at December 31, 2009 from $0.5
million at December 31, 2008, primarily due to greater commissions earned in December 2009 relative to December 2008.

Deferred revenue
of $0.3 million at December 31, 2009 related to amounts received from our clearing firm based on the execution of a five-year agreement and a one-year extension of the agreement, and is being amortized at the rate of $8,333 per month through
September 2012.

Underwriter warrants  employee and independent contractor liability of $10,000 at December 31, 2009 represented
the fair value of underwriter warrants held for which the gain from the sale of the related stock upon exercise is due to certain employees.

In September 2001, our Board of Directors approved a stock repurchase program pursuant to which we are authorized to repurchase up to 600,000 shares of our common stock. In addition, in June 2008, our Board of Directors approved the
repurchase of up to a total of an additional 200,000 shares of our common stock. We repurchased 48,000 shares during 2009 and, at December 31, 2009, 195,011 shares remained available for repurchase. These repurchase programs do not have an
expiration date.

OFF-BALANCE SHEET ARRANGEMENTS

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

NEW ACCOUNTING PRONOUNCEMENTS

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

CONTRACTUAL PAYMENT OBLIGATIONS

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



16



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##### Table of Contents

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

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



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

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



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

None.



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

Disclosure
Controls and Procedures

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

Managements
Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rules 13a 15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we conducted
an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control  Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based
on our evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2009.

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

Changes in Internal Controls

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



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

None.



17



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##### Table of Contents

PART III



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

The information required by this item is incorporated by reference to the information under the captions Election of Directors, Executive Officers, Meetings and Committees of
the Board of Directors, Audit Committee Financial Expert and Section 16(a) Beneficial Ownership Reporting Compliance in our Proxy Statement for our 2010 Annual Meeting of Shareholders to be filed with the
Securities and Exchange Commission within 120 days after the end of our fiscal year.

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



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

The information
required by this item is incorporated by reference to the information under the captions Director Compensation and Executive Compensation in our Proxy Statement for our 2010 Annual Meeting of Shareholders to be filed with the
Securities and Exchange Commission within 120 days after the end of our fiscal year.



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

Equity Compensation Plan Information

The following table summarizes equity securities authorized for issuance pursuant to compensation plans as of December 31, 2009.



|                                                       |  |                                                                                             |  |                                                                             |      |                                                                                                                                            |  
|------------------------------------------------------ |  | ------------------------------------------------------------------------------------------- |  | --------------------------------------------------------------------------- | ---- | ------------------------------------------------------------------------------------------------------------------------------------------ | -
|Plan Category                                          |  | Number of securitiesto be issued uponexercise ofoutstanding options,warrants and rights (a) |  | Weighted averageexercise price ofoutstandingoptions, warrantsand rights
(b) |      | Number of securitiesremaining available for futureissuance under equitycompensation
plans(excluding securities reflectedin column (a)) (c)
|Equity compensation plans approved by shareholders(1)  |  | 476,000                                                                                     |  | $                                                                           | 1.13 |                                                                                                                                            | 
|                                                       |  |                                                                                             | 
|Equity compensation plans not approved by shareholders |  |                                                                                            |  |                                                                             |     |                                                                                                                                            | 
|                                                       |  |                                                                                             |  |                                                                             |      |                                                                                                                                            |  
|Total                                                  |  | 476,000                                                                                     |  | $                                                                           | 1.13 |                                                                                                                                            | 
|                                                       |  |                                                                                             |  |                                                                             |      |                                                                                                                                            |  



|(1) | Includes our 1999 Stock Option Plan, which expired in September 2009.
|--- | ---------------------------------------------------------------------

Additional information required by this item is incorporated by reference to the information under the caption Stock Ownership of Principal Owners and Management in our Proxy Statement for our
2010 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days after the end of our fiscal year.



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

Information required by this item is incorporated by reference to the information under the caption Director Independence in our Proxy Statement for our 2010 Annual Meeting of Shareholders to
be filed with the Securities and Exchange Commission within 120 days after the end of our fiscal year.



18



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##### Table of Contents

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

The information required by this item is incorporated by reference to the information under the caption Independent Registered Public Accountants in our Proxy Statement for our 2010 Annual Meeting of Shareholders to be filed
with the Securities and Exchange Commission within 120 days after the end of our fiscal year.

PART
IV



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

Financial Statements and Schedules

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



|                                                                                               |  |     
|---------------------------------------------------------------------------------------------- |  | ----
|                                                                                               |  | Page
|Report of McGladrey & Pullen, LLP, Independent Registered Public Accounting Firm               |  | F-1 
|                                                                                               | 
|Consolidated Balance Sheets as of December 31, 2009 and 2008                                   |  | F-2 
|                                                                                               | 
|Consolidated Statements of Operations for the years ended December 31, 2009 and 2008           |  | F-3 
|                                                                                               | 
|Consolidated Statements of Shareholders Equity for the years ended December 31, 2009 and 2008 |  | F-4 
|                                                                                               | 
|Consolidated Statements of Cash Flows for the years ended December 31, 2009 and 2008           |  | F-5 
|                                                                                               | 
|Notes to Consolidated Financial Statements                                                     |  | F-6 
|                                                                                               | 
|Supplementary Schedule of Warrants Owned                                                       |  | F-19
|                                                                                               | 
|Schedule II  Valuation and Qualifying Accounts                                                |  | F-20

Exhibits

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



|       |  |                                                                                                                                                                                                                                                      
|------ |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Number |  | Description                                                                                                                                                                                                                                          
|       | 
|3.1    |  | Articles of Incorporation (incorporated by reference to Exhibit 3.1 to our Registration Statement on Form 10 filed with the Securities and Exchange Commission on December 18,
1989 ).                                                               
|       | 
|3.2    |  | Amended and Restated Bylaws (incorporated by reference to Exhibit 3.1 to Form 8-K filed December 18, 2007).                                                                                                                                          
|       | 
|10.1   |  | Office Lease renewal for the period from June 1, 1997 to May 31, 2001, dated as of May 6, 1997 (incorporated by reference to Exhibit 10.4 to Form 10-QSB for the
quarter ended June 30, 1997).                                                       
|       | 
|10.2   |  | Amendment 1 to Office Lease dated as of May 6, 1997 (incorporated by reference to Exhibit 10.5 to Form 10-KSB for the year ended December 31, 2001).                                                                                                 
|       | 
|10.3   |  | Amendment 2 to Office Lease dated as of May 6, 1997 (incorporated by reference to Exhibit 10.3 to Form 10-K for the year ended December 31, 2008).                                                                                                   
|       | 
|10.4*  |  | 1999 Stock Option Plan (incorporated by reference to Exhibit 10.5 to Form 10-KSB for the year ended December 31, 1999).                                                                                                                              
|       | 
|10.5*  |  | Form of Incentive Stock Option Agreement for July 2009 stock option grants pursuant to the Paulson Capital Corporation 1999 Stock Option Plan. (incorporated by reference to Exhibit
10.1 to Form 10-Q for the quarter ended September 30, 2009).    
|       | 
|10.6*  |  | Form of Non-Qualified Stock Option Agreement for July 2009 stock option grants pursuant to the Paulson Capital Corporation 1999 Stock Option Plan. (incorporated by reference to
Exhibit 10.2 to Form 10-Q for the quarter ended September 30, 2009).
|       | 
|10.7   |  | Fully Disclosed Clearing Agreement between RBC Dain Correspondent Services and Paulson Investment Company, Inc. (incorporated by reference to Exhibit 10.1 to Form 10-Q for the
quarter ended June 30, 2006).                                        
|       | 
|21     |  | Subsidiaries of Paulson Capital Corp. (incorporated by reference to Exhibit 21 to Form 10-K for the year ended December 31, 2008).                                                                                                                   
|       | 
|23     |  | Consent of McGladrey & Pullen, LLP.                                                                                                                                                                                                                  
|       | 
|31.1   |  | Certification of Principal Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934.                                                                                                                    
|       | 
|31.2   |  | Certification of Principal Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934.                                                                                                                    
|       | 
|32.1   |  | Certification of Principal Executive Officer pursuant to Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.                                                                                         
|       | 
|32.2   |  | Certification of Principal Financial Officer pursuant to Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.                                                                                         



19



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##### Table of Contents

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Paulson Capital Corp. has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized on March 30, 2010:



PAULSON CAPITAL CORP.(Registrant)By

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


Pursuant to the
requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 30, 2010.



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



20



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##### Table of Contents

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders

Paulson Capital Corp.

We have audited the accompanying consolidated balance sheets of Paulson
Capital Corp. and Subsidiaries as of December 31, 2009 and 2008, and the related consolidated statements of operations, shareholders equity and cash flows for the years then ended. Our audits also included the financial statement
schedules of Paulson Capital Corp. and Subsidiaries listed in Item 15. These financial statements and financial statement schedules are the responsibility of the Companys management. Our responsibility is to express an opinion on these
financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Paulson Capital Corp. and Subsidiaries as of December 31, 2009 and 2008, and the results of their operations and their cash flows for the years then ended, in conformity with
U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the
information set forth therein.

We were not engaged to examine managements assessment of the effectiveness of Paulson Capital Corp. and
Subsidiaries internal control over financial reporting as of December 31, 2009 included in the accompanying Managements Report on Internal Control Over Financial Reporting and, accordingly, we do not express an opinion thereon.

/s/ McGladrey & Pullen, LLP

Chicago, Illinois

March 30, 2010



F-1



---

##### Table of Contents

Paulson Capital Corp. and Subsidiaries

Consolidated Balance Sheets



|                                                                                                                 |  |              |            |      |   |           
|---------------------------------------------------------------------------------------------------------------- |  | ------------ | ---------- | ---- | - | ----------
|                                                                                                                 |  | December 31,
|                                                                                                                 |  | 2009         |            | 2008
|Assets                                                                                                           |  |              |            |      |   |           
|Cash                                                                                                             |  | $            | 245,292    |      | $ | 318,810   
|Receivable from clearing organization                                                                            |  |              | 10,505,232 |      |   | 7,469,811 
|Notes and other receivables                                                                                      |  |              | 524,231    |      |   | 635,027   
|Income taxes receivable                                                                                          |  |              | 2,181,895  |      |   | 6,480,699 
|Deferred income taxes                                                                                            |  |              |           |      |   | 1,409,000 
|Trading and investment securities owned, at fair value                                                           |  |              | 7,848,363  |      |   | 6,611,097 
|Underwriter warrants, at fair value                                                                              |  |              | 1,290,000  |      |   | 1,675,000 
|Prepaid and deferred expenses                                                                                    |  |              | 844,211    |      |   | 885,136   
|Furniture and equipment, at cost, net of accumulated depreciation and amortization of $898,107 and $881,621      |  |              | 41,767     |      |   | 94,991    
|                                                                                                                 |  |              |            |      |   |           
|Total Assets                                                                                                     |  | $            | 23,480,991 |      | $ | 25,579,571
|                                                                                                                 |  |              |            |      |   |           
|                                                                                                                 |  |             
|Liabilities and Shareholders Equity                                                                             |  |              |            |      |   |           
|Accounts payable and accrued liabilities                                                                         |  | $            | 742,641    |      | $ | 675,491   
|Payable to clearing organization                                                                                 |  |              | 2,288,945  |      |   | 2,490,075 
|Compensation, employee benefits and payroll taxes                                                                |  |              | 767,574    |      |   | 497,791   
|Trading securities sold, not yet purchased, at fair value                                                        |  |              | 284        |      |   |          
|Income taxes payable - long-term                                                                                 |  |              | 508,460    |      |   | 315,000   
|Deferred revenue                                                                                                 |  |              | 275,000    |      |   | 375,000   
|Underwriter warrantsemployee and independent contractor, at fair value                                          |  |              | 10,000     |      |   | 124,000   
|                                                                                                                 |  |              |            |      |   |           
|Total Liabilities                                                                                                |  |              | 4,592,904  |      |   | 4,477,357 
|                                                                                                                 |  |             
|Commitments and Contingencies (Note 11)                                                                          |  |              |           |      |   |          
|                                                                                                                 |  |             
|Shareholders Equity                                                                                             |  |              |            |      |   |           
|Preferred stock, no par value; 500,000 shares authorized; none issued                                            |  |              |           |      |   |          
|Common stock, no par value; 20,000,000 shares authorized; shares issued and outstanding: 5,891,785 and
5,928,285 |  |              | 2,190,435  |      |   | 1,947,280 
|                                                                                                                 | 
|Retained earnings                                                                                                |  |              | 16,697,652 |      |   | 19,154,934
|                                                                                                                 |  |              |            |      |   |           
|Total Shareholders Equity                                                                                       |  |              | 18,888,087 |      |   | 21,102,214
|                                                                                                                 |  |              |            |      |   |           
|Total Liabilities and Shareholders Equity                                                                       |  | $            | 23,480,991 |      | $ | 25,579,571
|                                                                                                                 |  |              |            |      |   |           

See accompanying Notes to Consolidated Financial
Statements.



F-2



---

##### Table of Contents

Paulson Capital Corp. and Subsidiaries

Consolidated Statements of Operations



|                                                        |  |                                 |            |   |      |   |             |  
|------------------------------------------------------- |  | ------------------------------- | ---------- | - | ---- | - | ----------- | -
|                                                        |  | For the Year Ended December 31, |           
|                                                        |  | 2009                            |            |   | 2008 |  
|Revenues                                                |  |                                 |            |   |      |   |             |  
|Commissions                                             |  | $                               | 13,475,302 |   |      | $ | 14,390,079  |  
|Corporate finance                                       |  |                                 | 563,605    |   |      |   | 395,389     |  
|Investment loss                                         |  |                                 | (312,969   | ) |      |   | (17,728,748 | )
|Trading income (loss)                                   |  |                                 | 1,236,406  |   |      |   | (5,232,435  | )
|Interest and dividends                                  |  |                                 | 179,183    |   |      |   | 52,792      |  
|Other                                                   |  |                                 | 103,416    |   |      |   | 107,692     |  
|                                                        |  |                                 |            |   |      |   |             |  
|                                                        |  |                                 | 15,244,943 |   |      |   | (8,015,231  | )
|                                                        |  |                                
|Expenses                                                |  |                                 |            |   |      |   |             |  
|Commissions and salaries                                |  |                                 | 12,848,250 |   |      |   | 13,362,807  |  
|Underwriting expenses                                   |  |                                 | 208,815    |   |      |   | 428,440     |  
|Rent, telephone and quotation services                  |  |                                 | 1,168,873  |   |      |   | 1,173,426   |  
|Professional fees                                       |  |                                 | 729,673    |   |      |   | 807,426     |  
|Travel and entertainment                                |  |                                 | 143,112    |   |      |   | 252,094     |  
|Advertising and promotion                               |  |                                 | 184,788    |   |      |   | 202,098     |  
|Settlement expense                                      |  |                                 | 565,384    |   |      |   | 51,300      |  
|Bad debt expense                                        |  |                                 | 1,214,268  |   |      |   | 20,727      |  
|Depreciation and amortization                           |  |                                 | 55,425     |   |      |   | 107,206     |  
|Other                                                   |  |                                 | 1,021,477  |   |      |   | 1,599,145   |  
|                                                        |  |                                 |            |   |      |   |             |  
|                                                        |  |                                 | 18,140,065 |   |      |   | 18,004,669  |  
|                                                        |  |                                 |            |   |      |   |             |  
|                                                        |  |                                
|Loss before income taxes                                |  |                                 | (2,895,122 | ) |      |   | (26,019,900 | )
|                                                        |  |                                
|Income tax expense (benefit):                           |  |                                 |            |   |      |   |             |  
|Current                                                 |  |                                 | (1,879,000 | ) |      |   | (5,696,000  | )
|Deferred                                                |  |                                 | 1,409,000  |   |      |   | (3,230,000  | )
|                                                        |  |                                 |            |   |      |   |             |  
|                                                        |  |                                 | (470,000   | ) |      |   | (8,926,000  | )
|                                                        |  |                                 |            |   |      |   |             |  
|Net loss                                                |  | $                               | (2,425,122 | ) |      | $ | (17,093,900 | )
|                                                        |  |                                 |            |   |      |   |             |  
|Basic and diluted net loss per share                    |  | $                               | (0.41      | ) |      | $ | (2.86       | )
|                                                        |  |                                 |            |   |      |   |             |  
|Shares used in basic and diluted per share calculations |  |                                 | 5,904,484  |   |      |   | 5,966,676   |  
|                                                        |  |                                 |            |   |      |   |             |  

See accompanying Notes to Consolidated Financial Statements.



F-3



---

##### Table of Contents

Paulson Capital Corp. and Subsidiaries

Consolidated Statements of Shareholders Equity

For the Years Ended December 31, 2009 and 2008



|                                                       |  |              |   |  |                  |           |   |                          |   |             |   |  |   |             |  
|------------------------------------------------------ |  | ------------ | - |  | ---------------- | --------- | - | ------------------------ | - | ----------- | - |  | - | ----------- | -
|                                                       |  | Common Stock |   |  | RetainedEarnings |           |   | TotalShareholdersEquity |  
|                                                       |  | Shares       |   |  | Amount           |           |   |                         
|Balance at December 31, 2007                           |  | 6,037,150    |   |  | $                | 1,972,319 |   |                          | $ | 36,720,558  |   |  | $ | 38,692,877  |  
|                                                       |  |              |   | 
|Redemption of common stock                             |  | (108,865     | ) |  |                  | (25,039   | ) |                          |   | (471,724    | ) |  |   | (496,763    | )
|Net loss                                               |  |             |   |  |                  |          |   |                          |   | (17,093,900 | ) |  |   | (17,093,900 | )
|                                                       |  |              |   |  |                  |           |   |                          |   |             |   |  |   |             |  
|Balance at December 31, 2008                           |  | 5,928,285    |   |  |                  | 1,947,280 |   |                          |   | 19,154,934  |   |  |   | 21,102,214  |  
|                                                       |  |              |   | 
|Stock option grant                                     |  |             |   |  |                  | 241,000   |   |                          |   |            |   |  |   | 241,000     |  
|Stock options exercised and related income tax benefit |  | 11,500       |   |  |                  | 13,195    |   |                          |   |            |   |  |   | 13,195      |  
|Redemption of common stock                             |  | (48,000      | ) |  |                  | (11,040   | ) |                          |   | (32,160     | ) |  |   | (43,200     | )
|Net loss                                               |  |             |   |  |                  |          |   |                          |   | (2,425,122  | ) |  |   | (2,425,122  | )
|                                                       |  |              |   |  |                  |           |   |                          |   |             |   |  |   |             |  
|Balance at December 31, 2009                           |  | 5,891,785    |   |  | $                | 2,190,435 |   |                          | $ | 16,697,652  |   |  | $ | 18,888,087  |  
|                                                       |  |              |   |  |                  |           |   |                          |   |             |   |  |   |             |  

See accompanying Notes to Consolidated Financial Statements.



F-4



---

##### Table of Contents

Paulson Capital Corp. and Subsidiaries

Consolidated Statements of Cash Flows



|                                                                                                |  |                                 |            |   |      |   |             |  
|----------------------------------------------------------------------------------------------- |  | ------------------------------- | ---------- | - | ---- | - | ----------- | -
|                                                                                                |  | For the Year Ended December 31, |           
|                                                                                                |  | 2009                            |            |   | 2008 |  
|Cash flows from operating activities:                                                           |  |                                 |            |   |      |   |             |  
|Net loss                                                                                        |  | $                               | (2,425,122 | ) |      | $ | (17,093,900 | )
|Adjustments to reconcile net loss to net cash flows provided by (used in) operating activities: |  |                                 |            |   |      |   |             |  
|Receipt of underwriter warrants                                                                 |  |                                 | (217,000   | ) |      |   | (462,320    | )
|Unrealized depreciation/expiration of underwriter warrants                                      |  |                                 | 602,000    |   |      |   | 15,160,320  |  
|Unrealized depreciation of underwriter warrants - employee and independent contractor           |  |                                 | (114,000   | ) |      |   | (527,000    | )
|Stock-based compensation                                                                        |  |                                 | 241,000    |   |      |   |            |  
|Depreciation and amortization                                                                   |  |                                 | 55,425     |   |      |   | 107,205     |  
|Deferred income taxes                                                                           |  |                                 | 1,094,654  |   |      |   | (3,938,974  | )
|Valuation allowance on deferred tax assets                                                      |  |                                 | 314,346    |   |      |   | 708,974     |  
|Deferred revenue                                                                                |  |                                 | (100,000   | ) |      |   |            |  
|Bad debt expense                                                                                |  |                                 | 1,214,268  |   |      |   | 20,727      |  
|Loss on asset disposition                                                                       |  |                                 | 280        |   |      |   |            |  
|Change in assets and liabilities:                                                               |  |                                 |            |   |      |   |             |  
|Receivable from/payable to clearing organization                                                |  |                                 | (3,236,551 | ) |      |   | 4,259,192   |  
|Notes and other receivables                                                                     |  |                                 | (698,513   | ) |      |   | 907,776     |  
|Income taxes receivable                                                                         |  |                                 | 4,298,804  |   |      |   | (6,480,699  | )
|Trading and investment securities owned                                                         |  |                                 | (1,642,225 | ) |      |   | 13,583,817  |  
|Prepaid and deferred expenses                                                                   |  |                                 | 40,925     |   |      |   | 54,235      |  
|Accounts payable, accrued liabilities and compensation payables                                 |  |                                 | 336,933    |   |      |   | (4,133,567  | )
|Trading securities sold, not yet purchased                                                      |  |                                 | 284        |   |      |   | (36,259     | )
|Income taxes payable - current                                                                  |  |                                 |           |   |      |   | (1,369,710  | )
|Income taxes payable - long term                                                                |  |                                 | 193,460    |   |      |   | 18,000      |  
|                                                                                                |  |                                 |            |   |      |   |             |  
|Net cash provided by (used in) operating activities                                             |  |                                 | (41,032    | ) |      |   | 777,817     |  
|                                                                                                |  |                                
|Cash flows from investing activities:                                                           |  |                                 |            |   |      |   |             |  
|Additions to furniture and equipment                                                            |  |                                 | (2,481     | ) |      |   | (5,863      | )
|                                                                                                |  |                                 |            |   |      |   |             |  
|Net cash used in investing activities                                                           |  |                                 | (2,481     | ) |      |   | (5,863      | )
|                                                                                                |  |                                
|Cash flows from financing activities:                                                           |  |                                 |            |   |      |   |             |  
|Proceeds from stock option exercise and related tax benefit                                     |  |                                 | 13,195     |   |      |   |            |  
|Redemption of common stock                                                                      |  |                                 | (43,200    | ) |      |   | (496,763    | )
|                                                                                                |  |                                 |            |   |      |   |             |  
|Net cash used in financing activities                                                           |  |                                 | (30,005    | ) |      |   | (496,763    | )
|                                                                                                |  |                                 |            |   |      |   |             |  
|                                                                                                |  |                                
|Increase (decrease) in cash                                                                     |  |                                 | (73,518    | ) |      |   | 275,191     |  
|                                                                                                |  |                                
|Cash:                                                                                           |  |                                 |            |   |      |   |             |  
|Beginning of year                                                                               |  |                                 | 318,810    |   |      |   | 43,619      |  
|                                                                                                |  |                                 |            |   |      |   |             |  
|End of year                                                                                     |  | $                               | 245,292    |   |      | $ | 318,810     |  
|                                                                                                |  |                                 |            |   |      |   |             |  
|                                                                                                |  |                                
|Supplemental cash flow information:                                                             |  |                                 |            |   |      |   |             |  
|Cash received (paid) during the period for income taxes, net                                    |  | $                               | 6,371,464  |   |      | $ | (2,136,409  | )
|                                                                                                |  |                                
|Supplemental non-cash information:                                                              |  |                                 |            |   |      |   |             |  
|Conversion of corporate finance client note receivable to equity investment                     |  | $                               | 404,959    |   |      | $ |            |  

See accompanying Notes
to Consolidated Financial Statements.



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PAULSON CAPITAL CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization

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

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

During 2008, Paulson Capital Corp. formed a new
100% owned subsidiary, Paulson Capital Properties, LLC, for the purpose of purchasing, improving and remarketing undervalued real estate. Through December 31, 2009, we had not purchased any real estate.

Summary of Significant Accounting Policies

Codification

Effective July 1, 2009, the Financial Accounting Standards Boards (FASB) Accounting
Standards Codification (ASC) became the single official source of authoritative, nongovernmental generally accepted accounting principles (GAAP) in the United States. The historical GAAP hierarchy was eliminated and the
ASC became the only level of authoritative GAAP, other than guidance issued by the Securities and Exchange Commission. Our accounting policies were not affected by the conversion to ASC.

Principles of Consolidation

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

Use of Estimates

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

Revenue Recognition

Securities transactions and related revenue are recorded on a trade date basis. Managers fees, underwriters fees, and other underwriting revenues are recognized at the time the underwriting is completed. Tax deferred revenue is
recognized at the time individual tax deferred units are sold. Revenue from the receipt of underwriter warrants is recognized on the date the warrants are received based on the



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fair value of the securities received as estimated using the Black-Scholes option-pricing model taking into account the exercise price, remaining life of the warrant, the current price of the
underlying stock and its expected volatility, expected dividends on the stock and the risk-free interest rate for the remaining term of the warrant.

Cash

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

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

Fair Value of Trading and Investment Securities Owned

Our trading and investment securities owned consist of both marketable securities and not readily marketable securities and are recorded at fair value.
Changes in the value of these securities are reflected currently in our results of operations as a component of investment income. See also Notes 4 and 5.

Fair Value of Underwriter Warrants

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

In addition, we have recorded a liability related to
underwriter warrants that were previously held by certain employees. We are obligated to pay a bonus to these employees equal to the gain recognized by us when the warrants are exercised and the related stock is sold. See also Note 4.

Fair Value of Financial Instruments

Substantially all of our financial instruments are carried at fair value or amounts that approximate fair value. The carrying amounts reflected in the financial statements for cash, receivables and payables approximate their respective fair
values due to the short-term nature of these items. The fair values of securities owned and trading securities sold, not yet purchased are equal to the carrying value. Changes in the fair value of these securities are reflected currently in our
results of operations. Other than those separately disclosed in Note 4, our remaining financial instruments are generally short-term in nature and their carrying values approximate fair value.

Furniture and Equipment

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

Income Taxes

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



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We recognize benefits for uncertain tax positions if we determine that they are
more-likely-than-not to be sustained by the taxing authority. Interest and penalties accrued on unrecognized tax benefits are recognized as tax expense.

Earnings Per Share

Basic earnings per share is computed based on the weighted
average number of common shares outstanding during the year. Diluted earnings per share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the year. Common equivalent shares from
stock options are excluded from the computation when their effect is antidilutive. Basic earnings per share is the same as diluted earnings per share for the years ended December 31, 2009 and 2008 since we were in a loss position in both years.

Advertising

Advertising costs are charged to expense when incurred. Advertising expense for the years ended December 31, 2009 and 2008 totaled $185,000 and $202,000, respectively.

Stock-Based Compensation

Stock-based compensation cost for equity classified awards
is measured at the grant date, based on the fair value of the award, and is recognized as an expense over the employees requisite service period (generally the vesting period of the equity award). We utilize the Black-Scholes option pricing
model for determining the fair value of awards.

Comprehensive Income (Loss)

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

NOTE 2 - RECEIVABLE FROM AND PAYABLE TO CLEARING ORGANIZATION

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

At December 31, 2009, the receivable from RBC CS was comprised of $0.7 million in commissions
receivable and $9.8 million in deposits to facilitate principal trading activity.

At December 31, 2009, the payable to RBC CS was
comprised entirely of amounts used to finance principal trading activity.

NOTE 3 - NOTES AND OTHER RECEIVABLES

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



|                    |  |              |     |      |   |    
|------------------- |  | ------------ | --- | ---- | - | ---
|                    |  | December 31,
|                    |  | 2009         |     | 2008
|Officers            |  | $            | 61  |      | $ | 68 
|Employees           |  |              | 35  |      |   | 43 
|Independent brokers |  |              | 279 |      |   | 72 
|Other               |  |              | 149 |      |   | 452
|                    |  |              |     |      |   |    
|                    |  | $            | 524 |      | $ | 635
|                    |  |              |     |      |   |    



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Employees and independent brokers receivables relate principally to advances and expenses in excess of
commission earnings and inventory losses charged to our employees and registered representatives. Other receivables are primarily related to advances to underwriting clients, as well as to commissions receivable and amounts receivable from insurance
companies as reimbursement for insured losses. An allowance is recorded for specific amounts when they are determined by management to be uncollectible. For the years ended December 31, 2009 and 2008, receivables of $1.2 million and
$21,000, respectively, were determined by management to be uncollectible and written off to bad debt expense. The bad debt expense of $1.2 million in 2009 was mainly related to write-offs of notes receivable primarily from two corporate finance
clients.

NOTE 4 - FAIR VALUE MEASUREMENTS

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



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



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



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

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

Following are the disclosures related to our financial assets and (liabilities) (in thousands):



|                                                           |  |              |       |      |             |         |            |   |       |             |  |        
|---------------------------------------------------------- |  | ------------ | ----- | ---- | ----------- | ------- | ---------- | - | ----- | ----------- |  | -------
|                                                           |  | December 31,
|                                                           |  | 2009         |       | 2008
|                                                           |  | Fair Value   |       |      | Input Level |         | Fair Value |   |       | Input Level
|Trading and investment securities owned:                   |  |              |       |      |             |         |            |   |       |             |  |        
|Corporate equities, marketable                             |  | $            | 4,693 |      |             | Level 1 |            | $ | 3,717 |             |  | Level 1
|Corporate equities, not readily marketable                 |  |              | 2,776 |      |             | Level 3 |            |   | 2,276 |             |  | Level 3
|Corporate options/warrants, marketable                     |  |              | 379   |      |             | Level 1 |            |   | 618   |             |  | Level 1
|Trading securities sold, not yet purchased:                |  |              |       |      |             |         |            |   |       |             |  |        
|Corporate equities                                         |  |              |      |      |             | Level 1 |            |   |      |             |  |       
|Underwriter warrants                                       |  |              | 1,290 |      |             | Level 3 |            |   | 1,675 |             |  | Level 3
|Underwriter warrants  employee and independent contractor |  |              | (10   | )    |             | Level 3 |            |   | (124  | )           |  | Level 3



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



|                                                                                                                                |  |                     |         |   |                                                        |   |      |                                           |  |   |      
|------------------------------------------------------------------------------------------------------------------------------- |  | ------------------- | ------- | - | ------------------------------------------------------ | - | ---- | ----------------------------------------- |  | - | -----
|                                                                                                                                |  | UnderwriterWarrants |         |   | UnderwriterWarrants Employee andIndependentContractor |   |      | Not ReadilyMarketableInvestmentSecurities
|Balance, December 31, 2007                                                                                                      |  | $                   | 16,373  |   |                                                        | $ | (651 | )                                         |  | $ | 1,946
|Fair value of warrants received, included as a component of corporate finance revenue                                           |  |                     | 462     |   |                                                        |   |     |                                           |  |   |     
|Net unrealized gain (loss), included as a component of investment income (loss) related to securities held at December 31,
2008 |  |                     | (14,100 | ) |                                                        |   | 483  |                                           |  |   | 330  
|Value of warrants exercised and expired, included as a component of investment income (loss)                                    |  |                     | (1,060  | ) |                                                        |   | 44   |                                           |  |   |     
|                                                                                                                                |  |                     |         |   |                                                        |   |      |                                           |  |   |      
|Balance, December 31, 2008                                                                                                      |  |                     | 1,675   |   |                                                        |   | (124 | )                                         |  |   | 2,276
|Fair value of underwriter warrants received included as a component of corporate finance income                                 |  |                     | 217     |   |                                                        |   |     |                                           |  |   |     
|Net unrealized gain (loss), included as a component of investment income (loss) related to securities held at December 31,
2009 |  |                     | (592    | ) |                                                        |   | 114  |                                           |  |   | 95   
|Underwriter warrants exercised or expired included as a component of investment income                                          |  |                     | (10     | ) |                                                        |   |     |                                           |  |   |     
|Conversion of corporate finance client note receivable to equity investment                                                     |  |                     |        |   |                                                        |   |     |                                           |  |   | 405  
|                                                                                                                                |  |                     |         |   |                                                        |   |      |                                           |  |   |      
|Balance, December 31, 2009                                                                                                      |  | $                   | 1,290   |   |                                                        | $ | (10  | )                                         |  | $ | 2,776
|                                                                                                                                |  |                     |         |   |                                                        |   |      |                                           |  |   |      

Valuation of Marketable Trading and Investment Securities Owned

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

Valuation of Trading Securities Sold, Not Yet Purchased

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

Valuation of Not Readily Marketable Investment Securities

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

Valuation of Underwriter Warrants

We estimate the fair value of our underwriter warrants using the Black-Scholes Option Pricing Model. The warrants generally have a five-year expiration date and vest immediately. The warrants are generally subject to a restriction
period of six months to one-year in which we cannot exercise the warrants. The Black-Scholes model requires us to use five inputs including: stock price, risk free rate, exercise price, time remaining on the warrant and price volatility. After
stock price, the most influential factor in this model is price volatility, which we calculate for each companys warrants based on each companys own



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##### Table of Contents

historical closing stock prices as well as an index of historical prices for comparable companies. When we initially receive a new underwriter warrant from an initial public offering, its
calculated volatility factor is entirely based on the volatility of an index of comparable companies, since there is no price history for a new publicly traded company. As each underwriter warrant approaches its expiration date, its volatility
factor is derived primarily from the historical prices of its underlying common stock. We cannot assure you that we will ultimately be able to exercise any of our warrants in a way that will realize the value that we attribute to them in our
financial statements based on this model.

NOTE 5 - TRADING AND INVESTMENT SECURITIES OWNED AND TRADING SECURITIES SOLD, NOT YET PURCHASED

Certain information regarding our trading and investment securities owned and our trading securities sold, not yet purchased was as
follows (in thousands):



|                           |  |                   |       |                      |   |                       |  |                   |   |                      |   |                       |  |   |       |  |   |  
|-------------------------- |  | ----------------- | ----- | -------------------- | - | --------------------- |  | ----------------- | - | -------------------- | - | --------------------- |  | - | ----- |  | - | -
|                           |  | December 31, 2009 |       | December 31, 2008   
|Fair Value:                |  | TradingSecurities |       | InvestmentSecurities |   | Sold, NotYetPurchased |  | TradingSecurities |   | InvestmentSecurities |   | Sold, NotYetPurchased
|Corporate equities         |  | $                 | 4,649 |                      | $ | 2,820                 |  | $                 |  |                      | $ | 3,488                 |  | $ | 2,505 |  | $ | 
|Corporate options/warrants |  |                   | 379   |                      |   |                      |  |                   |  |                      |   | 540                   |  |   | 78    |  |   | 
|                           |  |                   |       |                      |   |                       |  |                   |   |                      |   |                       |  |   |       |  |   |  
|                           |  | $                 | 5,028 |                      | $ | 2,820                 |  | $                 |  |                      | $ | 4,028                 |  | $ | 2,583 |  | $ | 
|                           |  |                   |       |                      |   |                       |  |                   |   |                      |   |                       |  |   |       |  |   |  

Certain information regarding our investment securities was as follows
(in thousands):



|                                                                                                                                                                        |  |                         |        |   |      |   |        |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | ------ | - | ---- | - | ------ | -
|                                                                                                                                                                        |  | Year Ended December 31, |       
|                                                                                                                                                                        |  | 2009                    |        |   | 2008 |  
|Net unrealized appreciation of securities held based on quoted market prices or, for securities that are not readily marketable,
our estimate of their fair value       |  | $                       | 3,922  |   |      | $ | 4,554  |  
|Net realized losses on the sale of securities with quoted market prices, securities that are not readily marketable and gains
from the exercise of underwriter warrants |  | $                       | (3,747 | ) |      | $ | (7,650 | )



|           |  |              |       |      |   |      
|---------- |  | ------------ | ----- | ---- | - | -----
|           |  | December 31,
|           |  | 2009         |       | 2008
|Cost basis |  | $            | 3,359 |      | $ | 7,044

NOTE 6 - UNDERWRITER WARRANTS

Underwriter warrant activity was as follows (in thousands):



|                                         |  |   |         |  
|---------------------------------------- |  | - | ------- | -
|Fair value at December 31, 2007          |  | $ | 16,373  |  
|Fair value of warrants received          |  |   | 462     |  
|Net unrealized loss in value of warrants |  |   | (14,100 | )
|Value of warrants exercised or expired   |  |   | (1,060  | )
|                                         |  |   |         |  
|Fair value at December 31, 2008          |  |   | 1,675   |  
|Fair value of warrants received          |  |   | 217     |  
|Net unrealized loss in value of warrants |  |   | (592    | )
|Value of warrants exercised or expired   |  |   | (10     | )
|                                         |  |   |         |  
|Fair value at December 31, 2009          |  | $ | 1,290   |  
|                                         |  |   |         |  
|                                         |  |   |         |  

NOTE 7 - FURNITURE AND EQUIPMENT, NET

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



|                                               |  |              |      |   |      |   |      |  
|---------------------------------------------- |  | ------------ | ---- | - | ---- | - | ---- | -
|                                               |  | December 31, |     
|                                               |  | 2009         |      |   | 2008 |  
|Furniture and equipment                        |  | $            | 809  |   |      | $ | 846  |  
|Leasehold improvements                         |  |              | 131  |   |      |   | 131  |  
|                                               |  |              |      |   |      |   |      |  
|                                               |  |              | 940  |   |      |   | 977  |  
|Less accumulated depreciation and amortization |  |              | (898 | ) |      |   | (882 | )
|                                               |  |              |      |   |      |   |      |  
|                                               |  | $            | 42   |   |      | $ | 95   |  
|                                               |  |              |      |   |      |   |      |  



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##### Table of Contents

NOTE 8 - INCOME TAXES

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



|                                |  |                         |        |   |      |   |        |  
|------------------------------- |  | ----------------------- | ------ | - | ---- | - | ------ | -
|                                |  | Year Ended December 31, |       
|                                |  | 2009                    |        |   | 2008 |  
|Current tax expense (benefit):  |  |                         |        |   |      |   |        |  
|Federal                         |  | $                       | (1,901 | ) |      | $ | (5,536 | )
|State and local                 |  |                         | 22     |   |      |   | (160   | )
|                                |  |                         |        |   |      |   |        |  
|                                |  |                         | (1,879 | ) |      |   | (5,696 | )
|Deferred tax expense (benefit): |  |                         |        |   |      |   |        |  
|Federal                         |  |                         | 1,281  |   |      |   | (2,938 | )
|State and local                 |  |                         | 128    |   |      |   | (292   | )
|                                |  |                         |        |   |      |   |        |  
|                                |  |                         | 1,409  |   |      |   | (3,230 | )
|                                |  |                         |        |   |      |   |        |  
|                                |  | $                       | (470   | ) |      | $ | (8,926 | )
|                                |  |                         |        |   |      |   |        |  

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



|                                                                                 |  |                         |      |   |      |   |        |  
|-------------------------------------------------------------------------------- |  | ----------------------- | ---- | - | ---- | - | ------ | -
|                                                                                 |  | Year Ended December 31, |     
|                                                                                 |  | 2009                    |      |   | 2008 |  
|Income tax (benefit) at statutory federal tax rate                               |  | $                       | (984 | ) |      | $ | (8,847 | )
|State and local taxes, net of federal tax effect                                 |  |                         | (86  | ) |      |   | (867   | )
|Permanent differences  employee stock options, officer life insurance and other |  |                         | 122  |   |      |   | 108    |  
|Change in valuation allowance on net deferred tax asset                          |  |                         | 314  |   |      |   | 709    |  
|Change in reserve for tax contingencies                                          |  |                         | 193  |   |      |   |       |  
|Other, net                                                                       |  |                         | (29  | ) |      |   | (29    | )
|                                                                                 |  |                         |      |   |      |   |        |  
|                                                                                 |  | $                       | (470 | ) |      | $ | (8,926 | )
|                                                                                 |  |                         |      |   |      |   |        |  

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



|                                                   |  |              |        |   |      |   |       |  
|-------------------------------------------------- |  | ------------ | ------ | - | ---- | - | ----- | -
|                                                   |  | December 31, |       
|                                                   |  | 2009         |        |   | 2008 |  
|Accrued expenses                                   |  | $            | 25     |   |      | $ | 12    |  
|Fixed asset depreciation and amortization          |  |              | 54     |   |      |   | 46    |  
|Deferred revenue                                   |  |              | 103    |   |      |   | 140   |  
|Federal capital loss carryforward                  |  |              | 64     |   |      |   |      |  
|State net operating loss carryforwards and credits |  |              | 483    |   |      |   | 226   |  
|State net capital loss carryforwards               |  |              | 251    |   |      |   | 212   |  
|Unrealized depreciation on securities              |  |              | 213    |   |      |   | 1,667 |  
|Compensation and benefits                          |  |              | 32     |   |      |   | 8     |  
|Charitable contribution carryforwards and other    |  |              | 20     |   |      |   | 20    |  
|                                                   |  |              |        |   |      |   |       |  
|                                                   |  |              | 1,245  |   |      |   | 2,331 |  
|Valuation allowance                                |  |              | (1,083 | ) |      |   | (769  | )
|                                                   |  |              |        |   |      |   |       |  
|                                                   |  |              | 162    |   |      |   | 1,562 |  
|                                                   |  |             
|Prepaid expenses                                   |  |              | (162   | ) |      |   | (153  | )
|                                                   |  |              |        |   |      |   |       |  
|                                                   |  | $            |       |   |      | $ | 1,409 |  
|                                                   |  |              |        |   |      |   |       |  

We recorded an increase to our valuation allowance for 2009 and 2008 of $314,000 and $709,000, respectively, based upon
managements assessment that it is more likely than not that the deferred tax assets will not be fully realized. We exhausted all opportunities to carry back current net operating and capital losses to the greatest extent allowable under
current tax law. The realization of these deferred tax assets is dependent on having future taxable income. Management will continue to review the net deferred tax asset and may adjust the valuation allowance in future periods.

State net operating loss carryforwards of approximately $9.9 million at December 31, 2009 expire from 2010 through 2029. State net capital losses of
approximately $8.2 million at December 31, 2009 expire from 2013 to 2014. There were no federal net operating loss carryforwards as of December 31, 2009.



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

|                                                      |  |   |    
|----------------------------------------------------- |  | - | ---
|                                                      |  |   |    
|Balance at December 31, 2007                          |  | $ | 272
|Additions for tax positions taken in prior years      |  |   |   
|Additions for tax positions taken in the current year |  |   |   
|                                                      |  |   |    
|Balance at December 31, 2008                          |  |   | 272
|Additions for tax positions taken in prior years      |  |   | 146
|                                                      |  |   |    
|Balance at December 31, 2009                          |  |   | 418
|Interest on unrecognized tax benefits                 |  |   | 90 
|                                                      |  |   |    
|                                                      |  | $ | 508
|                                                      |  |   |    

All of our unrecognized tax benefits would have an impact on the
effective tax rate if recognized. Interest accrued on unrecognized tax benefits was $90,000 at December 31, 2009 and $43,000 at December 31, 2008. We believe it is reasonably possible that the total amount of unrecognized tax benefits
relating to various state tax matters, including interest, may decrease by approximately $270,000 within the next 12 months due to the closure of certain statutes of limitations.

We are no longer subject to U.S. federal income tax examinations by tax authorities for years prior to the tax year ended December 31, 2004. Depending on the jurisdiction, we are no longer subject to
state examinations by tax authorities for years prior to the December 31, 2004 tax years. We are currently under IRS examination for the tax years ended December 31, 2005 through December 31, 2008. The tax years which remain open to
examination in the U.S., our only major taxing jurisdiction, are 2005 through 2009.

NOTE 9 - STOCK-BASED COMPENSATION PLANS

1999 Stock Option Plan

Our 1999 Stock Option Plan (the Plan) reserves 1.0 million shares of our common stock for issuance upon exercise of options granted under the Plan. The Plan expired in September 2009 and, accordingly, there were no
options available for grant at December 31, 2009. At December 31, 2009 476,000 shares of our common stock were reserved for issuance related to the Plan. Activity under the Plan in 2009 was as follows:



|                                 |  |                    |   |  |                               |     
|-------------------------------- |  | ------------------ | - |  | ----------------------------- | ----
|                                 |  | OptionsOutstanding |   |  | WeightedAverageExercise Price
|Outstanding at December 31, 2008 |  |                   |   |  | $                             |    
|Granted                          |  | 487,500            |   |  |                               | 1.13
|Exercised                        |  | (11,500            | ) |  |                               | 1.13
|                                 |  |                    |   |  |                               |     
|Outstanding at December 31, 2009 |  | 476,000            |   |  |                               | 1.13
|                                 |  |                    |   |  |                               |     

Certain information regarding options outstanding and exercisable as of December 31, 2009 was as follows:



|                                            |  |                                   |          
|------------------------------------------- |  | --------------------------------- | ---------
|                                            |  | OptionsOutstanding andExercisable
|Number                                      |  |                                   | 476,000  
|Weighted average per share exercise price   |  | $                                 | 1.13     
|Aggregate intrinsic value                   |  | $                                 | 219,000  
|Weighted average remaining contractual term |  |                                   | 6.5 years

Stock-Based Compensation

We estimate the fair value of stock options using the Black-Scholes option pricing model. This valuation model takes into account the
exercise price of the award, as well as a variety of significant assumptions. We believe that the valuation technique and the approach utilized to develop the underlying assumptions are appropriate in calculating the fair values of our stock
options. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by persons who receive equity awards. Our options are fully vested upon the date of grant. Accordingly, we recognize the related
stock-based compensation expense on the grant date as a component of commissions and salaries on our consolidated statements of operations. Stock-based compensation totaled $241,000 and $0 in 2009 and 2008, respectively.



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The following weighted average assumptions were utilized in determining fair value pursuant to the
Black-Scholes option pricing model:



|                                       |  |           |  
|-------------------------------------- |  | --------- | -
|Year Ended December 31,                |  | 2009      |  
|Risk-free interest rate                |  | 1.81      | %
|Dividend yield                         |  | 0.0       | %
|Expected lives                         |  | 3.5 years |  
|Volatility                             |  | 59.0      | %
|Discount for post vesting restrictions |  | 0.0       | %

No options were granted during
2008.

The risk-free rate used is based on the U.S. Treasury yield over the expected life of the options granted. Expected lives were
estimated using the simplified method, which considers the vesting term and original contract term. The expected volatility is calculated based on the historical volatility of our common stock.

Shares to be issued upon the exercise of stock options will come from newly issued shares.

Certain information regarding our stock-based compensation plan was as follows (in thousands, except per share amounts):



|                                                                          |  |                         |      |      |   |  
|------------------------------------------------------------------------- |  | ----------------------- | ---- | ---- | - | -
|                                                                          |  | Year Ended December 31,
|                                                                          |  | 2009                    |      | 2008
|Weighted average grant-date per share fair value of share options granted |  | $                       | 0.49 |      | $ | 
|Total intrinsic value of share options exercised                          |  |                         | 6    |      |   | 
|Cash received from options exercised                                      |  |                         | 13   |      |   | 
|Tax deduction realized related to stock options exercised                 |  |                         |     |      |   | 

As of December 31,
2009, there was no unrecognized stock-based compensation.

NOTE 10 - LOSS PER SHARE

Shares used for our basic net loss per share and our diluted net loss per share were the same in both 2009 and 2008 since we were in a loss position.

Stock options not included in the diluted net loss per share calculations because they would be antidilutive were 476,000 and zero in 2009
and 2008, respectively.

NOTE 11 - COMMITMENTS AND CONTINGENCIES

Leases

We lease office space under the terms of various non-cancellable operating
leases. The future minimum payments for each of the next five years and thereafter required for leases were as follows at December 31, 2009 (in thousands):



|                         |  |   |    
|------------------------ |  | - | ---
|Year Ending December 31, |  |  
|2010                     |  | $ | 558
|2011                     |  |   | 90 
|                         |  |   |    
|                         |  | $ | 648
|                         |  |   |    

The leases are accounted for on a straight-line basis and provide for
payment of taxes and other expenses by us. Rent expense for the years ended December 31, 2009 and 2008 was approximately $545,000 and $544,000, respectively.



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##### Table of Contents

Legal

We are named in and subject to various proceedings and claims arising primarily from our securities business activities, including lawsuits, arbitration claims, class actions and regulatory matters. Some
of these claims seek substantial compensatory, punitive or indeterminate damages. We are also involved in other reviews, investigations and proceedings by governmental and self-regulatory agencies regarding our business, certain of which may result
in adverse judgments, settlements, fines, penalties, injunctions or other relief. Because litigation is inherently unpredictable, particularly in cases where claimants seek substantial or indeterminate damages or when investigations and proceedings
are in the early stages, we cannot predict with certainty the losses or range of losses related to such matters, how such matters will be resolved, when they will ultimately be resolved, or what the eventual settlement, fine, penalty or other relief
might be. Consequently, we cannot estimate losses or ranges of losses for matters where there is only a reasonable possibility that a loss may have been incurred. Although the ultimate outcome of these matters cannot be ascertained at this time, it
is the opinion of management, after consultation with counsel, that the resolution of the foregoing matters will not have a material adverse effect on our consolidated financial statements, taken as a whole; such resolution may, however, have a
material effect on the operating results in any future period, and, depending on the outcome and timing of any particular matter, may be material to the operating results for any period depending on the operating results for that period. We have
provided loss allowances for such matters when the likelihood of them occurring is probable and the amount can be reasonably estimated. The ultimate resolution may differ materially from the amounts provided. Settlement expense totaled $565,000 and
$51,000 in 2009 and 2008, respectively. The 2009 amount was primarily related to a failed corporate finance transaction, partially offset by insurance recoveries on customer claims.

NOTE 12 - EMPLOYEE BENEFIT PLANS

Retirement benefits for our employees who have completed
certain service requirements are provided by a defined contribution profit-sharing plan. Plan contributions are determined by the Board of Directors. Contributions to the plan for the years ended December 31, 2009 and 2008 were
approximately $12,000 and $66,000, respectively, and consisted of 401(k) matching contributions.

NOTE 13 - NET CAPITAL REQUIREMENT

We are subject to the Securities and Exchange Commission Uniform Net Capital rule (Rule 15c3-1), which requires the maintenance of minimum net
capital and requires that the ratio of aggregate indebtedness to net capital, both as defined, shall not exceed 15 to 1. The rule also provides that equity capital may not be withdrawn or cash dividends paid if the resulting net capital ratio would
exceed 10 to 1. At December 31, 2009, we had net capital of $8.9 million, which was $8.7 million in excess of our required net capital of $0.2 million. Our net capital ratio was 0.25 to 1 at December 31, 2009. The minimum requirements may
effectively restrict the payment of cash dividends.

NOTE 14 - SHARE REPURCHASE PLAN

In September 2001, our Board of Directors approved a stock repurchase program pursuant to which we are authorized to repurchase up to 600,000 shares of our
common stock. In addition, in June 2008, our Board of Directors approved the repurchase of up to a total of an additional 200,000 shares of our common stock. During 2009 and 2008, we repurchased a total of 48,000 shares for $43,000 and 108,865
shares for $497,000, respectively, and, at December 31, 2009, 195,011 shares remained available for repurchase. These repurchase programs do not have an expiration date.

NOTE 15 - CONVERSION OF NOTE RECEIVABLE TO EQUITY

In February 2009, our $0.4 million note
receivable from Shiftwise, Inc. (Shiftwise), a corporate finance client, was converted to 966,598 shares of Series A2 Preferred Stock of Shiftwise with a fair value of $0.5 million. When added to our previously existing shares, this
resulted in our ownership of a total of 3,466,598 shares of Shiftwise Series A2 Preferred Stock.



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##### Table of Contents

NOTE 16 - CONCENTRATION OF RISK AND GEOGRAPHIC INFORMATION

Our trading and investment securities owned include investments in the common stock and warrants of the following companies, which represent more than 10% of
trading and investment securities owned at December 31, 2009 and 2008 (dollars in thousands):



|                                 |  |                         |       |                    |      |  
|-------------------------------- |  | ----------------------- | ----- | ------------------ | ---- | -
|As of December 31, 2009: Company |  | Investment atFair Value |       | Percentage ofTotal |     
|Shiftwise                        |  | $                       | 1,770 |                    | 22.5 | %
|Ascent Solar Technologies, Inc.  |  |                         | 1,748 |                    | 22.3 | %
|Charles & Colvard, Ltd.          |  |                         | 915   |                    | 11.7 | %
|Converted Organics, Inc.         |  |                         | 881   |                    | 11.2 | %
|                                 |  |                         |       |                    |      |  
|                                 |  | $                       | 5,314 |                    | 67.7 | %
|                                 |  |                         |       |                    |      |  



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

In 2009 and 2008, none of our revenue was from foreign sources and no customer represented 10% or more of our total revenue.
In addition, all of our long-lived assets were located within the United States.

We are also exposed to concentrations of credit risk related
to our cash deposits. We maintain cash at a financial institution where the total cash balance is insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per depositor, per bank. At any given time, our cash
balance may exceed the balance insured by the FDIC. We monitor such credit risk at the financial institution and have not experienced any losses related to such risks to date.

In addition, we are engaged in trading and brokerage activities with RBC CS. In the event RBC CS does not fulfill its obligations, we may be exposed to risk. The risk of default depends on the
creditworthiness of RBC CS. It is our policy to review, as necessary, the credit standing of RBC CS.

NOTE 17 - RELATED PARTY TRANSACTIONS

During the years ended December 31, 2009 and 2008, we paid approximately $58,000 and $90,000, respectively, of legal costs on behalf
of our officers, employees and independent contractors.

NOTE 18 - DEFERRED REVENUE

Deferred revenue consists of amounts received related to our clearing firm agreement. Other income in both 2009 and 2008 included $100,000 in amortization of
deferred revenue.

NOTE 19 - NEW ACCOUNTING PRONOUNCEMENTS

Recently Adopted Accounting Guidance

Amendment to ASC 855

ASC 855, Subsequent Events, was amended and defines subsequent events as transactions that occur after the balance sheet date but before
financial statements are issued or are available to be issued. The amendment defines two types of subsequent events: (i) events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet,
including the estimates inherent in the process of preparing financial statements (that is, recognized subsequent events); and (ii) events that provide evidence about conditions that did not exist at the date of the balance sheet but arose
after that date (that is, nonrecognized subsequent events). In addition, the amendment requires an entity to disclose the date through which subsequent events have been evaluated, as well as whether that date is the date the financial statements
were issued or the date the financial statements were available to be issued. The amendment was effective for periods ending after June 15, 2009. The adoption of the amendment, effective June 30, 2009, did not have any effect on our
financial position, results of operations or cash flows.



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##### Table of Contents

Amendment to ASC 825

ASC 825, Financial Instruments, was amended to require disclosures about fair value of financial instruments for interim reporting periods as well as in annual financial statements. This
amendment also requires those disclosures in summarized financial information at interim reporting periods. The adoption of this amendment, effective June 30, 2009, did not have any effect on our financial position, results of operations or
cash flows.

Amendment to ASC 820 and ASC 320

ASC 820, Fair Value Measurements and Disclosures, and ASC 320, Investments  Debt and Equity Securities, were amended to provide additional guidance for estimating fair value
and emphasize that, even if there has been a significant decrease in the volume and level of activity for the asset or liability and regardless of the valuation techniques used, the fair value is the price that would be received to sell an asset or
paid to transfer a liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions.

The amendments also require disclosure in interim and annual periods regarding the inputs and valuation techniques used to measure fair value and a
discussion of changes in valuation techniques and related inputs, if any, during the period. It also requires that entities define major categories for equity and debt securities. The adoption of these amendments, effective June 30, 2009, did
not have any effect on our financial position, results of operations or cash flows.

Recent Accounting Guidance Not Yet Adopted

ASU 2010-06

Accounting
Standards Update (ASU) 2010-06, Improving Disclosures about Fair Value Measurements, requires new disclosures about recurring or nonrecurring fair-value measurements including significant transfers into or out of Level 1 and
Level 2 fair-value classifications. It also requires information on purchases, sales, issuances and settlements on a gross basis in the reconciliation of Level 3 fair-value assets and liabilities. These disclosures are required for fiscal years
beginning on or after December 15, 2009. The ASU also clarifies existing fair-value measurement disclosure guidance about the level of disaggregation, inputs and valuation techniques, which are required to be implemented in fiscal years
beginning on or after December 15, 2010. Since the requirements of this ASU only relate to disclosure, the adoption of the guidance will not have any effect on our financial position, results of operations or cash flows.

ASU 2009-05

ASU 2009-05, Fair Value
Measurements and Disclosures (Topic 820)  Measuring Liabilities at Fair Value, amends ASC Topic 820, Fair Value Measurements, to allow companies determining the fair value of a liability to use the perspective of an investor
that holds the related obligation as an asset. The new guidance is effective for interim and annual periods beginning after August 27, 2009, and applies to all fair-value measurements of liabilities required by GAAP. No new fair-value
measurements are required by the update. We do not believe that the adoption of this ASU will have a material effect on our financial position, results of operations or cash flows.



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##### Table of Contents

Amendment to ASC 860

ASC 860, Transfers and Servicing, was amended to improve the relevance, representational faithfulness and comparability of the information that a reporting entity provides in its financial
reports about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferors continuing involvement in transferred financial assets. The amendments to ASC 860 are
effective as of the beginning of an entitys first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. Earlier
application is prohibited. The amendments must be applied to transfers occurring on or after the effective date. While we are still analyzing the effects of the adoption of the amendments, we do not believe that the adoption will have a material
effect on our financial position, results of operations or cash flows.

NOTE 20 - SUBSEQUENT EVENT

In January 2010, we completed a follow-on public offering in which we, together with a co-underwriter, raised $6.5 million for our client.

We have evaluated subsequent events for potential recognition and/or disclosure through the date the financial statements were issued.



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##### Table of Contents

Paulson Capital Corp. and Subsidiaries

SUPPLEMENTARY SCHEDULE OF WARRANTS OWNED

As of December 31, 2009



|                                  |  |                   |  |                                               |  |                 |  |                          |       |                |         
|--------------------------------- |  | ----------------- |  | --------------------------------------------- |  | --------------- |  | ------------------------ | ----- | -------------- | --------
|Description                       |  | Number ofWarrants |  | WarrantsObligated toEmployeesIncludedin Total |  | DateExercisable |  | ExercisePrice perWarrant |       | ExpirationDate
|Ascent Solar Technologies (units) |  | 112,500           |  |                                              |  | 07/10/07        |  | $                        | 6.60  |                | 07/10/11
|Converted Organics, Inc. (units)  |  | 131,219           |  | 18,224                                        |  | 02/13/08        |  |                          | 6.60  |                | 02/13/12
|Healthy Fast Foods (units)        |  | 76,500            |  |                                              |  | 03/19/09        |  |                          | 6.12  |                | 03/19/13
|ICOP Digital (units)              |  | 23,400            |  | 23,400                                        |  | 01/04/06        |  |                          | 9.90  |                | 07/08/10
|ICOP Digital (common and warrant) |  | 47,125            |  | 47,125                                        |  | 01/08/06        |  |                          | 5.92  |                | 07/08/10
|ICOP Digital (units)              |  | 65,000            |  |                                              |  | 06/01/10        |  |                          | 5.52  |                | 06/01/14
|Nuvim (units)                     |  | 243,000           |  | 58,050                                        |  | 12/18/05        |  |                          | 1.20  |                | 06/20/10
|The Quantum Group (units)         |  | 84,000            |  |                                              |  | 12/12/08        |  |                          | 13.20 |                | 12/12/12
|Vaughan Foods (units)             |  | 191,275           |  | 43,038                                        |  | 06/27/08        |  |                          | 7.80  |                | 06/27/12
|XELR8 Holdings, Inc. (common)     |  | 5,500             |  | 2,750                                         |  | 03/27/08        |  |                          | 1.50  |                | 03/27/12



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##### Table of Contents

SCHEDULE II

Paulson Capital Corp. and Subsidiaries

Valuation and Qualifying Accounts

For the Two Years in the Period Ended
December 31, 2009



|                                     |  |                              |   |                             |   |                                    |  |                          |          |  |                        |            |   |  |   |  
|------------------------------------ |  | ---------------------------- | - | --------------------------- | - | ---------------------------------- |  | ------------------------ | -------- |  | ---------------------- | ---------- | - |  | - | -
|Column A                             |  | Column B                     |   | Column C                    |   | Column D                           |  |                          | Column E
|Description                          |  | Balanceat Beginningof Period |   | Chargedto Costs andExpenses |   | Charged toOther Accounts -Describe |  | Deductions -Describe (a) |          |  | Balanceat Endof
Period
|Year Ended December 31, 2008:        |  |                              |   |                             |   |                                    |  |                          |          |  |                        |            |   |  |   |  
|Allowance for uncollectible accounts |  | $                            |  |                             | $ | 20,727                             |  | $                        |         |  | $                      | (20,727    | ) |  | $ | 
|Year Ended December 31, 2009:        |  |                              |   |                             |   |                                    |  |                          |          |  |                        |            |   |  |   |  
|Allowance for uncollectible accounts |  | $                            |  |                             | $ | 1,214,268                          |  | $                        |         |  | $                      | (1,214,268 | ) |  | $ | 



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



F-20