**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-Q**




**(mark
      one)**





x
            **QUARTERLY
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934**





**** **FOR
      THE QUARTERLY PERIOD ENDED JUNE 30, 2006, OR**


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





**Commission
      file No. 0-30066**




**SANDERS
      MORRIS HARRIS GROUP INC.**


(Exact
      name of registrant as specified in its charter)




**Texas**
            
            **76-0583569****(State
                or other jurisdiction of**
            
            **(I.R.S.
                Employer****incorporation
                or organization)**
            
            **Identification
                No.)**


**600
      Travis, Suite 3100**


**Houston,
      Texas 77002**


**(Address
      of principal executive office)**





Registrant’s
      telephone number, including area code: **(713) 993-4610**





Indicate
      by check mark if 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.


[X]
      Yes
      [  ] No





Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      filer and larger accelerated filer” in Rule 12b-2 of the Exchange
      Act.




Large
      accelerated filer [  ]       Accelerated
      filer [X]      Non-accelerated filer [  ]





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


[
 ]
      Yes [X] No





As
      of
      August 4, 2006, the registrant had 19,258,223 outstanding shares of Common
      Stock, par value $0.01 per share.















**SANDERS
      MORRIS HARRIS GROUP INC. AND SUBSIDIARIES**





**INDEX**




PagePART
                I.FINANCIAL
                INFORMATIONItem
                1.
            Financial
                Statements
            2Condensed
                Consolidated Balance Sheet as of June 30, 2006 (unaudited) and  December
                31, 2005
            2Condensed
                Consolidated Statement of Income for the Three and Six
                MonthsEnded
                  June 30, 2006 and 2005 (unaudited)
            3Condensed
                Consolidated Statement of Shareholders' Equity for the SixMonths
                  Ended June 30, 2006 (unaudited)
            4Condensed
                Consolidated Statement of Cash Flows for the Six MonthsEnded
                  June 30, 2006 and 2005 (unaudited)
            5Notes
                  to Condensed Consolidated Financial Statements
                  (unaudited)
            6Item
                2.
            Management's
                Discussion and Analysis of Financial Condition and Results
                ofOperations
            20Item
                3.
            Quantitative
                and Qualitative Disclosures About Market Risk
            28Item
                4.
            Controls
                and Procedures
            29PART
                II.OTHER
                INFORMATIONItem
                1.
            Legal
                Proceedings
            30Item
                4.
            Submission
                of Matter to a Vote of Security Holders
            31Item
                6.
            Exhibits
            32





1


**PART
        I.   FINANCIAL INFORMATION**


**Item
        1.** ***Financial
        Statements***
  **SANDERS
        MORRIS HARRIS GROUP INC. AND SUBSIDIARIES**
 **Condensed
        Consolidated Balance Sheet**
 (in
        thousands, except share and per share amounts)
  **June
                  30,**
              
              **December
                  31,****2006**
              
              **2005**(unaudited)**ASSETS**Cash
                  and cash equivalents
              
              $
              10,670
              
              $
              14,612Receivables,
                  net of allowance of $519 and $512, respectivelyBroker-dealers
              
              
              733
              
              
              753Customers
              
              
              10,980
              
              
              9,537Related
                  parties
              
              
              4,658
              
              
              6,227Other
              
              
              4,365
              
              
              1,815Deposits
                  with clearing brokers
              
              
              1,078
              
              
              1,073Securities
                  owned
              
              
              202,053
              
              
              73,657Securities
                  available for sale
              
              
              1,764
              
              
              1,884Furniture
                  and equipment, net
              
              
              11,732
              
              
              9,673Other
                  assets and prepaid expenses
              
              
              2,318
              
              
              2,050Goodwill,
                  net
              
              
              80,009
              
              
              84,398Total
                  assets
              
              $
              330,360
              
              $
              205,679**LIABILITIES
                  AND SHAREHOLDERS' EQUITY**Liabilities:Accounts
                  payable and accrued liabilities
              
              $
              19,468
              
              $
              21,881Borrowings
              
              
              15,080
              
              
              10,706Deferred
                  tax liability, net
              
              
              1,894
              
              
              2,408Securities
                  sold, not yet purchased
              
              
              96,548
              
              
              8,168Payable
                  to clearing broker-dealers
              
              
              32,780
              
              
              17Other
                  liabilities
              
              
              33
              
              
              33Total
                  liabilities
              
              
              165,803
              
              
              43,213Commitments
                  and contingenciesMinority
                  interests
              
              
              8,911
              
              
              7,781Shareholders'
                  equity:Preferred
                  stock, $.10 par value; 10,000,000 sharesauthorized;
                  no shares issued and outstanding
              
              
              -
              
              
              -Common
                  stock, $.01 par value; 100,000,000 sharesauthorized;
                  19,897,625 and 19,634,260 shares issued, respectively
              
              
              199
              
              
              196Additional
                  paid-in capital
              
              
              136,448
              
              
              134,004Retained
                  earnings
              
              
              22,426
              
              
              23,936Accumulated
                  other comprehensive income
              
              
              54
              
              
              30Treasury
                  stock at cost, 739,402 shares
              
              
              (3,481
              )
              
              (3,481
              )Total
                  shareholders' equity
              
              
              155,646
              
              
              154,685Total
                  liabilities and shareholders' equity
              
              $
              330,360
              
              $
              205,679


The
        accompanying notes are an integral part of these condensed consolidated
        financial statements.




2


**SANDERS
        MORRIS HARRIS GROUP INC. AND SUBSIDIARIES**
 **Condensed
        Consolidated Statement of Income**
 (in
        thousands, except share and per share amounts)
 (unaudited)
  **Three
                  Months Ended**
              
              
              **Six
                  Months Ended****June
                  30,**
              
              
              **June
                  30,****2006**
              
              
              **2005**
              
              
              **2006**
              
              
              **2005**Revenues:Commissions
              
              $
              15,223
              
              $
              10,085
              
              $
              30,009
              
              $
              21,436Investment
                  banking
              
              
              12,018
              
              
              8,088
              
              
              21,991
              
              
              14,181Investment
                  advisory and related services
              
              
              8,598
              
              
              8,094
              
              
              17,380
              
              
              13,107Principal
                  transactions
              
              
              3,771
              
              
              2,221
              
              
              10,716
              
              
              4,071Interest
                  and dividends
              
              
              1,974
              
              
              1,138
              
              
              3,535
              
              
              2,320Other
                  income
              
              
              1,587
              
              
              873
              
              
              2,983
              
              
              1,724Total
                  revenues
              
              
              43,171
              
              
              30,499
              
              
              86,614
              
              
              56,839Expenses:Employee
                  compensation and benefits
              
              
              26,906
              
              
              17,719
              
              
              53,426
              
              
              34,210Floor
                  brokerage, exchange and clearance fees
              
              
              1,978
              
              
              1,124
              
              
              3,779
              
              
              2,192Communications
                  and data processing
              
              
              2,267
              
              
              2,230
              
              
              4,548
              
              
              3,996Occupancy
              
              
              2,914
              
              
              1,939
              
              
              5,550
              
              
              4,011Interest
              
              
              717
              
              
              42
              
              
              1,106
              
              
              43Goodwill
                  impairment charge
              
              
              4,456
              
              
              -
              
              
              4,456
              
              
              -Other
                  general and administrative
              
              
              5,944
              
              
              3,551
              
              
              11,549
              
              
              6,304Total
                  expenses
              
              
              45,182
              
              
              26,605
              
              
              84,414
              
              
              50,756(Loss)
                  income before equity in income oflimited
                  partnerships, minority interests,and
                  income taxes
              
              
              (2,011
              )
              
              3,894
              
              
              2,200
              
              
              6,083Equity
                  in income of limited partnerships
              
              
              748
              
              
              706
              
              
              2,573
              
              
              2,402(Loss)
                  income before minority interests and
              
              
              (1,263
              )
              
              4,600
              
              
              4,773
              
              
              8,485income
                  taxesMinority
                  interests in net income of consolidatedcompanies
              
              
              (1,624
              )
              
              (828
              )
              
              (3,022
              )
              
              (1,625
              )(Loss)
                  income before income taxes
              
              
              (2,887
              )
              
              3,772
              
              
              1,751
              
              
              6,860(Benefit)
                  provision for income taxes
              
              
              (1,184
              )
              
              1,546
              
              
              693
              
              
              2,802Net
                  (loss) income
              
              $
              (1,703
              )
              $
              2,226
              
              $
              1,058
              
              $
              4,058(Loss)
                  earnings per share:Basic
              
              $
              (0.09
              )
              $
              0.12
              
              $
              0.06
              
              $
              0.22Diluted
              
              $
              (0.09
              )
              $
              0.12
              
              $
              0.05
              
              $
              0.21Weighted
                  average common shares outstanding:Basic
              
              
              19,118,912
              
              
              18,605,636
              
              
              19,054,114
              
              
              18,455,976Diluted
              
              
              19,580,799
              
              
              19,209,037
              
              
              19,531,875
              
              
              19,086,352




The
        accompanying notes are an integral part of these condensed consolidated
        financial statements.


3


**SANDERS
        MORRIS HARRIS GROUP INC. AND SUBSIDIARIES**


**Condensed
        Consolidated Statement of Shareholders' Equity**
 **For
        the six months ended June 30, 2006**
 (in
        thousands, except shares)
 (unaudited)
  Amounts
              
              
              
              
              
              Shares**Common
                  stock**Balance,
                  beginning of period
              
              $
              196
              
              
              
              
              
              19,634,260Stock
                  issued pursuant to employee benefit plan
              
              
              3
              
              
              
              
              
              263,365Balance,
                  end of period
              
              
              199
              
              
              
              
              
              19,897,625**Additional
                  paid-in capital**Balance,
                  beginning of period
              
              
              134,004Stock
                  issued pursuant to employee benefit plan,including
                  tax benefit
              
              
              1,362Amortization
                  of restricted stock grants
              
              
              1,067Collection
                  of receivable for shares issued
              
              
              15Balance,
                  end of period
              
              
              136,448**Retained
                  earnings**Balance,
                  beginning of period
              
              
              23,936Dividends
                  ($0.135 per share)
              
              
              (2,568
              )Net
                  income
              
              
              1,058
              
              
              1,058Balance,
                  end of period
              
              
              22,426
              
              
              1,058**Accumulated
                  other comprehensive loss**Balance,
                  beginning of period
              
              
              30Net
                  change in unrealized appreciationon
                  securities available for sale
              
              
              38
              
              
              38Income
                  tax expense on change
              
              
              (14
              )
              
              (14
              )Balance,
                  end of period
              
              
              54
              
              
              24**Comprehensive
                  income**
              
              
              
              
              
              1,082**Treasury
                  stock**Balance,
                  beginning of period
              
              
              (3,481
              )
              
              
              
              
              (739,402
              )Balance,
                  end of period
              
              
              (3,481
              )
              
              
              
              
              (739,402
              )**Total
                  shareholders' equity and common shares
                  outstanding**
              
              **$**
              **155,646**
              
              
              
              
              
              **19,158,223**


The
        accompanying notes are an integral part of these condensed consolidated
        financial statements.




4




**SANDERS
        MORRIS HARRIS GROUP INC. AND SUBSIDIARIES**
 **Condensed
        Consolidated Statement of Cash Flows**
 **For
        the six months ended June 30, 2006 and 2005**
 (in
        thousands)
 (unaudited)
  **2006**
              
              **2005**CASH
                  FLOWS FROM OPERATING ACTIVITIES:Net
                  income
              
              $
              1,058
              
              $
              4,058Adjustments
                  to reconcile net income to net cash (used in) provided byoperating
                  activities:Realized
                  (gain) loss on securities available for sale
              
              
              (9
              )
              
              5Depreciation
              
              
              1,403
              
              
              954Provision
                  for bad debts
              
              
              214
              
              
              54Compensation
                  expense related to amortization of restricted stock grants
              
              
              1,067
              
              
              923Goodwill
                  impairment charge
              
              
              4,456
              
              
              -Deferred
                  income taxes
              
              
              (528
              )
              
              (1,096
              )Equity
                  in income of limited partnerships
              
              
              (2,573
              )
              
              (2,402
              )Minority
                  interests in income of consolidated companies
              
              
              3,022
              
              
              1,624Change
                  in receivables
              
              
              (2,618
              )
              
              (1,028
              )Change
                  in deposits with clearing brokers
              
              
              (5
              )
              
              (1,223
              )Change
                  in securities owned
              
              
              (125,823
              )
              
              6,581Change
                  in other assets
              
              
              (268
              )
              
              106Change
                  in securities sold, not yet purchased
              
              
              88,380
              
              
              (3,382
              )Change
                  in payable to clearing broker-dealers
              
              
              32,763
              
              
              1,346Change
                  in other liabilities
              
              
              -
              
              
              (34
              )Change
                  in accounts payable and accrued liabilities
              
              
              (2,480
              )
              
              (6,064
              )Net
                  cash (used in) provided by operating activities
              
              
              (1,941
              )
              
              422CASH
                  FLOWS FROM INVESTING ACTIVITIES:Capital
                  expenditures
              
              
              (3,462
              )
              
              (1,401
              )Acquisitions,
                  net of cash acquired of $0 and $421, respectively
              
              
              -
              
              
              (16,129
              )Purchase
                  of securities available for sale
              
              
              -
              
              
              (851
              )Proceeds
                  from sales and maturities of securities available for sale
              
              
              167
              
              
              71Net
                  cash used in investing activities
              
              
              (3,295
              )
              
              (18,310
              )CASH
                  FLOWS FROM FINANCING ACTIVITIES:Proceeds
                  from shares issued
              
              
              965
              
              
              1,790Tax
                  benefit of stock options exercised
              
              
              400
              
              
              548Collection
                  of receivable for shares issued
              
              
              15
              
              
              -Proceeds
                  from borrowings
              
              
              7,844
              
              
              10,500Repayment
                  of borrowings
              
              
              (3,470
              )
              
              -Investments
                  by minority interests
              
              
              40
              
              
              41Distributions
                  to minority interests
              
              
              (1,932
              )
              
              (890
              )Payments
                  of cash dividends
              
              
              (2,568
              )
              
              (1,495
              )Net
                  cash provided by financing activities
              
              
              1,294
              
              
              10,494Net
                  decrease in cash and cash equivalents
              
              
              (3,942
              )
              
              (7,394
              )CASH
                  AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
              
              
              14,612
              
              
              21,678CASH
                  AND CASH EQUIVALENTS AT END OF PERIOD
              
              $
              10,670
              
              $
              14,284Supplemental
                  cash flow information:Cash
                  paid for income taxes, net
              
              $
              733
              
              $
              4,576Cash
                  paid for interest
              
              
              388
              
              
              -Noncash
                  activities:Acquisitions
                  and consolidation:Fixed
                  assets
              
              
              -
              
              
              338Other
                  assets
              
              
              -
              
              
              273Goodwill
              
              
              68
              
              
              22,685Accounts
                  payable and accrued liabilties
              
              
              (68
              )
              
              (808
              )Minority
                  interest
              
              
              -
              
              
              (109
              )


The
        accompanying notes are an integral part of the condensed consolidated financial
        statements.




5




**SANDERS
        MORRIS HARRIS GROUP INC. AND SUBSIDIARIES**
 **Notes
        to Condensed Consolidated Financial Statements**
 (unaudited)




**1.**
            **BASIS
                OF PRESENTATION**





*Nature
      of Operations*


Through
      its operating subsidiaries Sanders Morris Harris Inc. (“Sanders Morris Harris”
or “SMH”), Salient Capital Management, LLC (“Salient”), SMH Capital Advisors,
      Inc. (“SMCA”), Charlotte Capital, LLC, The Edelman Financial Center, LLC
      (“Edelman”), and Select Sports Group, Ltd (“SSG”), Sanders Morris Harris Group
      Inc. (“SMHG” or “the Company”) provides a broad range of financial and other
      professional services, including asset and wealth management (including
      investment advice and management, financial planning, trust related services,
      sports representation and management), investment and merchant banking, and
      institutional services (including institutional sales and trading, prime
      brokerage, and research). The Company serves a diverse group of institutional,
      corporate, and individual clients.





The
      Company merged with and acquired its operating subsidiaries from 1999 through
      2005. The acquisitions were accounted for using the purchase method and
      accordingly, results of an acquired entity are included in the Company’s
      condensed consolidated financial statements from the date of acquisition. As
      a
      result the current period results are not comparable to the prior periods.





*Consolidation*




The
      unaudited condensed consolidated financial statements of the Company include
      the
      accounts of its subsidiaries. All material intercompany transactions and
      balances have been eliminated in consolidation.





In
      management's opinion, the unaudited condensed consolidated financial statements
      include all adjustments necessary for a fair presentation of our consolidated
      financial position at June 30, 2006, our results of operations for the three
      and
      six months ended June 30, 2006 and 2005, and our cash flows for the six months
      ended June 30, 2006 and 2005. All adjustments are of a normal recurring nature.
      Interim results are not necessarily indicative of results for a full
      year.





These
      financial statements and notes should be read in conjunction with the Company’s
      Annual Report on Form 10-K for the year ended December 31, 2005.





*Effects
      of Recently Issued Accounting Standards*


In
      December 2004, the Financial Accounting Standards Board, or FASB, issued SFAS
      No. 123R, *Share-Based
      Payment (Revised 2004).* SFAS No.
      123R established standards for the accounting for transactions in which an
      entity (1) exchanges its equity instruments for goods or services, or (2) incurs
      liabilities in exchange for goods or services that are based on the fair value
      of the entity’s equity instruments or that may be settled by the issuance of the
      equity instruments. SFAS No. 123R eliminated the ability to account for
      stock-based compensation using APB 25 and requires that such transactions be
      recognized as compensation cost in the income statement based on their fair
      values on the date of the grant. SFAS No. 123R was effective for the Company
      on
      January 1, 2006. The Company transitioned to fair value based accounting for
      stock-based compensation using a modified version of prospective application
      (“modified prospective application”). Under modified prospective application the
      Company applies SFAS No. 123R to new awards and to awards modified, repurchased,
      or cancelled after January 1, 2006. Additionally, compensation cost for the
      portion of awards for which the requisite service has not been rendered
      (generally referring to non-vested awards) that were outstanding as of January
      1, 2006 must be recognized as the remaining requisite service is rendered during
      the period of and/or the periods after the adoption of SFAS No. 123R. The
      attribution of compensation cost for those earlier awards is based on the same
      method and on the same grant-date fair values previously determined for the
      pro
      forma disclosures required for companies that did not adopt the fair value
      accounting method for stock-based employee compensation. As a result of the
      adoption of SFAS No. 123R, the Company recognized additional pretax compensation
      cost of $34,000 in the first six months of 2006 for stock-based compensation
      awards outstanding as of December 31, 2005, for which the requisite service
      was
      not fully rendered prior to January 1, 2006. Approximately $93,000 remains
      to be
      recognized over 1.20 weighted average years. Future levels of compensation
      cost
      recognized related to




6


stock-based
      compensation awards (including the aforementioned expected costs during the
      period of adoption) may be impacted by new awards and/or modifications,
      repurchase and cancellations of existing awards before and after the adoption
      of
      this standard. (See Note 11.)





In
      June
      2005 the Emerging Issues Task Force (EITF) issued EITF No. 04-5, *Investor’s
      Accounting for an Investment in a Limited Partnership When the Investor Is
      the
      Sole General Partner and the Limited Partners Have Certain
      Rights* .
      In
      conjunction with EITF No. 04-5, the FASB staff is planning to amend SOP 78-9, *Accounting
      for Investments in Real Estate Ventures* to be
      consistent with EITF No. 04-5. SOP 78-9-1, *Interaction
      of AICPA Statement of Position 78-9 and EITF No. 04-5,* presumes
      that a general partner controls a limited partnership and therefore should
      consolidate the partnership. This presumption can be overcome if the limited
      partners have kick-out or substantive participating rights. As all of the
      limited partnerships for which we act as general partner have kick-out or
      substantive participating rights, the impact that these new accounting standards
      had on our consolidated financial statements was minimal. The effective date
      of
      SOP 78-9-1 and EITF No. 04-5 was January 1, 2006 for existing limited
      partnerships. EITF 04-5 and SOP 78-9-1 was effective immediately for new and
      modified limited partnerships.





On
      July
      13, 2006, FASB Interpretation (FIN) No. 48, *Accounting
      for Uncertainty in Income Taxes - An Interpretation of FASB Statement No.
      109,* was
      issued. FIN 48 clarifies the accounting for uncertainty in income taxes
      recognized in an enterprise’s financial statements in accordance with FASB
      Statement No. 109, *Accounting
      for Income Taxes.* FIN
      48
      also prescribes a recognition threshold and measurement attribute for the
      financial statement recognition and measurement of a tax position taken or
      expected to be taken in a tax return. The new FASB standard also provides
      guidance on derecognition, classification, interest and penalties, accounting
      in
      interim periods, disclosure, and transition.





The
      evaluation of a tax position in accordance with FIN 48 is a two-step process.
      The first step is a recognition process whereby the enterprise determines
      whether it is more likely than not that a tax position will be sustained upon
      examination, including resolution of any related appeals or litigation
      processes, based on the technical merits of the position. In evaluating whether
      a tax position has met the more-likely-than-not recognition threshold, the
      enterprise should presume that the position will be examined by the appropriate
      taxing authority that has full knowledge of all relevant information. The second
      step is a measurement process whereby a tax position that meets the
      more-likely-than-not recognition threshold is calculated to determine the amount
      of benefit to recognize in the financial statements. The tax position is
      measured at the largest amount of benefit that is greater than 50% likely of
      being realized upon ultimate settlement.





The
      provisions of FIN 48 are effective for fiscal years beginning after December
      15,
      2006. Earlier application is permitted as long as the enterprise has not yet
      issued financial statements, including interim financial statements, in the
      period of adoption. The provisions of FIN 48 are to be applied to all tax
      positions upon initial adoption of this standard. Only tax positions that meet
      the more-likely-than-not recognition threshold at the effective date may be
      recognized or continue to be recognized upon adoption of FIN 48. The Company
      is
      evaluating the impact that the pronouncement will have on its condensed
      consolidated financial statements.





*Reclassifications*





Certain
      reclassifications have been made to the 2005 condensed consolidated financial
      statements to conform them to the 2006 presentation. The reclassifications
      had
      no effect on retained earnings, results of operations or cash flows as
      previously reported.





**2.**
            **ACQUISITIONS
                AND DISPOSITION**





On
      May
      10, 2005, the Company acquired a 51% interest in The Edelman Financial Center,
      LLC, one of the leading financial planning firms in the country. The Company
      will acquire the remaining 49% of Edelman over four years. Edelman, based in
      Fairfax, Virginia, manages over $2.7 billion in assets. At the initial closing,
      SMHG bought 51% of the outstanding membership units of Edelman (“the First
      Tranche Units”). The Company paid $12.5 million, in a combination of cash and
      shares of the Company’s common stock for the First Tranche Units. The
      consideration for the First Tranche Units is subject to later adjustment (the
      “Earn-Out Consideration”) based on a multiple of the pretax income of Edelman
      for the period of October 1, 2005 through September 30, 2006. The multiple
      used
      to calculate the Earn-Out Consideration will also be based upon the level of
      pretax income for the period. The Earn-Out Consideration will be paid 50% in
      cash and 50% in the Company’s common stock.





7


In
      May
      2008, the Company will purchase an additional 25% membership interest in
      Edelman. The Company will pay an amount equal to 25% of a multiple of between
      8
      and 11 times Edelman’s pretax income for the fiscal year ending December 31,
      2007 (the “Second Tranche Consideration”). The multiple will be determined based
      upon the compound annual growth rate of Edelman’s pretax income over a specified
      period. The Second Tranche Consideration will be paid in a combination of cash
      and the Company’s common stock.





In
      May
      2009, the Company will purchase all of the remaining issued and outstanding
      membership interests of Edelman. The Company will pay an amount equal to 24%
      of
      a multiple of between 8 and 11 times Edelman’s pretax income for the fiscal year
      ending December 31, 2008 (the “Third Tranche Consideration”). The multiple will
      be determined based upon the compound annual growth rate of Edelman’s pretax
      income over a specified period. The Third Tranche Consideration will also be
      paid in a combination of cash and the Company’s common stock.





At
      the
      initial closing, the Company advanced an additional $7.5 million, in a
      combination of cash and the Company’s common stock, as a nonrefundable credit
      against future payments for the Earn-Out Consideration, the Second Tranche
      Consideration, and the Third Tranche Consideration. Also, the aggregate
      issuances of common stock may never exceed 20% of the total number of shares
      of
      the Company’s common stock issued and outstanding on the initial closing date.
      The shares of common stock issued were not registered in reliance upon the
      exemption provided in Section 4(2) of the Securities Act of 1933.





The
      acquisition was accounted for as a purchase, and accordingly, the financial
      information of Edelman has been included in the Company’s consolidated financial
      statements from May 10, 2005. Consideration of $20.0 million, consisting of
      the
      initial consideration of $12.5 million and the $7.5 million nonrefundable credit
      against future payments, exceeded the fair market value of identifiable net
      tangible assets by approximately $20.2 million, which has been recorded as
      goodwill.





On
      April
      15, 2005, the Company acquired a 50% interest in an investment advisory business
      of two financial advisors who are based in Colorado Springs, Colorado. The
      customer accounts were added to those of Sanders Morris Harris and the business
      operates as SMH Colorado. As the Company may exercise control to a degree
      greater than its voting interests, the acquisition was accounted for as a
      purchase, and accordingly, the financial information of SMH Colorado has been
      included in the Company’s consolidated financial statements from April 15, 2005.
      The consideration of $2.5 million, consisting of a combination of cash and
      shares of the Company’s common stock, exceeded the fair market value of
      identifiable net tangible assets by $2.5 million, which has been recorded as
      goodwill.




On
      April
      1, 2005, the Company sold its Douglas, Noyes division to a third party. The
      Company retained cash, receivables, and fixed assets, as well as all accounts
      payable and accrued liabilities associated with Douglas, Noyes. In April 2006
      and continuing thereafter, the Company receives a portion of the investment
      advisory fees earned by Douglas, Noyes. SMHG recorded no gain or loss on the
      sale of Douglas, Noyes. Douglas, Noyes, based in New York City provides
      investment management services.







8








**3.**
            **SECURITIES
                OWNED AND SECURITIES SOLD, NOT YET
                PURCHASED**





Securities
      owned and securities sold, not yet purchased as of June 30, 2006 and December
      31, 2005 were as follows:


June
                  30, 2006
              
              
              December
                  31, 2005Sold,
                  Not Yet
              
              
              
              
              
              Sold,
                  Not YetOwned
              
              
              Purchased
              
              
              Owned
              
              
              Purchased(in
                  thousands)
              
              
              (in
                  thousands)(unaudited)
              
              
              (unaudited)Marketable:U.S.
                  government and agency
              
              $
              85,402
              
              $
              60,846
              
              $
              4,619
              
              $
              2,019Corporate
                  stocks and options
              
              
              31,364
              
              
              10,849
              
              
              18,096
              
              
              6,149Corporate
                  bonds
              
              
              39,788
              
              
              24,853
              
              
              7,933
              
              
              -156,554
              
              
              96,548
              
              
              30,648
              
              
              8,168Not
                  readily marketable:Partnerships
              
              
              35,752
              
              
              -
              
              
              34,108
              
              
              -Corporate
                  stocks and warrants
              
              
              9,747
              
              
              -
              
              
              8,901
              
              
              -$
              202,053
              
              $
              96,548
              
              $
              73,657
              
              $
              8,168




The
      increase in securities owned and securities sold, not yet purchased is due
      primarily to the trading portfolio of the Fixed Income National division, which
      began operations in January 2006.





Securities
      not readily marketable include investment securities (a) for which there is
      no
      market on a securities exchange or no independent publicly quoted market, (b)
      that cannot be publicly offered or sold unless registration has been effected
      under the Securities Act of 1933, or (c) that cannot be offered or sold because
      of other arrangements, restrictions, or conditions applicable to the securities
      or to the Company. Not readily marketable securities consist of investments
      in
      limited partnerships, equities, options, and warrants. The investments in
      limited partnerships are accounted for using the equity method, which
      approximates fair value, and principally consist of Environmental Opportunities
      Fund, L.P., Environmental Opportunities Fund II, L.P., Environmental
      Opportunities Fund II (Institutional), L.P., Corporate Opportunities Fund,
      L.P.,
      Corporate Opportunities Fund (Institutional), L.P., Sanders Opportunity Fund,
      L.P., Sanders Opportunity Fund (Institutional), L.P., Tactical Opportunities
      High Yield Fund, L.P., Life Sciences Opportunity Fund, L.P., Life Sciences
      Opportunity Fund (Institutional), L.P., Life Sciences Opportunity Fund II,
      L.P.,
      Life Sciences Opportunity Fund (Institutional) II, L.P., 2003 Houston Energy
      Partners, L.P., 2005 Houston Energy Partners, L.P., Concept Capital, LLC, Select
      Sports Group, Ltd., Endowment Advisors, L.P., SMH Private Equity Group I, L.P.,
      Salient Enhanced Credit Fund, L.P., Salient Total Return Fund, L.P., and Global
      Hedged Equity Fund, L.P.





**4.**
            **SECURITIES
                AVAILABLE FOR SALE**





Securities
      available for sale at June 30, 2006 were as follows:


**Amortized**
              
              
              **Gross
                  Unrealized**
              
              
              **Estimated****Cost**
              
              
              **Gains**
              
              
              **Losses**
              
              
              **Fair
                  Value**(in
                  thousands)U.S.
                  Government and agency obligations
              
              $
              966
              
              $
              5
              
              $
              (13
              )
              $
              958Corporate
                  bonds
              
              
              251
              
              
              -
              
              
              (1
              )
              
              250Marketable
                  equity securities
              
              
              459
              
              
              97
              
              
              -
              
              
              556Total
              
              $
              1,676
              
              $
              102
              
              
              (14
              )
              $
              1,764






9




The
      contractual maturities of debt securities available for sale at June 30, 2006,
      were as follows (in thousands):


Due
                  before 5 years
              $
              986Due
                  after 25 years through 30 years
              $
              222




Gross
      realized gains on sales of securities available for sale were $9,000 for the
      six
      months ended June 30, 2006 and $6,000 for the six months ended June 30, 2005.
      Gross realized losses on securities available for sale were $0 for the six
      months ended June 30, 2006 and $11,000 for the six months ended June 30, 2005.





The
      Company has pledged securities valued at $275,000 to the bank commissioner
      of
      the state of Oklahoma to secure its performance of fiduciary duties for trust
      activities in that state.





**5.**
            **INCOME
                TAXES**





The
      differences between the effective tax rate reflected in the income tax (benefit)
      provision from operations and the statutory federal rate were as
      follows:




**Three
                  Months Ended**
              
              
              **Six
                  Months Ended****June
                  30,**
              
              
              **June
                  30,****2006**
              
              
              **2005**
              
              
              **2006**
              
              
              **2005**(in
                  thousands)Tax
                  computed using the statutory rate
              
              $
              (982
              )
              $
              1,320
              
              $
              595
              
              $
              2,401State
                  income taxes and other
              
              
              (202
              )
              
              226
              
              
              98
              
              
              401Total
              
              $
              (1,184
              )
              $
              1,546
              
              $
              693
              
              $
              2,802




**6.**
            **BORROWINGS**





During
      May 2005, the Company entered into a $15.0 million revolving credit facility
      with a bank. The line of credit expires in May 2007, unless extended. Borrowings
      under the line of credit bear interest based on LIBOR. The interest rate on
      the
      Company’s borrowings ranged from 5.85% to 6.68% during 2006. The credit facility
      is secured by a pledge of ownership interests in two of the Company’s
      subsidiaries. Debt covenants require the Company to maintain certain
      debt-to-EDITDA and liquidity to funded debt ratios, as well as minimum assets
      under management. At June 30, 2006, the Company was in compliance with all
      covenants. The outstanding balance on the line of credit was $13.0 million
      at
      June 30, 2006.





During
      December 2005, Salient entered into a $2.5 million revolving credit facility
      with a bank. The line of credit expires in December 2007. Borrowings under
      the
      line of credit bear interest based on LIBOR. The interest rate of Salient’s
      borrowings ranged from 6.03% to 6.99% during 2006. The credit facility is
      unsecured and not subject to financial covenants; however, SMHG and the
      principals of Salient guarantee payment. The outstanding balance on the line
      of
      credit was $580,000 at June 30, 2006.





During
      December 2005, Edelman entered into a $1.5 million construction loan agreement
      with a bank. Proceeds from the loan were used to build out Edelman’s new office
      facilities. The loan is not subject to financial covenants and is secured by
      Edelman’s property and other assets and guaranteed by Mr. Edelman and SMHG.
      Beginning in January 2006 and ending in December 2006, interest will be paid
      in
      monthly installments at an interest rate, which is based on prime. The interest
      rate on Edelman’s borrowings ranged from 6.75% to 7.75% during 2006. Principal
      and interest payments will be made in equal monthly installments beginning
      in
      January 2007 and ending in December 2013. At June 30, 2006, the outstanding
      balance on the loan was $1.5 million.





10





**7.**
            **COMMITMENTS
                AND CONTINGENCIES**





In
      April
      2004, the Company acquired a 69% interest in Charlotte Capital from a previous
      investor. Employees of Charlotte Capital retained a 31% ownership interest
      in
      the firm. Employees of Charlotte Capital can earn up to an additional 9%
      ownership interest by achieving specified revenue run rates during the 36-month
      period beginning January 1, 2006 and ending December 31, 2009. No additional
      consideration has been earned as of June 30, 2006.




The
      Company has issued letters of credit in the amounts of $1.2 million, $199,000,
      $144,000, and $92,000 to the owners of four of the offices that we lease to
      secure payment of our lease obligations for those facilities. The Company has
      issued a letter of credit in the amount of $100,000 to secure the payment of
      the
      deductible portion of the Company’s workers compensation insurance policy.





The
      Company has uncommitted financing arrangements with clearing brokers that
      finance our customer accounts, certain broker-dealer balances, and firm trading
      positions. Although these customer accounts and broker-dealer balances are
      not
      reflected on the consolidated balance sheet for financial accounting reporting
      purposes, the Company has generally agreed to indemnify these clearing brokers
      for losses they may sustain in connection with the accounts, and therefore,
      retains risk on these accounts. The Company is required to maintain certain
      cash
      or securities on deposit with our clearing brokers.





In
      the
      normal course of business, the Company enters into underwriting commitments.
      There were no firm underwriting commitments open at June 30, 2006.





The
      NASD
      conducted an inspection of our prime broker and private investment or hedge
      fund
      support operations based in our New York office in the fall of 2004. Subsequent
      to such inspection the NASD opened an investigation and has requested the
      production of additional documents and materials on twelve occasions in 2005
      and
      2006 with respect to our prime broker and related hedge fund operations. The
      investigation is ongoing. We do not know when the NASD staff will complete
      its
      investigation or what, if any, actions the NASD may propose with respect to
      this
      matter.




The
      Company is a party to various legal proceedings that are of an ordinary or
      routine nature incidental to our operations. The Company believes it has
      adequately reserved for such litigation matters and that they will not have
      a
      material adverse effect on consolidated financial position, results of
      operations or cash flows.





The
      Company and its subsidiaries have obligations under operating leases that expire
      by 2014 with initial noncancelable terms in excess of one year.











11





**8.**
            **(LOSS)
                EARNINGS PER COMMON SHARE**





Basic
      and
      diluted (loss) earnings per-share computations for the periods indicated were
      as
      follows:


**Three
                  Months Ended June 30,****2006**
              
              
              **2005**(in
                  thousands, except per
                share
                  amounts)Computation
                  of basic and diluted (loss) earnings percommon
                  share:Net
                  (loss) income
              
              $
              (1,703
              )
              $
              2,226Weighted
                  average common shares outstanding
              
              
              19,118,912
              
              
              18,605,636Common
                  shares issuable under stock option plan
              
              
              781,335
              
              
              899,396Less
                  shares assumed repurchased with proceeds
              
              
              (319,448
              )
              
              (295,995
              )Weighted
                  average common shares outstanding
              
              
              19,580,799
              
              
              19,209,037Basic
                  (loss) earnings per common share
              
              $
              (0.09
              )
              $
              0.12Diluted
                  (loss) earnings per common share
              
              $
              (0.09
              )
              $
              0.12
   **Six
                  Months Ended June 30,****2006**
              
              
              **2005**(in
                  thousands, except per
                share
                  amounts)Computation
                  of basic and diluted earnings percommon
                  share:Net
                  income
              
              $
              1,058
              
              $
              4,058Weighted
                  average common shares outstanding
              
              
              19,054,114
              
              
              18,455,976Common
                  shares issuable under stock option plan
              
              
              831,335
              
              
              911,896Less
                  shares assumed repurchased with proceeds
              
              
              (353,574
              )
              
              (281,520
              )Weighted
                  average common shares outstanding
              
              
              19,531,875
              
              
              19,086,352Basic
                  earnings per common share
              
              $
              0.06
              
              $
              0.22Diluted
                  earnings per common share
              
              $
              0.05
              
              $
              0.21




Outstanding
      stock options (72,500 for the three months ended June 30, 2006, and 12,500
      for
      the three months ended June 30, 2005; and 22,500 for the six months ended June
      30,2006, and zero for the six months ended June 30, 2005) have not been included
      in diluted earnings per common share because to do so would have been
      antidilutive for the periods presented.





**9.**
            **GOODWILL**




During
      the three months ended June 30, 2006, the Company recognized goodwill impairment
      charges totaling $4.5 million related to its ownership of Charlotte Capital.
      The
      principal factor contributing to our decision to record the impairment charge
      related to the continuing decline of assets under management and to the fact
      that Charlotte Capital is not profitable at the current level of assets under
      management. Charlotte Capital’s assets under management have declined from $429
      million at December 31, 2004 to $173 million at June 30, 2006, primarily due
      to
      portfolio performance that has lagged the benchmark returns for the small and
      small/mid cap value styles that Charlotte Capital follows. Charlotte Capital
      provides investment management services to ten institutional investors, the
      loss
      of any one of which could have a material adverse impact on Charlotte Capital’s
      assets under management and, consequently, Charlotte Capital’s revenues and
      earnings.





12








**10.**
            **BUSINESS
                SEGMENT INFORMATION**





SMHG
      operates through four business segments: Asset and Wealth Management, which
      can
      be further divided into Asset Management and Retail Brokerage; Institutional
      Services, which can be further divided into Institutional Brokerage and Prime
      Brokerage; Investment Banking; and Corporate and Other. The business segments
      are based upon factors such as the services provided and distribution channels
      served. Certain services are provided to customers through more than one of
      our
      business segments.





***Asset
      and Wealth Management***





The
      Asset
      Management segment provides investment advisory, wealth and investment
      management, financial planning, and trust services to institutional and
      individual clients. The Company earns an advisory fee based on such factors
      as
      the amount of assets under management and the type of services provided. The
      asset management segment may also earn commission revenues from the sale of
      equity, fixed income, mutual fund, and annuity products; and sales credits
      from
      the distribution of investment banking issues. In addition, performance fees
      may
      be earned for exceeding performance benchmarks for the investment portfolios
      in
      the limited partnerships that we manage.





The
      Retail Brokerage segment distributes a range of financial products through
      its
      branch distribution network, including equity and fixed income securities,
      mutual funds, and annuities. Retail revenues consist of commissions and
      principal credits earned on equity and fixed income transactions in customer
      brokerage accounts, distribution fees earned from mutual funds, fees earned
      from
      managed accounts, and net interest on customers’ margin loan and credit account
      balances. Additionally, retail revenues include sales credits from investment
      banking transactions such as the distribution of underwritings that we co-manage
      or in which we participate and private placements of securities in which we
      serve as placement agent. The firm employs registered representatives and also
      licenses independent financial advisors.





***Institutional
      Services***





The
      Institutional Brokerage segment distributes equity and fixed income products
      through its distribution network to its institutional clients. Institutional
      revenues consist of commissions and principal credits earned on transactions
      in
      customer brokerage accounts, net interest on customers’ margin loan and credit
      account balances, and sales credits from the distribution of investment banking
      products.





The
      Prime
      Brokerage segment provides trade execution, clearing, custody and other
      back-office services to hedge funds and other professional traders. Prime broker
      revenues consist of commissions and principal credits earned on equity, and
      fixed income transactions; interest income from securities lending services
      to
      customers; and net interest on customers’ margin loan and credit account
      balances.





***Investment
      Banking***





The
      Investment Banking segment provides corporate securities underwriting, private
      financings, and financial advisory services. The Company participates in
      corporate securities distributions as a manager, co-manager or member of an
      underwriting syndicate or of a selling group in public offerings managed by
      other underwriters. Fees earned for our role as an advisor, manager, or
      underwriter are included in the investment banking segment. Sales credits
      associated with the distribution of investment banking products are reported
      in
      Retail Brokerage, Institutional Brokerage, or Asset Management depending on
      the
      relevant distribution channel.





***Corporate
      and Other***





The
      Corporate and Other segment include realized and unrealized gains and losses
      on
      the Company’s investment portfolios and interest and dividends earned on our
      cash and securities positions. Unallocated corporate revenues and expenses
      are
      included in Corporate and Other. Gains and losses from sports representation
      and
      management services performed by SSG are included in Corporate and Other.





13


The
      following summarizes certain financial information of each reportable business
      segment for the three and six months in the period ended June 30, 2006 and
      2005,
      respectively. SMHG does not analyze asset information in all business
      segments.


**Three
                  Months Ended**
              
              
              **Six
                  Months Ended****June
                  30,**
              
              
              **June
                  30,****2006**
              
              
              **2005**
              
              
              **2006**
              
              
              **2005**(in
                  thousands)**Revenues:**Asset
                  and Wealth ManagementAsset
                  management
              
              $
              14,623
              
              $
              10,152
              
              $
              29,220
              
              $
              17,194Retail
                  brokerage
              
              
              5,418
              
              
              3,378
              
              
              9,903
              
              
              8,029Asset
                  and Wealth Management Total
              
              
              20,041
              
              
              13,530
              
              
              39,123
              
              
              25,223Institutional
                  ServicesInstitutional
                  brokerage
              
              
              6,275
              
              
              7,025
              
              
              13,563
              
              
              12,857Prime
                  brokerage
              
              
              8,021
              
              
              4,766
              
              
              16,168
              
              
              8,877Institutional
                  Services Total
              
              
              14,296
              
              
              11,791
              
              
              29,731
              
              
              21,734Investment
                  banking
              
              
              8,289
              
              
              4,276
              
              
              15,340
              
              
              7,949Corporate
                  and other
              
              
              545
              
              
              902
              
              
              2,420
              
              
              1,933Total
              
              $
              43,171
              
              $
              30,499
              
              $
              86,614
              
              $
              56,839**(Loss)
                  income before equity in income of limited****partnerships,
                  minority interest and income taxes:**Asset
                  and Wealth ManagementAsset
                  management
              
              $
              3,835
              
              $
              2,937
              
              $
              7,484
              
              $
              4,351Retail
                  brokerage
              
              
              (792
              )
              
              174
              
              
              (955
              )
              
              791Asset
                  and Wealth Management Total
              
              
              3,043
              
              
              3,111
              
              
              6,529
              
              
              5,142Institutional
                  ServicesInstitutional
                  brokerage
              
              
              (1,368
              )
              
              1,214
              
              
              (1,379
              )
              
              1,639Prime
                  brokerage
              
              
              650
              
              
              609
              
              
              1,120
              
              
              998Institutional
                  Services Total
              
              
              (718
              )
              
              1,823
              
              
              (259
              )
              
              2,637Investment
                  banking
              
              
              2,939
              
              
              1,583
              
              
              5,547
              
              
              2,616Corporate
                  and other
              
              
              (7,275
              )
              
              (2,623
              )
              
              (9,617
              )
              
              (4,312
              )Total
              
              $
              (2,011
              )
              $
              3,894
              
              $
              2,200
              
              $
              6,083**Equity
                  in income of limited partnerships:**Asset
                  and Wealth ManagementAsset
                  management
              
              $
              647
              
              $
              513
              
              $
              2,122
              
              $
              2,179Retail
                  brokerage
              
              
              -
              
              
              -
              
              
              -
              
              
              -Asset
                  and Wealth Management Total
              
              
              647
              
              
              513
              
              
              2,122
              
              
              2,179Institutional
                  ServicesInstitutional
                  brokerage
              
              
              -
              
              
              -
              
              
              -
              
              
              -Prime
                  brokerage
              
              
              -
              
              
              -
              
              
              -
              
              
              -Institutional
                  Services Total
              
              
              -
              
              
              -
              
              
              -
              
              
              -Investment
                  banking
              
              
              -
              
              
              -
              
              
              -
              
              
              -Corporate
                  and other
              
              
              101
              
              
              193
              
              
              451
              
              
              223Total
              
              $
              748
              
              $
              706
              
              $
              2,573
              
              $
              2,402





14


**Three
                  Months Ended**
              
              
              **Six
                  Months Ended****June
                  30,**
              
              
              **June
                  30,****2006**
              
              
              **2005**
              
              
              **2006**
              
              
              **2005**(in
                  thousands)**Minority
                  interests in net income of consolidated****companies:**Asset
                  and Wealth ManagementAsset
                  management
              
              $
              (1,624
              )
              $
              (754
              )
              
              (3,022
              )
              
              (1,553
              )Retail
                  brokerage
              
              
              -
              
              
              -
              
              
              -
              
              
              -Asset
                  and Wealth Management Total
              
              
              (1,624
              )
              
              (754
              )
              
              (3,022
              )
              
              (1,553
              )Institutional
                  ServicesInstitutional
                  brokerage
              
              
              -
              
              
              -
              
              
              -
              
              
              -Prime
                  brokerage
              
              
              -
              
              
              -
              
              
              -
              
              
              -Institutional
                  Services Total
              
              
              -
              
              
              -
              
              
              -
              
              
              -Investment
                  banking
              
              
              -
              
              
              -
              
              
              -
              
              
              -Corporate
                  and other
              
              
              -
              
              
              (74
              )
              
              -
              
              
              (72
              )Total
              
              $
              (1,624
              )
              $
              (828
              )
              $
              (3,022
              )
              $
              (1,625
              )**(Loss)
                    income before income taxes:**Asset
                  and Wealth ManagementAsset
                  management
              
              $
              2,858
              
              $
              2,696
              
              $
              6,584
              
              $
              4,977Retail
                  brokerage
              
              
              (792
              )
              
              174
              
              
              (955
              )
              
              791Asset
                  and Wealth Management Total
              
              
              2,066
              
              
              2,870
              
              
              5,629
              
              
              5,768Institutional
                  ServicesInstitutional
                  brokerage
              
              
              (1,368
              )
              
              1,214
              
              
              (1,379
              )
              
              1,639Prime
                  brokerage
              
              
              650
              
              
              609
              
              
              1,120
              
              
              998Institutional
                  Services Total
              
              
              (718
              )
              
              1,823
              
              
              (259
              )
              
              2,637Investment
                  banking
              
              
              2,939
              
              
              1,583
              
              
              5,547
              
              
              2,616Corporate
                  and other
              
              
              (7,174
              )
              
              (2,504
              )
              
              (9,166
              )
              
              (4,161
              )Total
              
              $
              (2,887
              )
              $
              3,772
              
              $
              1,751
              
              $
              6,860




**11.**
            **ACCOUNTING
                FOR STOCK BASED COMPENSATION
                PLANS**





Effective
      January 1, 2006, the Company adopted the provisions of SFAS No. 123R, *Share-Based
      Payment (Revised 2004),* which
      requires the Company to recognize the cost of all stock-based compensation
      in
      its consolidated financial statements. The Company’s equity-classified awards
      are measured at grant-date fair value and are not subsequently remeasured.
      The
      valuation of equity instruments underlying stock-based compensation, and the
      period during which the expense is recognized is based on assumptions related
      to
      stock volatility, interest rates, vesting terms, and dividend yields. Changes
      in
      these assumptions, including forfeiture rates, could have significant impacts
      on
      the expense recognized. The Company recognized additional pretax compensation
      expense of $67,000 during the second quarter of 2006, and $85,000 for the six
      months ended June 30, 2006 as a result of the adoption of SFAS No. 123R, which
      includes compensation expense relating to stock-based compensation awards
      outstanding as of December 31, 2005 and grants made subsequent to December
      31,
      2005.




15


The
      following table illustrates the pro forma effect on net income and earnings
      per
      share as if the Company had applied the fair value recognition provisions of
      SFAS No. 123 for the three and six months ended in June 30, 2005.


**Three
                  Months**
              
              
              **Six
                  Months**(in
                  thousands, except
                per
                  share amounts)Net
                  income as reported
              
              $
              2,226
              
              $
              4,058Deduct:
                  Total stock based employee compensationexpense
                  determined under fair value basedmethod
                  for all awards, net of related tax effects
              
              
              (58
              )
              
              (117
              )Pro
                  forma income
              
              $
              2,168
              
              $
              3,941Earnings
                  per shareBasic-as
                  reported
              
              $
              0.12
              
              $
              0.22Basic-pro
                  forma
              
              $
              0.12
              
              $
              0.21Diluted-as
                  reported
              
              $
              0.12
              
              $
              0.21Diluted-pro
                  forma
              
              $
              0.11
              
              $
              0.21





Under
      its
      1998 Incentive Plan, as amended, (the Incentive Plan), the Company has reserved
      25% of the outstanding common stock of the Company, or 4,000,000 shares of
      common stock, whichever is greater, for the purpose of issuing incentive awards
      under the Incentive Plan. The Company had 1,224,801 shares of common stock
      available for grant under the Incentive Plan at June 30, 2006.





The
      Company has two types of stock-based compensation awards: (1) stock options,
      and
      (2) restricted common stock.





**Stock
      Options**





The
      Incentive Plan provides for the issuance to eligible employees of, among other
      things, incentive and non-qualified stock options, that may expire up to 10
      years from the date of grant. The outstanding options vest over one to five
      year
      service periods and have an exercise price equal to the closing price of the
      Company’s stock on the date of the grant. Unvested options on the date of
      termination of employment are forfeited within 90 days of termination.
      Typically, new shares are issued upon the exercise of stock
      options.





During
      the six months ended June 30, 2006, 111,436 options were exercised for which
      the
      Company received proceeds of $590,000. During the six months ended June 30,
      2005, 137,132 options were exercised for which the Company received proceeds
      of
      $721,000.





As
      a
      result of the adoption of SFAS No. 123R, the Company recognized additional
      pretax compensation cost of $34,000 in the first six months of 2006 for
      stock-based compensation awards outstanding as of December 31, 2005, for which
      the requisite service was not fully rendered prior to January 1, 2006.
      Approximately $93,000 remains to be recognized over 1.20 weighted average years.
      During the six months ended June 30, 2006, 50,000 options were granted with
      a
      weighted average fair value of $183,000.





The
      intrinsic value of stock options exercised totaled $1.1 million during the
      six
      months ended June 30, 2006 and $1.6 million for the six months ended June 30,
      2005.




16


The
      following table sets forth pertinent information regarding stock option
      transactions for the six months ended June 30, 2006.


WeightedNumber
              
              
              Averageof
                  Shares
              
              
              Exercise
                  PriceOustanding
                  at January 1, 2006
              
              
              915,271
              
              $
              6.42Granted
              
              
              50,000
              
              
              15.34Exercised
              
              
              (111,436
              )
              
              5.29Outstanding
                  at June 30, 2006
              
              
              853,835
              
              $
              7.09Options
                  exercisable at December 31, 2005
              
              
              850,271
              
              $
              5.98Options
                  exercisable at June 30, 2006
              
              
              785,085
              
              $
              6.44Options
                  available for grant at December 31, 2005
              
              
              1,360,889Options
                  available for grant at June 30, 2006
              
              
              1,224,801




The
      following table summarizes information related to stock options outstanding
      and
      exercisable at June 30, 2006:




Options
                  Outstanding
              
              Options
                  ExercisableNumber
              
              
              
              Wgtd.
                  Avg.
              
              
              
              
              
              Number
              Wgtd.
                  Avg.Range
                  of
              
              
              Outstanding
              
              
              
              Remaining
              
              
              
              Wgtd.
                  Avg.
              
              Exercisable
                  at
              
              Remaining
              
              
              Wgtd.
                  Avg.Exercise
                  Prices
              
              
              at
                  6/30/2006
              
              
              
              Contr.
                  Life
              
              
              
              Exercise
                  Price
              
              at
                  6/30/2006
              
              Contr.
                  Life
              
              
              Exercise
                  Price$4.44-$6.04
              
              
              623,835
              
              
              
              3.53
              
              
              $
              4.83
              
              623,835
              
              3.53
              
              $
              4.83$7.91-$10.00
              
              
              25,000
              
              
              
              6.63
              
              
              
              8.16
              
              25,000
              
              6.63
              
              
              8.16$12.02-$17.20
              
              
              205,000
              
              
              
              8.46
              
              
              
              13.85
              
              136,250
              
              8.16
              
              
              13.51$4.44-$17.20
              
              
              853,835
              
              
              
              4.81
              
              
              
              7.09
              
              785,085
              
              4.43
              
              
              6.44




The
      aggregate intrinsic value of options outstanding at June 30, 2006, was $6.8
      million. The aggregate intrinsic value of options exercisable at June 30, 2006,
      was $6.8 million.





The
      fair
      value of options at date of grant was estimated using the Black-Scholes
      option-pricing model with the following weighted-average
      assumptions:


Six
                  Months EndedJune
                  30,2006
              
              
              2005Estimated
                  life in years
              
              
              10.00
              
              
              10.00Interest
                  rate
              
              
              4.88
              %
              
              4.05%
                  - 4.21
              %Volatility
              
              
              19.51
              %
              
              22.23%
                  - 26.58
              %Dividend
                  yield
              
              
              1.23
              %
              
              1.05%
                  - 1.17
              %




**Restricted
      Common Stock**





The
      Incentive Plan permits the Company to grant restricted common stock to its
      employees. Additionally, eligible employees and consultants are allowed to
      purchase in lieu of salary, commission, or bonus, shares of the Company’s
      restricted common stock at a price equal to 66.6% of the 20-day average of
      the
      closing sales prices for a share of the Company’s common stock, ending on the
      day prior to the date the shares were issued. All shares are valued at the
      closing price on the date the shares are issued. The value of restricted shares
      granted, less consideration paid, if any, is amortized to compensation expense
      over the one to five-year vesting periods assuming continued employment through
      such date.




17




Employees
      deferred compensation of $375,000 during the six months ended June 30, 2006,
      and
      $50,000 during the six months ended June 30, 2005, that was used to purchase
      restricted common stock. The Company recognized compensation expense of $1.1
      million during the six months ended June 30, 2006, and $923,000 during the
      six
      months ended June 30, 2005, related to its restricted common stock
      plan.





The
      following table summarizes certain information related to restricted common
      stock grants at June 30, 2006:


WeightedNumber
                  of
              
              
              AverageShares
              
              
              Grant
                  Date Fair ValueNonvested
                  at January 1, 2006
              
              
              380,632
              
              $
              13.58Nonvested
                  at June 30, 2006
              
              
              426,963
              
              $
              13.47For
                  the six months ended June 30, 2006:Granted
              
              
              151,929
              
              $
              15.45Vested
              
              
              105,598
              
              $
              12.56Forfeited
              
              
              -
              
              
              -




During
      the six months ended June 30, 2006, the Company granted 151,929 restricted
      common shares with a weighted average grant date fair value of $15.45. During
      the six months ended June 30, 2005, the Company granted 89,414 restricted common
      shares with a weighted average grant date fair value of $16.23. During the
      six
      months ended June 30, 2006, 105,598 restricted common shares vested with a
      weighted average grant date fair value of $12.56. During the six months ended
      June 30, 2005, 180,203 restricted common shares vested with a weighted average
      grant date fair value of $9.00. At June 30, 2006, total unrecognized
      compensation cost, net of estimated forfeitures related to nonvested restricted
      stock totaled $4.0 million and is expected to be recognized over the next 57
      months.





**12.**
            **RELATED
                PARTIES**





The
      Company had receivables from related parties totaling $4.7 million at June
      30,
      2006, primarily consisting of $3.5 million of notes receivable from employees
      and consultants, and $512,000 of management fees receivable from the limited
      partnerships managed by the Company.





**13.**
            **SUBSEQUENT
                EVENT**





The
      Company recorded pretax operating losses of $3.1 million during the first six
      months of 2006, primarily due to a lack of revenues, and as a result, made
      the
      decision to close and closed most of the fixed income activities in the division
      known as Fixed Income National during the third quarter of 2006. The Company
      will exit the mortgage-backed, agency, and high-grade corporate bond businesses
      in New York City, but will continue the high-yield and syndicate activities.
      The
      assets and liabilities of the business consist primarily of marketable
      securities owned and securities sold, not yet purchased, with values at June
      30,
      2006 of $114.1 million and $84.9 million, respectively. The securities will
      be
      liquidated in an orderly fashion during the third quarter of 2006. We do not
      anticipate material losses associated with the liquidation of the securities.
      The Company may incur employee termination and other costs of closure that
      will
      be recorded in its consolidated financial statements during the third quarter
      of
      2006 or thereafter. We are evaluating the impact that this exit activity will
      have on our consolidated financial statements. The condensed consolidated
      financials of the Company as of June 30, 2006, do not reflect any expense or
      liability associated with this exit activity. The division was started during
      the first quarter of 2006 when a 30-person team formerly employed by Advest
      Group joined the Company.




18


**Item
      2.**  ***Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations***





The
      following discussion should be read in conjunction with the Condensed
      Consolidated Financial Statements and their related notes.





**Overview**





Sanders
      Morris Harris Group (the “Company” or “SMHG”) is a holding company that, through
      its subsidiaries and affiliates, provides asset and wealth management,
      investment banking, and institutional services to a large and diversified group
      of clients and customers, including individuals, corporations, and financial
      institutions. A summary of these services follows:





*Asset
      and Wealth Management* provides
      investment advisory, wealth and investment management, financial planning,
      and
      trust services, to high net worth and mass affluent individuals and
      institutions, including investment strategies and alternatives, tax efficient
      estate and financial planning, trusts, and agent/fiduciary investment management
      services, throughout their financial life cycle, as well as private client
      brokerage services. In addition, we provide specialized asset management
      products and services in specific investment styles to corporations and
      institutions both through internal marketing efforts and externally through
      formal sub-advisory relationships and other distribution arrangements with
      third
      parties.




*Investment
      Banking* includes
      capital raising, public offerings and private placements of equity and debt
      securities, financial advisory services, including advice on mergers,
      acquisitions and restructurings, and merchant banking services.





*Institutional
      Services* provides
      institutional equity and fixed income brokerage, institutional research, prime
      brokerage, and proprietary trading to a broad array of institutions throughout
      North America, Europe, and Asia, including banks, retirement funds, mutual
      funds, endowments, investment advisors, and insurance companies.





We
      have
      expanded both the range and depth of services offered to our clients through
      a
      combination of acquisitions and internal expansion. This growth has necessitated
      that we add additional personnel, as well as production-related incentive
      compensation plans. We have also improved and expanded our infrastructure
      including facilities, technology, and information services, to enable us to
      better compete with other firms that offer services similar to
      ours.





Our
      financial services business is affected by general economic conditions. Our
      revenues relating to asset-based advisory services and managed accounts are
      typically from fees based on the market value of assets under management or
      administration. The growth in assets under our management resulted in higher
      management fees for us. While growth in assets under management has resulted
      in
      higher management fees for us, the instability in the overall stock market,
      lower trading volume, and reduced commission rates have had a negative impact
      on
      our commission revenue.





We
      closely monitor our operating environment to enable us to respond promptly
      to
      market cycles. In addition, we seek to lessen earnings volatility by controlling
      expenses, increasing fee-based business, and developing new revenue sources.
      Nonetheless, operating results of any specific period should not be considered
      representative of future performance.




The
      discussion of the Company’s results of operations below may contain
      forward-looking statements. These statements, which reflect management’s beliefs
      and expectations, are subject to risks and uncertainties that may cause actual
      results to differ materially. For a discussion of the risks and uncertainties
      that may affect the Company’s future results, please see “Competition” and
“Government Regulation” in Part I, Item 1, “Risk Factors” in Part I, Item 1A,
      and “Factors Affecting Forward-Looking Statements” in Part II, Item 7, and other
      items throughout the Company’s Annual Report on Form 10-K for the year ended
      December 31, 2005.





19


Beginning
      in the first quarter of 2006, the Company’s retail brokerage business is
      included in Asset and Wealth Management and the Company’s prime brokerage
      business is included in institutional services.




**Components
      of Revenue and Expenses**





*Revenue* .
      Our
      revenues are comprised primarily of (1) commission revenue from retail, prime
      and institutional brokerage transactions, (2) fees from asset-based advisory
      services, asset management, financial planning, and fiduciary services (3)
      principal transactions, and (4) investment banking revenue from corporate
      finance fees, merger and acquisition fees, and merchant banking fees. We also
      earn interest on cash held and dividends received from the equity and fixed
      income securities held in our corporate capital accounts and have realized
      and
      unrealized gains (or losses) on securities in our inventory account.





*Expenses.* Our
      expenses consist of (1) compensation and benefits, (2) floor brokerage and
      clearing costs, and (3) other expenses. Compensation and benefits have both
      a
      variable component based on revenue production, and a fixed component. The
      variable component includes institutional and retail sales commissions, bonuses,
      overrides, and other incentives. Retail and institutional commissions are based
      on competitive commission schedules. Employees of the investment banking group
      and the research group receive a salary and discretionary bonuses as
      compensation. The fixed component includes administrative and executive
      salaries, payroll taxes, employee benefits, and temporary employee costs.
      Compensation and benefits is our largest expense item and includes wages,
      salaries, and benefits. During the second quarter of 2006, compensation and
      benefits represented 60% of total expenses and 62% of total revenue, compared
      to
      67% of total expenses and 58% of total revenue during the second quarter of
      2005. During the first six months of 2006, compensation and benefits represented
      63% of total expenses and 62% of total revenues compared to 67% of total
      expenses and 60% of total revenues for the same period in 2005.





Floor
      brokerage, exchange, and clearance expenses include clearing and trade execution
      costs associated with the retail, prime, and institutional brokerage business
      at
      SMH. SMH clears its transactions through several clearing firms, including
      Pershing LLC, a member of BNY Securities Group and a subsidiary of The Bank
      of
      New York, Goldman Sachs Execution & Clearing, L.P., ADP Clearing &
Outsourcing, Inc., and First Clearing Corporation.





Other
      expenses include (1) occupancy and equipment expenses, such as rent and utility
      charges for facilities, and (2) communications and data processing expenses,
      such as third-party systems, data, and software providers.





**Results
      of Operations**





*Three
      Months Ended June 30, 2006 Compared to Three Months Ended June 30,
      2005*





The
      May
      10, 2005, acquisition of a 51% interest in Edelman is reflected in our operating
      results from the date of the transaction. The Company expanded its institutional
      fixed income brokerage operations during the first quarter of 2006 when a
      30-person team formerly employed by Advest Group joined the Company. The new
      division is known as Fixed Income National.





Total
      revenues were $43.2 million in the second quarter of 2006 compared to $30.5
      million for the same quarter in 2005, an increase of $12.7 million, or 42%
      reflecting the acquisition of Edelman in May 2005, and growth in investment
      banking and proprietary trading operations. Total expenses for the second
      quarter of 2006 increased $18.6 million, or 70% to $45.2 million from $26.6
      million in the same quarter of the previous year. The Company recorded a
      goodwill impairment charge in the amount of $4.5 million during 2006 associated
      with its Charlotte Capital division. Net income attributable to minority
      interest increased to $1.6 million during the second quarter of 2006 from
      $828,000 during the same period in 2005, primarily due to the acquisition of
      Edelman. The net loss for the three-month period ended June 30, 2006, totaled
      $1.7 million, compared to net income of $2.2 million in the same period in
      2005.
      Basic and diluted loss per share was $0.09 for the three months ended June
      30,
      2006, compared to net income per share of $0.12 for the same period in 2005.





20


Commissions
      revenue increased to $15.2 million in the second quarter of 2006 from $10.1
      million for the same period in 2005, primarily as a result of the Edelman
      acquisition. Investment banking revenue increased to $12.0 million during the
      second quarter of 2006 from $8.1 million in the same period of 2005, principally
      due to an increase in private placement and advisory fees. Revenues from
      investment advisory and related services fees increased to $8.6 million in
      the
      second quarter of 2006 from $8.1 million in the same quarter of 2005 primarily
      due to the acquisition of Edelman during the second quarter of 2005. Principal
      transactions revenue totaled $3.8 million for the second quarter of 2006 versus
      $2.2 million in the second quarter of 2005 reflecting growth in our proprietary
      trading operations. Interest and dividend income increased to $2.0 million
      in
      the second quarter of 2006 from $1.1 million in the same period last year,
      due
      to higher margin interest reflecting an increase in margin balances. Other
      income increased from $873,000 during the second quarter of 2005 to $1.6 million
      during the same period in 2006 due to an increase in fees earned on the
      Company’s cash balance and customer credit balances at its clearing firms
      resulting from higher deposit balances.





During
      the three months ended June 30, 2006, employee compensation and benefits
      increased to $26.9 million from $17.7 million in the same period last year
      due
      to more employees and higher revenues during 2006. Floor brokerage, exchange
      and
      clearance fees increased to $2.0 million in the second quarter of 2006 from
      $1.1
      million in the same quarter of 2005 reflecting higher clearing and execution
      costs resulting from the increased trading volume. Occupancy costs totaled
      $2.9
      million during the second quarter of 2006, compared to $1.9 million in the
      prior
      year quarter due to expansion of our New York City offices, the addition of
      two
      new retail offices, and the addition of Edelman. The
      Company recorded a goodwill impairment charge in the amount of $4.5 million
      during 2006 associated with its Charlotte Capital division. Other
      general and administrative expenses increased to $5.9 million during the second
      quarter of 2006 from $3.6 million in the second quarter of last year mainly
      due
      to our growth and to legal costs associated with the settlement of customer
      claims during the 2006 quarter.





Our
      effective tax rate was 41% for the three months ended June 30, 2006 and for
      the
      three months ended June 30, 2005.





Results
      by Segment





**Asset
      and Wealth Management**





*Asset
      Management*


**Three
                  Months Ended June 30,****2006**
              
              
              **2005**(in
                  thousands)Revenues
              
              $
              14,623
              
              $
              10,152Income
                  before income taxes
              
              $
              2,858
              
              $
              2,696




Revenues
      from asset management increased to $14.6 million from $10.2 million, and income
      before taxes increased to $2.9 million from $2.7 million. Commission revenues
      increased to $4.1 million from $906,000, while investment management and related
      service fees increased to $8.2 million from $7.8 million. Other income increased
      from $390,000 to $1.1 million, primarily due to an increase in insurance
      commissions. The revenue growth is primarily due to the acquisition of Edelman
      in May 2005. Total expenses rose to $10.9 million from $7.2 million due to
      the
      higher revenues. Minority interests in net income of consolidated companies
      reflect the portion of net income attributable to minority interest ownership
      of
      entities included in this segment’s consolidated financial statements. Income
      attributable to minority interests, which reduces SMHG’s pretax income,
      increased to $1.6 million in 2006 from $754,000 in 2005, principally due to
      increased income from the Company’s ownership of 51% of Edelman. While revenues
      increased by $4.5 million, or 44%, income before income taxes increased by
      $200,000, or 6%, mainly due to an increase in the percentage of revenues derived
      from entities that are not wholly owned by SMHG and for which minority interest
      charges are recorded.





21


*Retail
      Brokerage*


**Three
                  Months Ended June 30,****2006**
              
              
              **2005**(in
                  thousands)Revenues
              
              $
              5,418
              
              $
              3,378(Loss)
                  income before income taxes
              
              $
              (792
              )
              $
              174




Revenues
      from retail brokerage increased to $5.4 million from $3.4 million, and income
      before income taxes declined to a loss of $792,000 from a profit of $174,000.
      Commission revenue increased to $2.9 million from $1.9 million due primarily
      to
      the addition of two new retail offices. Sales credits from investment banking
      transactions increased to $1.5 million from $639,000 due to an increase in
      fees
      earned from private placement transactions. Total expenses increased to $6.2
      million from $3.2 million in 2005 primarily due to costs associated with the
      opening of two new retail offices, and to an increase in legal expenses related
      to arbitration claims against the Company.





**Institutional
      Services**





*Institutional
      Brokerage*


**Three
                    Months Ended June 30,****2006**
                
                
                **2005**(in
                    thousands)Revenues
                
                $
                6,275
                
                $
                7,025(Loss)
                    income before income taxes
                
                $
                (1,368
                )
                $
                1,214




Revenues
      from institutional brokerage declined to $6.3 million from $7.0 million, and
      income before taxes declined to a loss of $1.4 million from income of $1.2
      million. Sales credits from investment banking transactions declined to $1.2
      million from $2.1 million due primarily to a decrease in fees earned from the
      Company’s participation in syndicate transactions. Total expenses increased to
      $7.6 million from $5.8 million in 2005 primarily due to the startup of the
      Fixed
      Income National division during the first quarter of 2006.





*Prime
      Brokerage*




**Three
                  Months Ended June 30,****2006**
              
              
              **2005**(in
                  thousands)Revenues
              
              $
              8,021
              
              $
              4,766Income
                  before income taxes
              
              $
              650
              
              $
              609
   22


Revenues
      from prime brokerage increased to $8.0 million from $4.8 million, and income
      before taxes increased to $650,000 from $609,000. Commission revenue increased
      to $4.5 million from $3.5 million, while principal transaction revenue increased
      to $2.8 million from $975,000, reflecting growth in proprietary trading
      activities. Total expenses increased to $7.4 million during 2006 from $4.2
      million during the second quarter of 2005 reflecting increased compensation
      and
      other costs related to proprietary trading activities. Compensation and other
      costs when measured as a percentage of proprietary trading revenues are higher
      than similar costs associated with other revenue sources.





**Investment** **** **Banking**


**Three
                  Months Ended June 30,****2006**
              
              
              **2005**(in
                  thousands)Revenues
              
              $
              8,289
              
              $
              4,276Income
                  before income taxes
              
              $
              2,939
              
              $
              1,583




Revenues
      from investment banking increased to $8.3 million from $4.3 million, and income
      before taxes increased to $2.9 million from $1.6 million. The revenue increase
      is primarily due to increased revenues from private placement transactions
      and
      advisory fees during 2006. Total expenses increased to $5.4 million from $2.7
      million in 2005 due to higher compensation costs related to the higher revenues
      and to higher occupancy costs caused by the division’s relocation to larger
      offices in the New York area.





**Corporate
      and Other**


**Three
                  Months Ended June 30,****2006**
              
              
              **2005**(in
                  thousands)Revenues
              
              $
              545
              
              $
              902Loss
                  before income taxes
              
              $
              (7,174
              )
              $
              (2,504
              )




Revenues
      from corporate and other declined to $545,000 from $902,000, and the loss before
      taxes increased to $7.2 million from $2.5 million. The Company recorded a
      goodwill impairment charge in the amount of $4.5 million during 2006 associated
      with its Charlotte Capital division.





*Six
      Months Ended June 30, 2006 Compared to Six Months Ended June 30,
      2005*





Total
      revenues were $86.6 million in the first six months of 2006 compared to $56.8
      million for the same period in 2005, an increase of $29.8 million, or 52%
      reflecting the acquisition of Edelman in May 2005, and growth in the investment
      banking and proprietary trading operations. Total expenses for the first half
      of
      2006 increased $33.6 million, or 66% to $84.4 million from $50.8 million in
      the
      same period of the previous year. The Company recorded a goodwill impairment
      charge in the amount of $4.5 million during 2006 associated with its Charlotte
      Capital division. Income attributable to minority interests increased to $3.0
      million from $1.6 million during the first half of 2005, primarily due to the
      acquisition of Edelman. Net income for the six-month period ended June 30,
      2006,
      declined $3.0 million or 74% to $1.1 million from $4.1 million in the same
      period in 2005. Basic income per share was $0.06 for the six months ended June
      30, 2006 compared to $0.22 for the same period in 2005. Diluted income per
      share
      was $0.05 for the six months ended June 30, 2006, compared to $0.21 for the
      same
      period in 2005.





23


Commissions
      revenue increased to $30.0 million in the first six months of 2006 from $21.4
      million for the same period in 2005, primarily as a result of the Edelman
      acquisition. Investment banking revenue increased to $22.0 million during the
      first six months of 2006 from $14.2 million in the same period of 2005,
      principally due to an increase in private placement and advisory fees. Revenues
      from investment advisory and related services fees increased to $17.4 million
      in
      the first six months of 2006 from $13.1 million in the same period of 2005
      primarily due to the acquisition of Edelman during the first six months of
      2005.
      Principal transactions revenue totaled $10.7 million for the first six months
      of
      2006 versus $4.1 million in the first six months of 2005 reflecting growth
      in
      our proprietary trading operations and the addition of the Fixed Income National
      division. Interest and dividend income increased to $3.5 million in the first
      six months of 2006 from $2.3 million in the same period last year, due to higher
      margin interest reflecting an increase in margin balances. Other income
      increased from $1.7 million during the first six months of 2005 to $3.0
      million during the same period in 2006 due to an increase in fees earned on
      the
      Company’s cash balance and customer credit balances at its clearing firms
      resulting from higher deposit balances.





During
      the six months ended June 30, 2006, employee compensation and benefits increased
      to $53.4 million from $34.2 million in the same period last year due to more
      employees and higher revenues during 2006. Floor brokerage, exchange and
      clearance fees increased to $3.8 million in the first six months of 2006 from
      $2.2 million in the same period of 2005 reflecting higher clearing and execution
      costs resulting from the increased trading volume. Communication and data
      processing costs increased to $4.5 million in 2006 from $4.0 million in the
      same
      period last year resulting primarily from increased personnel and additional
      offices. Occupancy costs totaled $5.6 million during the first six months of
      2006, compared to $4.0 million in the prior year quarter due to expansion of
      our
      New York City offices, and the addition of Edelman. Interest expense totaled
      $1.1 million during the first half of 2006 compared to $43,000 during the same
      period in 2005, due to the addition of three credit facilities during 2005.
      The
      Company recorded a goodwill impairment charge in the amount of $4.5 million
      during 2006 associated with its Charlotte Capital division. Other general and
      administrative expenses increased to $11.5 million during the first six months
      of 2006 from $6.3 million in the first six months of last year mainly due to
      our
      growth.





Our
      effective tax rate was 40% for the six months ended June 30, 2006 compared
      to
      41% for the six months ended June 30, 2005.





Results
      by Segment





**Asset
      and Wealth Management**





*Asset
      Management*


**Six
                  Months Ended June 30,****2006**
              
              
              **2005**(in
                  thousands)Revenues
              
              $
              29,220
              
              $
              17,194Income
                  before income taxes
              
              $
              6,584
              
              $
              4,977




Revenues
      from asset management increased to $29.2 million from $17.2 million, and income
      before taxes increased to $6.6 million from $5.0 million. Commission revenues
      increased to $7.8 million from $2.3 million, while investment management and
      related service fees increased to $16.7 million from $12.5 million. Other income
      increased from $502,000 during 2005 to $1.9 million in 2006, primarily due
      to an
      increase in insurance commissions. The revenue growth is primarily due to the
      acquisition of Edelman in May 2005. Total expenses rose to $21.7 million from
      $12.8 million due to the higher revenues. Minority interests in net income
      of
      consolidated companies reflect the portion of net income attributable to
      minority interest ownership of entities included in this segment’s consolidated
      financial statements. Income attributable to minority interests, which reduces
      SMHG’s pretax income, increased to $3.0 million in 2006 from $1.6 million in
      2005, principally due to increased income from the Company’s ownership of 51% of
      Edelman. While revenues increased by $12.0 million, or 70%, income before income
      taxes increased by $1.6 million, or 32%, mainly due to an increase in the
      percentage of revenues derived from entities that are not wholly owned by SMHG
      and for which minority interest charges are recorded.





24


*Retail
      Brokerage*


**Six
                  Months Ended June 30,****2006**
              
              
              **2005**(in
                  thousands)Revenues
              
              $
              9,903
              
              $
              8,029(Loss)
                  income before income taxes
              
              $
              (955
              )
              $
              791




Revenues
      from retail brokerage increased to $9.9 million from $8.0 million, and income
      before income taxes declined to a loss of $955,000 from income of $791,000.
      Commission revenues increased to $5.5 million from $4.4 million due primarily
      to
      two new offices. Sales credits from investment banking transactions increased
      to
      $2.2 million from $1.7 million due to an increase in fees earned from the
      Company’s participation in syndicate transactions. Total expenses increased to
      $10.9 million from $7.2 million in 2005 primarily due to costs associated with
      the opening of two new retail offices, and to an increase in legal expenses
      related to arbitration claims against the Company.




**Institutional
      Services**





*Institutional
      Brokerage*


**Six
                  Months Ended June 30,****2006**
              
              
              **2005**(in
                  thousands)Revenues
              
              $
              13,563
              
              $
              12,857(Loss)
                  income before income taxes
              
              $
              (1,379
              )
              $
              1,639


Revenues
      from institutional brokerage increased to $13.6 million from $12.9 million,
      and
      income before taxes declined to a loss of $1.4 million from income of $1.6
      million. Commission revenue increased to $8.3 million from $8.0 million, while
      revenues from principal transactions increased to $2.5 million from $1.5
      million. Both the increase in commissions and principal transactions are due
      to
      the startup of the Fixed Income National division during the first quarter
      of
      2006. Sales credits from investment banking transactions declined to $2.1
      million from $3.2 million due to a reduction in fees earned from syndicate
      transactions. Total expenses increased to $16.9 million from $12.6 million
      in
      2005 primarily due to the startup of the Fixed Income National division.





*Prime
      Brokerage*


**Six
                  Months Ended June 30,****2006**
              
              
              **2005**(in
                  thousands)Revenues
              
              $
              16,168
              
              $
              8,877Income
                  before income taxes
              
              $
              1,120
              
              $
              998
  25


Revenues
      from prime brokerage increased to $16.2 million from $8.9 million, and income
      before taxes increased to $1.1 million from $998,000. Commission revenue
      increased to $8.3 million from $6.7 million, while principal transaction revenue
      increased to $6.6 million from $1.6 million, reflecting growth in proprietary
      trading activities. Interest income increased from $457,000 to $1.1 million
      reflecting higher earnings from the financing of the proprietary trading
      accounts. Total expenses increased to $15.0 million during the first six months
      of 2006 from $7.9 million during the first six months of 2005 reflecting
      increased compensation and other costs related to proprietary trading
      activities. Compensation and other costs when measured as a percentage of
      proprietary trading revenues are higher than similar costs associated with
      other
      revenue sources.





**Investment** **** **Banking**


**Six
                  Months Ended June 30,****2006**
              
              
              **2005**(in
                  thousands)Revenues
              
              $
              15,340
              
              $
              7,949Income
                  before income taxes
              
              $
              5,547
              
              $
              2,616


Revenues
      from investment banking increased to $15.3 million from $7.9 million, and income
      before taxes increased to $5.5 million from $2.6 million. The revenue increase
      is primarily due to increased revenues from private placement transactions
      and
      advisory fees during 2006. Total expenses increased to $9.8 million from $5.3
      million in 2005 due to higher compensation costs related to the higher revenues
      and to higher occupancy costs caused by the division’s relocation to larger
      offices in the New York area.





**Corporate
      and Other**


**Six
                  Months Ended June 30,****2005**
              
              
              **2005**(in
                  thousands)Revenues
              
              $
              2,420
              
              $
              1,933Loss
                  before income taxes
              
              $
              (9,166
              )
              $
              (4,161
              )




Revenues
      from corporate and other increased to $2.4 million from $1.9 million, and the
      loss before taxes increased to $9.2 million from $4.2 million. The revenue
      increase is due primarily to realized and unrealized gains in our merchant
      banking portfolio. The Company recorded a goodwill impairment charge in the
      amount of $4.5 million during 2006 related to its Charlotte Capital
      division.





**Liquidity
      and Capital Resources**





We
      intend
      to satisfy a large portion of our funding needs with our own capital resources,
      consisting mainly of internally generated earnings and liquid assets we
      currently hold.





At
      June
      30, 2006, we had approximately $10.7 million in cash and cash equivalents,
      which
      together with receivables from broker-dealers, deposits with clearing brokers,
      marketable securities owned, and securities available for sale represented
      approximately 52% of our total assets at the end of the second quarter.





For
      the
      six months ended June 30, 2006, net cash used in operations totaled $1.9 million
      versus net cash provided by operations of $422,000 during the first six months
      of 2005. Accounts payable and accrued liabilities decreased by $2.5 million
      during the six months ended June 30, 2006, principally due to the payment of
      accrued compensation during the first quarter of 2006.





26


Securities
      owned increased by $125.8 million, net of equity in income of limited
      partnerships of $2.6 million, during the first six months of 2006, while
      securities sold, not yet purchased increased by $88.4 million and payables
      to
      clearing brokers increased by $32.8 million. The increases in securities owned,
      securities sold, not yet purchased and payables to clearing brokers is primarily
      due to the trading portfolios of the Fixed Income National division, which
      began
      operations during January 2006, and our proprietary trading operations. The
      Company’s Fixed Income National division and its proprietary trading operations
      carry both long and short fixed income and equity securities. These trading
      operations generally seek to generate profits based on trading spreads, rather
      than through speculation on the direction of the market. We employ hedging
      strategies designed to insulate the net value of our trading inventories from
      fluctuations in the general level of interest rates and equity price variances.
      We finance a portion of our trading positions through our clearing
      broker-dealers.





Capital
      expenditures for the first half quarter of 2006 were $3.5 million, mainly for
      the purchase of furniture, computer equipment and software, as well as for
      leasehold improvements, necessary for our growth.





At
      June
      30, 2006, SMH, our registered broker-dealer subsidiary, was in compliance with
      the net capital requirements of the Securities and Exchange Commission's Uniform
      Net Capital Rules and had capital in excess of the required minimum. Salient
      Trust Co., LTA was in compliance with the Texas Department of Banking net
      capital requirement and had capital in excess of the required minimum.





We
      are a
      party to various legal proceedings that are of an ordinary or routine nature
      incidental to our operations. We believe we have adequately reserved for such
      litigation matters and that they will not have a material adverse effect on
      our
      consolidated financial position, results of operations, or cash
      flows.





**Factors
      Affecting Forward-Looking Statements**





This
      quarterly report on Form 10-Q includes "forward-looking statements" within
      the
      meaning of Section 27A of the Securities Act of 1933, as amended, and Section
      21E of the Securities and Exchange Act of 1934, as amended (the "Acts"). These
      forward-looking statements may relate to such matters as anticipated financial
      performance, future revenues or earnings, business prospects, projected
      ventures, new products, anticipated market performance and similar matters.
      The
      Private Securities Litigation Reform Act of 1995 provides a safe harbor for
      forward-looking statements. To comply with the safe harbor, the Company cautions
      readers that a variety of factors could cause the Company's actual results
      to
      differ materially from the anticipated results or other expectations expressed
      in the Company's forward-looking statements. These risks and uncertainties,
      many
      of which are beyond the Company's control, include, but are not limited to
      (1)
      trading volume in the securities markets; (2) volatility of the securities
      markets and interest rates; (3) changes in regulatory requirements, which could
      affect the demand for the Company's services or the cost of doing business;
      (4)
      general economic conditions, both domestic and foreign, especially in the
      regions where the Company does business; (5) changes in the rate of inflation
      and related impact on securities markets; (6) competition from existing
      financial institutions and other new participants in the securities markets;
      (7)
      legal developments affecting the litigation experience of the securities
      industry; (8) successful implementation of technology solutions; (9) changes
      in
      valuations of the Company’s trading and warrant portfolios resulting from
      mark-to-market adjustments; (10) dependence on key personnel; and (11) demand
      for the Company's services. The Company does not undertake to publicly update
      or
      revise any forward-looking statements.





**Item
      3** ***.
      Quantitative and Qualitative Disclosures About Market
      Risk***





**Market
      Risks**





During
      the six months ended June 30, 2006, there has been no material changes to the
      information contained in Part II, Item 7A of the Company’s Annual Report on Form
      10-K for the year ended December 31, 2005.





27


At
      June
      30, 2006, securities owned by the Company were recorded at a fair value of
      $202.1 million, including $156.6 million in marketable securities, $35.8 million
      representing the Company’s investments in limited partnerships and $9.7 million
      representing other not readily marketable securities.





At
      June
      30, 2006, Salient had securities available for sale with a fair value of $1.8
      million. These securities have an original cost of $1.7 million, and are subject
      to equity price risk. At June 30, 2006, the unrealized increase in market value
      totaling $88,000 less tax of $34,000 has been included as a separate component
      of shareholders’ equity.




**Item
      4.**  ***Controls
      and Procedures***





** Our
      management, including our Chief Executive Officer and Chief Financial Officer,
      have conducted an evaluation of the effectiveness of our disclosure controls
      and
      procedures (as defined in Rule 13a-15(e) promulgated under the Exchange Act),
      as
      of the end of the fiscal period covered by this report. Based upon that
      evaluation, our Chief Executive Officer and Chief Financial Officer have
      concluded that our disclosure controls and procedures are effective in ensuring
      that the information required to be disclosed in the reports we file or submit
      under the Exchange Act is recorded, processed, summarized and reported within
      the time periods specified in the rules and forms of the Securities and Exchange
      Commission and that such information is accumulated and communicated to our
      management, including our Chief Executive Officer and Chief Financial Officer,
      as appropriate to allow timely decisions regarding required disclosure. There
      have been no changes made in our internal controls over financials reporting
      during the period covered by this report that have materially affected, or
      are
      reasonably likely to materially affect, our internal control over financial
      reporting.







28


**PART
      II. OTHER INFORMATION**





**Item
      1.** ***Legal
      Proceedings***





Many
      aspects of our business involve substantial risks of liability. In the normal
      course of business, we have been and in the future may be named as defendant
      or
      co-defendant in lawsuits and arbitration proceedings involving primarily claims
      for damages. We are also involved in a number of regulatory matters arising
      out
      of the conduct of our business. There can be no assurance that these matters
      will not have a material adverse effect on our results of operation in any
      future period and a significant judgment could have a material adverse impact
      on
      our consolidated financial position, results of operations, and cash flows.
      In
      addition to claims for damages and monetary sanctions that may be made against
      us, we incur substantial costs in investigating and defending claims and
      regulatory matters.




The
      NASD
      conducted an inspection of our prime broker and private investment or hedge
      fund
      support operations based in our New York office in November 2004. Subsequently,
      the NASD opened an investigation and has requested the production of additional
      documents and materials on twelve occasions in 2005 and 2006 with respect to
      our
      prime broker and related hedge fund operations and has conducted formal
      interviews of a number of our employees involved in these operations. The
      investigation is ongoing. We do not know when the NASD staff will complete
      its
      investigation or what, if any, actions the NASD may propose with respect to
      this
      matter.





In
      view
      of the inherent difficulty of predicting the outcome of legal proceedings,
      particularly where the plaintiffs seek substantial or indeterminate damages
      or
      where novel legal theories or a large number of parties are involved, we cannot
      state with confidence what the eventual outcome of currently pending matters
      will be, what the timing of the ultimate resolution of these matters will be,
      or
      what the eventual result in each pending matter will be. Based on currently
      available information, we have established reserves for certain litigation
      matters and our management does not believe that resolution of any matter will
      have a material adverse effect on our liquidity or financial position although,
      depending on our results for a particular period, an adverse determination
      could
      have a material effect on quarterly or annual operating results in the period
      in
      which it is resolved.





During
      the second quarter all pending customer arbitration proceedings involving
      Sanders Morris Harris were decided or settled. Sanders Morris Harris paid
      aggregate damage awards, settlement payments, and legal expenses and costs
      of
      approximately $880,000 in connection with these matters. While Sanders Morris
      Harris currently does not have any pending customer complaints, in the normal
      course of business it has been and in the future may be named as a defendant
      or
      co-defendant in lawsuits and customer arbitration proceedings.






29




**Item
      4.** ***Submission
      of Matters to a Vote of Security Holders***





On
      May 8,
      2006, the Company held its annual meeting of shareholders to vote for election
      of directors to the Company’s Board of Directors. Each nominee was elected and
      the results of the votes were as follows:





**Number
                  of**
              
              **Number
                  of**
              
              **Number
                  of****Shares**
              
              **Shares**
              
              **Broker****Voted
                  For**
              
              **Withheld**
              
              **Non-Votes**George
                  L. Ball
              17,155,829
              
              214,789
              
              -Richard
                  E. Bean
              17,165,179
              
              205,439
              
              -Robert
                  M. Collie
              15,333,577
              
              2,037,041
              
              -Charles
                  W. Duncan III
              17,185,087
              
              185,531
              
              -Robert
                  E. Garrison II
              17,195,729
              
              174,889
              
              -Titus
                  H. Harris, Jr.
              17,195,300
              
              175,318
              
              -Gerald
                  H. Hunsicker
              17,221,411
              
              149,207
              
              -Scott
                  McClelland
              17,220,911
              
              149,707
              
              -Ben
                  T. Morris
              17,195,729
              
              174,889
              
              -Dr.
                  Albert W. Niemi, Jr.
              17,201,503
              
              169,115
              
              -Nolan
                  Ryan
              14,066,534
              
              3,304,084
              
              -Don
                  A. Sanders
              17,175,094
              
              195,524
              
              -W.
                  Blair Waltrip
              17,149,404
              
              221,214
              
              -Dan
                  S. Wilford
              17,220,911
              
              149,707
              
              -




30





**Item
      6** . ***Exhibits***




**Exhibit****Number**
              
              **Description**3.1
              
              Articles
                  of Incorporation of the Company, as amended (Filed as Exhibit 3.1
                  to the
                  Company’s Annual Report on Form 10-K for the year ended December 31, 2001
                  (File No. 000-30066), and incorporated herein by
                  reference).3.2
              
              Amended
                  and Restated Bylaws of the Company (Filed as Exhibit 3.2 to the
                  Company’s
                  Quarterly Report on Form 10-Q for the quarter ended June 30, 2004
                  (File
                  No. 000-30066), and incorporated herein by reference).†10.01
              
              Sanders
                  Morris Harris Group Inc. 1998 Incentive Plan as amended (Filed
                  as Appendix
                  A to the Definitive Proxy Statement on Schedule 14A of the Company
                  dated
                  May 3, 2002 (File No. 000-30066), and incorporated herein by
                  reference).†10.02
              
              Sanders
                  Morris Harris Group Inc. Capital Incentive Program (Filed as Exhibit
                  10.1
                  to the Company’s Form 10-Q for the quarter ended September 30, 2001 (File
                  No. 000-30066), and incorporated herein by reference).†10.03
              
              Form
                  of Option Agreement pursuant to 1998 Incentive Plan (Filed as Exhibit
                  10.03 to the Company’s Annual Report on Form 10-K for the year ended
                  December 31, 2005 (File No. 000-30066), and incorporated herein
                  by
                  reference).†10.04
              
              Form
                  of Restricted Stock Agreement pursuant to 1998 Incentive Plan (Filed
                  as
                  Exhibit 10.04 to the Company’s Annual Report on Form 10-K for the year
                  ended December 31, 2005 (File No. 000-30066), and incorporated
                  herein by
                  reference).10.05
              
              Sublease
                  Agreement dated January 19, 1994, between Texas Commerce Bank National
                  Association and Harris Webb & Garrison, Inc., as amended by that
                  certain First Amendment to Sublease Agreement dated February 23,
                  1994, the
                  Second Amendment to Sublease Agreement dated April 26, 1994, and
                  the Third
                  Amendment to Sublease Agreement dated January 19, 1995 (Filed as
                  Exhibit
                  10.16 to the Proxy Statement/Prospectus of the Company dated December
                  31,
                  1998 (File No. 333-65417), and incorporated herein by
                  reference).10.06
              
              On-Line
                  Services Agreement dated as of June 1, 2005, between Innovest Systems,
                  LLC
                  and Pinnacle Trust Co., LTA. (Filed as Exhibit 10.05 to the Company’s
                  Quarterly Report on Form 10-Q for the quarter ended September 30,
                  2005
                  (File No. 000-30066), and incorporated herein by
                  reference).10.07
              
              Office
                  Lease Agreement and related amendments dated September 25, 1996,
                  between
                  Texas Tower Limited and Sanders Morris Mundy Inc. (Filed as Exhibit
                  10.3
                  to the Company’s Quarterly Report on Form 10-Q for the quarter ended March
                  31, 2000 (File No. 000-30066), and incorporated herein by
                  reference).10.08
              
              Credit
                  Agreement dated as of May 9, 2005, between Sanders Morris Harris
                  Group
                  Inc. and JPMorgan Chase Bank, National Association (Filed as Exhibit
                  10.7
                  to the Company’s Quarterly Report on Form 10-Q for the quarter ended June
                  30, 2005 (File No. 000-30066), and incorporated herein by
                  reference).10.09
              
              Reorganization
                  and Purchase Agreement dated as of May 10, 2005, among Sanders
                  Morris
                  Harris Group Inc., The Edelman Financial Center, Inc., The Edelman
                  Financial Center, LLC, and Fredric M. Edelman (Filed as Exhibit
                  2.1 to the
                  Company’s Current Report on Form 8-K dated May 10, 2005 (File No.
                  000-30066), and incorporated herein by reference).*10.10
              
              Agreement
                  and Amendment to Credit Agreement dated as of May 8, 2006, between
                  Sanders
                  Morris Harris Group Inc. and JPMorgan Chase Bank, National
                  Association.*10.11
              
              Agreement
                  and Amendment to Credit Agreement dated as of February 27, 2006,
                  between
                  Sanders Morris Harris Group, Inc. and JPMorgan Chase Bank, National
                  Association.*31.1
              
              Rule
                  13a-14(a)/15d - 14(a) Certification of Chief Executive
                  Officer.*31.2
              
              Rule
                  13a-14(a)/15d - 14(a) Certification of Chief Financial
                  Officer.*32.1
              
              Certification
                  Pursuant to 18 U.S.C. 1350, as Adopted Pursuant to Section 906
                  of the
                  Sarbanes-Oxley Act of 2002.*32.2
              
              Certification
                  Pursuant to 18 U.S.C. 1350, as Adopted Pursuant to Section 906
                  of the
                  Sarbanes-Oxley Act of 2002.___________________*Filed
                  herewith.†Management
                  contract or compensation plan or
                  arrangement.
  31




**SIGNATURES**





Pursuant
      to the requirements of the Securities Exchange Act of 1934, the registrant
      has
      duly caused this report to be signed on its behalf by the undersigned, thereunto
      duly authorized.





SANDERS
                MORRIS HARRIS GROUP INC.By
              /s/
                  BEN T.
                  MORRIS**Ben
                  T. Morris****Chief
                  Executive Officer**By
              /s/
                  RICK
                  BERRY**Rick
                  Berry****Chief
                  Financial Officer**


Date:
      August 8, 2006





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