**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 SEPTEMBER 30, 2005, 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)





**(713)
      993-4610**


**(Registrant’s
      telephone number, including area code)**





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





Indicate
      by check mark whether registrant is an accelerated filer (as defined in Rule
      12b-2 of the Exchange Act). YES x NO
      o





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




The
      number of shares of the registrant’s Common Stock, par value $0.01 per share,
      outstanding as of October 31, 2005, was 18,869,279.










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





**INDEX**




Page**PART
                I.**
            **FINANCIAL
                INFORMATION**Item
                1.
            Financial
                Statements
            2Condensed
                Consolidated Balance Sheet as of September 30, 2005 (unaudited)
                andDecember
                31, 2004
            2Condensed
                Consolidated Statement of Income for the Three and Nine
                MonthsEnded
                September 30, 2005 and 2004 (unaudited)
            3Condensed
                Consolidated Statement of Shareholders' Equity for the
                NineMonths
                Ended September 30, 2005 (unaudited)
            4Condensed
                Consolidated Statement of Cash Flows for the Nine MonthsEnded
                September 30, 2005 and 2004 (unaudited)
            5Notes
                to Condensed Consolidated Financial Statements (unaudited)
            6Item
                2.
            Management's
                Discussion and Analysis of Financial Condition and Results
                ofOperations
            16Item
                3.
            Quantitative
                and Qualitative Disclosures About Market Risk
            25Item
                4.
            Controls
                and Procedures
            26**PART
                II.**
            **OTHER
                INFORMATION**Item
                1.
            Legal
                Proceedings
            27Item
                2.
            Unregistered
                Sales of Equity Securities and Use of Proceeds
            27Item
                6.
            Exhibits
            28








-1-





**PART
      I. FINANCIAL INFORMATION**


**Item
      1.** ***Financial
      Statements***




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


**CONDENSED
        CONSOLIDATED BALANCE SHEET**
 (in
        thousands, except shares)


**September
                30,**
            
            **December
                31,****2005**
            
            **2004****ASSETS**
            
            (unaudited)Cash
                and cash equivalents
            
            $
            15,542
            
            $
            21,678Receivables,
                net of allowance of $500 and $476, respectivelyBroker-dealers
            
            
            597
            
            
            412Customers
            
            
            7,746
            
            
            6,662Related
                parties
            
            
            4,543
            
            
            5,986Other
            
            
            6,417
            
            
            4,834Deposits
                with clearing brokers
            
            
            1,799
            
            
            1,068Securities
                owned
            
            
            64,414
            
            
            56,851Securities
                available for sale
            
            
            4,041
            
            
            3,078Furniture
                and equipment, net
            
            
            8,346
            
            
            7,643Other
                assets
            
            
            1,954
            
            
            1,915Goodwill,
                net
            
            
            84,398
            
            
            61,722Total
                assets
            
            $
            199,797
            
            $
            171,849**LIABILITIES
                AND SHAREHOLDERS' EQUITY**Liabilities:Accounts
                payable and accrued liabilities
            
            $
            16,769
            
            $
            19,882Short
                term borrowings
            
            
            10,500
            
            
            -Deferred
                tax liability, net
            
            
            1,967
            
            
            1,526Securities
                sold, not yet purchased
            
            
            7,183
            
            
            6,349Payable
                to clearing brokers
            
            
            19
            
            
            10Other
                liabilities
            
            
            34
            
            
            68Total
                liabilities
            
            
            36,472
            
            
            27,835Commitments
                and contingenciesMinority
                interests
            
            
            8,722
            
            
            5,230Shareholders'
                equity:Preferred
                stock, $0.10 par value; 10,000,000 shares authorized;no
                shares issued and outstanding
            
            
            -
            
            
            -Common
                stock, $0.01 par value; 100,000,000 shares authorized;19,608,211
                and 18,547,978 shares issued, respectively
            
            
            196
            
            
            185Common
                stock committed, 440,000 shares
            
            
            -
            
            
            7,819Additional
                paid-in capital
            
            
            139,422
            
            
            120,988Receivables
                for shares issued
            
            
            (917
            )
            
            (1,494
            )Retained
                earnings
            
            
            21,825
            
            
            16,452Accumulated
                other comprehensive income (loss)
            
            
            9
            
            
            (50
            )Unearned
                compensation
            
            
            (2,451
            )
            
            (1,635
            )Treasury
                stock at cost, 739,402 shares
            
            
            (3,481
            )
            
            (3,481
            )Total
                shareholders' equity
            
            
            154,603
            
            
            138,784Total
                liabilities and shareholders' equity
            
            $
            199,797
            
            $
            171,849




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**
              
              **Nine
                  Months Ended****September
                  30,**
              
              **September
                  30,****2005**
              
              **2004**
              
              **2005**
              
              **2004**Revenues:Commissions
              
              $
              11,827
              
              $
              13,446
              
              $
              33,264
              
              $
              39,491Principal
                  transactions
              
              
              3,099
              
              
              2,016
              
              
              7,169
              
              
              5,459Investment
                  banking
              
              
              8,322
              
              
              5,772
              
              
              22,503
              
              
              23,133Fiduciary,
                  custodial and advisory fees
              
              
              9,225
              
              
              5,545
              
              
              22,332
              
              
              14,274Interest
                  and dividends
              
              
              1,118
              
              
              1,067
              
              
              3,438
              
              
              2,912Other
                  income
              
              
              820
              
              
              715
              
              
              2,544
              
              
              1,754Total
                  revenues
              
              
              34,411
              
              
              28,561
              
              
              91,250
              
              
              87,023Expenses:Employee
                  compensation and benefits
              
              
              19,834
              
              
              15,990
              
              
              54,045
              
              
              50,965Floor
                  brokerage, exchange and clearance fees
              
              
              1,276
              
              
              1,546
              
              
              3,468
              
              
              4,071Communications
                  and data processing
              
              
              1,836
              
              
              1,839
              
              
              5,831
              
              
              5,301Occupancy
              
              
              2,206
              
              
              1,838
              
              
              6,218
              
              
              5,241Interest
              
              
              223
              
              
              10
              
              
              265
              
              
              30Goodwill
                  impairment charge
              
              
              -
              
              
              400
              
              
              -
              
              
              400Other
                  general and administrative
              
              
              4,250
              
              
              2,544
              
              
              10,554
              
              
              7,779Total
                  expenses
              
              
              29,625
              
              
              24,167
              
              
              80,381
              
              
              73,787Income
                  before equity in income oflimited
                  partnerships, minority interests,and
                  income taxes
              
              
              4,786
              
              
              4,394
              
              
              10,869
              
              
              13,236Equity
                  in income of limited partnerships
              
              
              4,168
              
              
              776
              
              
              6,569
              
              
              3,606Income
                  before minority interests and income taxes
              
              
              8,954
              
              
              5,170
              
              
              17,438
              
              
              16,842Minority
                  interests in net income of consolidatedcompanies
              
              
              (2,814
              )
              
              (741
              )
              
              (4,438
              )
              
              (2,126
              )Income
                  before income taxes
              
              
              6,140
              
              
              4,429
              
              
              13,000
              
              
              14,716Provision
                  for income taxes
              
              
              2,484
              
              
              1,754
              
              
              5,285
              
              
              5,824Net
                  income
              
              $
              3,656
              
              $
              2,675
              
              $
              7,715
              
              $
              8,892Earnings
                  per share:Basic
              
              $
              0.19
              
              $
              0.15
              
              $
              0.42
              
              $
              0.51Diluted
              
              $
              0.19
              
              $
              0.15
              
              $
              0.40
              
              $
              0.49Weighted
                  average common shares outstanding:Basic
              
              
              18,845,323
              
              
              17,640,293
              
              
              18,587,184
              
              
              17,542,678Diluted
              
              
              19,401,206
              
              
              18,212,456
              
              
              19,192,485
              
              
              18,131,012
  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 nine months ended September 30, 2005**
 (in
        thousands, except share and per share amounts)
 (unaudited)
  Amounts
              
              
              
              Shares**Common
                  stock**Balance,
                  beginning of period
              
              $
              185
              
              
              
              
              
              18,547,978Stock
                  issued pursuant to commitment
              
              
              5
              
              
              
              
              
              440,000Stock
                  issued pursuant to employee benefit plan
              
              
              2
              
              
              
              
              
              258,128Stock
                  issued for acquisitions
              
              
              4
              
              
              
              
              
              362,105Balance,
                  end of period
              
              
              196
              
              
              
              
              
              19,608,211**Common
                  stock committed**Balance,
                  beginning of period
              
              
              7,819
              
              
              
              
              
              440,000Stock
                  issued
              
              
              (7,819
              )
              
              
              
              
              (440,000
              )Balance,
                    end of period
              
              
              -
              
              
              
              
              
              -**Additional
                  paid-in capital**Balance,
                  beginning of period
              
              
              120,988Stock
                  issued pursuant to commitment
              
              
              7,814Stock
                  issued pursuant to employee benefit plan
              
              
              4,374Stock
                  issued for acquisitions
              
              
              6,246Balance,
                    end of period
              
              
              139,422**Receivables
                  for shares issued**Balance,
                  beginning of period
              
              
              (1,494
              )Issuance
                  of restricted stock
              
              
              (4
              )Amortization
                  of notes receivable
              
              
              581Balance,
                  end of period
              
              
              (917
              )**Retained
                  earnings**Balance,
                  beginning of period
              
              
              16,452Dividends
                  ($0.1275 per share)
              
              
              (2,342
              )Net
                  income
              
              
              7,715
              
              
              7,715Balance,
                  end of period
              
              
              21,825
              
              
              7,715**Accumulated
                  other comprehensive income (loss)**Balance,
                  beginning of period
              
              
              (50
              )Net
                  change in unrealized appreciationon
                  securities available for sale
              
              
              98
              
              
              98Income
                  tax provision on change
              
              
              (39
              )
              
              (39
              )Balance,
                  end of period
              
              
              9
              
              
              59**Comprehensive
                  income**
              
              
              
              
              
              7,774**Unearned
                  compensation**Balance,
                  beginning of period
              
              
              (1,635
              )Net
                  issuance of restricted stock
              
              
              (1,701
              )Amortization
                  of unearned compensation
              
              
              885Balance,
                  end of period
              
              
              (2,451
              )**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**
              
              **$**
              **154,603**
              
              
              
              
              
              **18,868,809**




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 nine months ended September 30, 2005 and 2004**
 (in
        thousands)
 (unaudited)
  **2005**
              
              **2004**CASH
                  FLOWS FROM OPERATING ACTIVITIES:Net
                  income
              
              $
              7,715
              
              $
              8,892Adjustments
                  to reconcile net income to net cash provided by (used in)operating
                  activities:Realized
                  gain on securities available for sale
              
              
              (2
              )
              
              (14
              )Depreciation
              
              
              1,511
              
              
              1,416Goodwill
                  impairment charge
              
              
              -
              
              
              400Provision
                  for bad debts
              
              
              163
              
              
              35Compensation
                  expense related to amortization ofnotes
                  receivable and unearned compensation
              
              
              1,466
              
              
              1,663Deferred
                  income taxes
              
              
              402
              
              
              (503
              )Equity
                  in income of limited partnerships
              
              
              (6,569
              )
              
              (3,606
              )Minority
                  interests in income of consolidated companies
              
              
              4,438
              
              
              2,126Changes
                  in assets and liabilities:Increase
                  in receivables
              
              
              (1,572
              )
              
              (4,509
              )Increase
                  in deposits with clearing brokers
              
              
              (731
              )
              
              -Increase
                  in securities owned
              
              
              (994
              )
              
              (9,525
              )Decrease
                  in other assets
              
              
              212
              
              
              668Increase
                  in securities sold, not yet purchased
              
              
              834
              
              
              2,935Increase
                  in payable to clearing brokers
              
              
              9
              
              
              -Decrease
                  in other liabilities
              
              
              (34
              )
              
              (55
              )Decrease
                  in accounts payable and accrued liabilities
              
              
              (3,924
              )
              
              (4,700
              )Net
                  cash provided by (used in) operating activities
              
              
              2,924
              
              
              (4,777
              )CASH
                  FLOWS FROM INVESTING ACTIVITIES:Capital
                  expenditures
              
              
              (1,876
              )
              
              (4,745
              )Acquisitions,
                  net of cash acquired of $421 and $478, respectively
              
              
              (16,106
              )
              
              (3,312
              )Cash
                  of business consolidated
              
              
              -
              
              
              49Purchase
                  of securities available for sale
              
              
              (1,132
              )
              
              (1,164
              )Proceeds
                  from sales and maturities of securities available for sale
              
              
              268
              
              
              400Net
                  cash used in investing activities
              
              
              (18,846
              )
              
              (8,772
              )CASH
                  FLOWS FROM FINANCING ACTIVITIES:Purchase
                  of treasury stock
              
              
              -
              
              
              (183
              )Proceeds
                  from short term borrowings
              
              
              10,500
              
              
              -Proceeds
                  from shares issued
              
              
              2,670
              
              
              1,477Investments
                  by minority interests
              
              
              41
              
              
              67Distributions
                  to minority interests
              
              
              (1,083
              )
              
              (1,665
              )Payments
                  of cash dividends
              
              
              (2,342
              )
              
              (1,315
              )Net
                  cash provided by (used in) financing activities
              
              
              9,786
              
              
              (1,619
              )Net
                  decrease in cash and cash equivalents
              
              
              (6,136
              )
              
              (15,168
              )CASH
                  AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
              
              
              21,678
              
              
              32,590CASH
                  AND CASH EQUIVALENTS AT END OF PERIOD
              
              $
              15,542
              
              $
              17,422Cash
                  paid for income taxes, net of refunds
              
              $
              5,807
              
              $
              6,011Interest
                  paid
              
              
              193
              
              
              30Noncash
                  activities:Acquisitions
                  and consolidation:Receivables
              
              
              -
              
              
              799Fixed
                  assets
              
              
              338
              
              
              34Other
                  assets
              
              
              250
              
              
              19Securities
                  owned
              
              
              -
              
              
              (800
              )Goodwill
              
              
              22,676
              
              
              800Accounts
                  payable and accrued liabilities
              
              
              (811
              )
              
              (1,049
              )Minority
                  interests
              
              
              (97
              )
              
              (997
              )


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


-5-
 
 **SANDERS
          MORRIS HARRIS GROUP INC. AND SUBSIDIARIES**
 **NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**


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





*Nature
      of Operations*




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





The
      Company merged with and acquired its operating subsidiaries in 1999 through
      2005. The acquisitions were accounted for using the purchase method and,
      accordingly, operating results of an acquired entity are included in the
      Company’s consolidated financial statements from the date of acquisition. As a
      result, 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 September 30, 2005, our results of operations for the
      three and nine months ended September 30, 2005 and 2004, and our cash flows
      for
      the nine months ended September 30, 2005 and 2004. 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, 2004.





-6-


*Effects
      of Recently Issued Accounting Standards*




In
      December 2004, the FASB issued SFAS No. 123R, *Share-Based
      Payment (Revised 2004).* SFAS
      123R
      establishes standards for the accounting for transactions in which an entity
      (i)
      exchanges its equity instruments for goods or services, or (ii) 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 123R eliminates 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 123R is effective for the Company on January 1, 2006. The
      Company will transition to fair value based accounting for stock-based
      compensation using a modified version of prospective application (“modified
      prospective application”). Under modified prospective application, as it is
      applicable to the Company, SFAS 123R applies 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 are
      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 123R. The attribution of compensation cost for those earlier awards
      will
      be 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.
      Based on the stock-based compensation awards outstanding as of September 30,
      2005, for which the requisite service is not expected to be fully rendered
      prior
      to January 1, 2006, the Company expects to recognize additional pre-tax,
      quarterly compensation cost of approximately $45,000 beginning in the first
      quarter of 2006 as a result of the adoption of SFAS 123R. Future levels of
      compensation cost recognized related to 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.





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* .
      EITF
      No. 04-5 changes the accounting for general partners that are in certain
      industries. 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-a, *Interaction
      of AICPA Statement of Position 78-9, Accounting for Investments in Real Estate
      Ventures,* and
      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* (SOP
      78-9-a) will have the presumption 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 a result of this new guidance, we may be required
      to
      consolidate for financial reporting purposes many of the limited partnerships
      for which we act as general partner. We are evaluating the impact that these
      new
      accounting standards will have on our consolidated financial statements. The
      effective date of SOP 78-9-a and EITF No. 04-5 is January 1, 2006 for existing
      limited partnerships. SOP 78-9-a is effective immediately for new and modified
      limited partnerships.




*Stock-Based
      Compensation*





SFAS
      No.
      148, *Accounting
      for Stock-Based Compensation - Transition and Disclosure,* was
      issued in December 2002. SFAS No. 148 amends SFAS No. 123, *Accounting
      for Stock-Based Compensation,* to
      provide alternative methods for transition for a voluntary change to the fair
      value based method of accounting for stock-based employee compensation. In
      addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to
      require prominent disclosures in both annual and interim financial statements
      about the method of accounting for stock-based employee compensation and the
      effect of the method used on reported results. The Company has adopted the
      disclosure provisions included in SFAS No. 148 in the notes to the condensed
      consolidated financial statements contained herein.





The
      following table illustrates the effect on net income as if the Company had
      applied the fair value recognition provisions of SFAS No. 123 as amended by
      SFAS
      No. 148:





-7-




**Three
                  Months Ended**
              
              **Nine
                  Months Ended****September
                  30,**
              
              **September
                  30,****2005**
              
              **2004**
              
              **2005**
              
              **2004**(in
                  thousands, except per share amounts)Net
                  income as reported
              
              $
              3,656
              
              $
              2,675
              
              $
              7,715
              
              $
              8,892Deduct:
                  Total stock based employee compensationexpense
                  determined under fair value basedmethod
                  for all awards, net of related tax effects
              
              
              (27
              )
              
              (78
              )
              
              (114
              )
              
              (323
              )Proforma
                  income
              
              $
              3,629
              
              $
              2,597
              
              $
              7,601
              
              $
              8,569Earnings
                  per share:Basic-as
                  reported
              
              $
              0.19
              
              $
              0.15
              
              $
              0.42
              
              $
              0.51Basic-pro
                  forma
              
              $
              0.19
              
              $
              0.15
              
              $
              0.41
              
              $
              0.49Diluted-as
                  reported
              
              $
              0.19
              
              $
              0.15
              
              $
              0.40
              
              $
              0.49Diluted-pro
                  forma
              
              $
              0.19
              
              $
              0.14
              
              $
              0.40
              
              $
              0.47




*Reclassifications*





Certain
      reclassifications have been made to the 2004 condensed consolidated financial
      statements to conform them with the 2005 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 $2.6 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 net 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 net
      income for the period. The Earn-Out Consideration will be paid 50% in cash
      and
      50% in the Company’s common stock.





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 net 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 net 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 net 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 net 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, as
      amended.





-8-


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 the 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 will operate 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. Beginning in
      April 2006 and continuing thereafter, the Company will receive 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.





On
      November 23, 2004, the Company acquired a 50% interest in Select Sports Group,
      Ltd., a sports representation and management services firm based in Houston,
      Texas. The former owners of SSG received cash of approximately $2.8 million
      and
      66,538 common shares of the Company with a market value of $965,000.
      Additionally, the Company paid SSG debt totaling approximately $596,000. As
      the
      Company may not exercise control to a degree greater than its voting interest,
      the Company’s investment in SSG is accounted for using the equity
      method.





On
      April
      1, 2004, the Company acquired a 69% member interest in Charlotte Capital, LLC
      from a previous investor. Employees of Charlotte Capital retained a 31%
      ownership interest in the firm. Charlotte Capital, based in Charlotte, North
      Carolina, manages approximately $260 million in assets for institutional
      investors in small cap value and small/mid cap value styles. SMHG paid $3.4
      million in cash at closing. The acquisition was accounted for as a purchase,
      and
      accordingly, the financial information of Charlotte Capital has been included
      in
      the Company’s consolidated financial statements from April 1, 2004. The
      consideration of $3.4 million exceeded the fair market value of identifiable
      net
      tangible assets by approximately $4.5 million, which has been recorded as
      goodwill. Employees may earn up to an additional 9% by achieving specified
      revenue run rates during the 36 month period beginning January 1, 2006 and
      ending December 31, 2009.





-9-





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





Securities
      owned and securities sold, not yet purchased as of September 30, 2005 were
      as
      follows:


**Sold,
                  Not Yet****Owned**
              
              **Purchased**(in
                  thousands)Marketable:U.S.
                  Government and agency
              
              $
              2,196
              
              $
              1,001Corporate
                  stocks and options
              
              
              14,771
              
              
              6,182Corporate
                  bonds
              
              
              7,810
              
              
              -24,777
              
              
              7,183Not
                  readily marketable:Partnerships
              
              
              32,064
              
              
              -Corporate
                  stocks and warrants
              
              
              7,573
              
              
              -$
              64,414
              
              $
              7,183




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 Opportunities Fund, L.P., Life Sciences
      Opportunity Fund (Institutional), L.P., Life Sciences Opportunities Fund II,
      L.P., Life Sciences Opportunities Fund (Institutional) II, L.P., 2003 Houston
      Energy Partners, L.P., 2005 Houston Energy Partners L.P., Houston Energy
      International, LTD, Concept Capital, LLC, Select Sports Group Ltd., The
      Endowment Fund G.P., L.P., Endowment Advisors, L.P., SMH Private Equity Group,
      L.P., PTC-Houston Investors, LLC, Symmetry Capital, LLC, Global Hedged Equity
      Master Fund, L.P., and Salient Total Return Fund, L.P.





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




Securities
      available for sale at September 30, 2005 were as follows:







**Amortized**
            
            **Gross
                Unrealized**
            
            **Estimated****Cost**
            
            **Gains**
            
            **Losses**
            
            **Fair
                Value**(in
                thousands)U.S.
                Government and agency obligations
            
            $
            1,034
            
            $
            6
            
            $
            (11
            )
            $
            1,029Corporate
                bonds
            
            
            251
            
            
            -
            
            
            (2
            )
            
            249Equity
                securities
            
            
            1,556
            
            
            114
            
            
            (208
            )
            
            1,462Partnerships
            
            
            1,185
            
            
            116
            
            
            -
            
            
            1,301Total
            
            $
            4,026
            
            $
            236
            
            $
            (221
            )
            $
            4,041




The
        contractual maturities of debt securities available for sale at September
        30,
        2005 were as follows (in thousands):





Due
                before 5 years
            
            $
            986Due
                after 25 years through 30 years
            
            $
            292





-10-


Gross
      realized gains on sales of securities available for sale were $21,000 for the
      nine months ended September 30, 2005, and $15,000 for the nine months ended
      September 30, 2004. Gross realized losses on securities available for sale
      were
      $19,000 for the nine months ended September 30, 2005 and $1,000 for the nine
      months ended September 30, 2004. Gross realized gains on sales of securities
      available for sale were $14,000 for the three months ended September 30, 2005,
      and $3,000 for the three months ended September 30, 2004. Gross realized losses
      on sales of securities available for sale were $8,000 for the three months
      ended
      September 30, 2005 and $1,000 for the three months ended September 30, 2004.





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 provision
      and the statutory federal rate were as follows:


**Three
                  Months Ended**
              
              **Nine
                  Months Ended****September
                  30,**
              
              **September
                  30,****2005**
              
              **2004**
              
              **2005**
              
              **2004**(in
                  thousands)Tax
                  computed using the statutory rate
              
              $
              2,149
              
              $
              1,506
              
              $
              4,550
              
              $
              5,003State
                  income taxes and other
              
              
              335
              
              
              248
              
              
              735
              
              
              821Total
              
              $
              2,484
              
              $
              1,754
              
              $
              5,285
              
              $
              5,824




**6.**
            **SHORT
                TERM 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 2006, unless extended. Borrowings
      under the line of credit bear interest based on LIBOR. The interest rate on
      the
      Company’s borrowings ranged from 4.81% to 5.3% during the three months ended
      September 30, 2005. 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-EBITDA and liquidity to funded debt ratios,
      as well as minimum assets under management. At September 30, 2005, the Company
      was in compliance with all covenants. The outstanding balance on the line of
      credit was $10.5 million at September 30, 2005.





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





In
      the
      normal course of business, the Company enters into underwriting commitments.
      There were no firm underwriting commitments open at September 30, 2005.





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





The
      Company has pledged a certificate of deposit in the amount of $50,000 to secure
      a loan made by a bank to a relative of one of the Company’s customers (the
“Debtor”). The pledge expires in April 2006. Proceeds from the bank loan were
      used to finance a business venture of the Debtor. Should the Debtor fail to
      repay the loan, the Company’s certificate of deposit will be used to satisfy any
      unpaid portion of the debt up to the face amount of the certificate of deposit.
      The Company expects the Debtor to pay the debt upon maturity. Therefore, the
      Company has recorded no reserve against this guarantee as of September 30,
      2005.





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





-11-


The
      Company has uncommitted financing arrangements with clearing brokers who finance
      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 and 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 its clearing brokers.





The
      Company has issued letters of credit in the amounts of $1.2 million and $92,000
      to the owners of two 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.





**8.**
            **EARNINGS
                PER COMMON SHARE**





Basic
      and
      diluted earnings per share computations for the periods indicated were as
      follows:





**Three
                    Months Ended September 30,****2005**
                
                **2004**(in
                    thousands, except per share amounts)Computation
                    of basic and diluted earnings per common share:Net
                    income
                
                $
                3,656
                
                $
                2,675Weighted
                    average common shares outstanding
                
                
                18,845,323
                
                
                17,640,293Common
                    shares issuable under stock option plan
                
                
                894,771
                
                
                1,059,027Less
                    shares assumed repurchased with proceeds
                
                
                (338,888
                )
                
                (486,864
                )Weighted
                    average common shares outstanding
                
                
                19,401,206
                
                
                18,212,456Basic
                    earnings per common share
                
                $
                0.19
                
                $
                0.15Diluted
                    earnings per common share
                
                $
                0.19
                
                $
                0.15
  **Nine
                    Months Ended September 30,****2005**
                
                **2004**(in
                    thousands, except per share amounts)Computation
                    of basic and diluted earnings per common share:Net
                    income
                
                $
                7,715
                
                $
                8,892Weighted
                    average common shares outstanding
                
                
                18,587,184
                
                
                17,542,678Common
                    shares issuable under stock option plan
                
                
                904,771
                
                
                1,059,027Less
                    shares assumed repurchased with proceeds
                
                
                (299,470
                )
                
                (470,693
                )Weighted
                    average common shares outstanding
                
                
                19,192,485
                
                
                18,131,012Basic
                    earnings per common share
                
                $
                0.42
                
                $
                0.51Diluted
                    earnings per common share
                
                $
                0.40
                
                $
                0.49





Outstanding
      stock options (22,500 and 12,500 for the three and nine months ended September
      30, 2005, and 45,000 for the three and nine months ended September 30, 2004)
      have not been included in diluted earnings per common share because to do so
      would have been antidilutive for the periods presented.





-12-





**9.**
            **IMPAIRMENT
                OF GOODWILL**





During
      the three months ended September 30, 2004, the Company recognized a goodwill
      impairment charge of $400,000 related to its investment in Brava Therapeutics.
      The principal factors contributing to our decision to record the impairment
      charge relate to the uncertainty and timing of a proposed joint venture between
      Brava and another entity that would create a more viable platform for further
      development of Brava’s products and expertise.





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





SMHG
      operates through six business segments: Retail Brokerage, Institutional
      Brokerage, Asset Management, 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.





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.





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
      Asset
      Management segment provides investment advisory, wealth and investment
      management, financial planning, and trust services to institutional and
      individual clients. It 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
      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.





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.





The
      Corporate and Other segment includes 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 nine months ended September 30, 2005 and 2004,
      respectively. SMHG does not analyze asset information for its business
      segments.




**Three
                  Months Ended**
              
              **Nine
                  Months Ended****September
                  30,**
              
              **September
                  30,****2005**
              
              **2004**
              
              **2005**
              
              **2004**(in
                  thousands)Revenues:Retail
                  brokerage
              
              $
              3,765
              
              $
              4,377
              
              $
              11,794
              
              $
              12,843Institutional
                  brokerage
              
              
              6,547
              
              
              6,756
              
              
              19,404
              
              
              23,062Asset
                  management
              
              
              12,340
              
              
              8,122
              
              
              29,534
              
              
              21,754Prime
                  brokerage
              
              
              4,978
              
              
              5,153
              
              
              13,855
              
              
              14,984Investment
                  banking
              
              
              5,465
              
              
              2,692
              
              
              13,414
              
              
              11,664Corporate
                  and other
              
              
              1,316
              
              
              1,461
              
              
              3,249
              
              
              2,716Total
              
              $
              34,411
              
              $
              28,561
              
              $
              91,250
              
              $
              87,023Income
                  (loss) before equity in income of limitedpartnerships,
                  minority interests and income taxes:Retail
                  brokerage
              
              $
              136
              
              $
              473
              
              $
              927
              
              $
              1,091Institutional
                  brokerage
              
              
              966
              
              
              1,210
              
              
              2,605
              
              
              3,996Asset
                  management
              
              
              3,396
              
              
              3,232
              
              
              7,747
              
              
              7,580Prime
                  brokerage
              
              
              390
              
              
              856
              
              
              1,388
              
              
              2,485Investment
                  banking
              
              
              2,140
              
              
              884
              
              
              4,756
              
              
              5,477Corporate
                  and other
              
              
              (2,242
              )
              
              (2,261
              )
              
              (6,554
              )
              
              (7,393
              )Total
              
              $
              4,786
              
              $
              4,394
              
              $
              10,869
              
              $
              13,236Equity
                  in income of limited partnerships:Retail
                  brokerage
              
              $
              -
              
              $
              -
              
              $
              -
              
              $
              -Institutional
                  brokerage
              
              
              -
              
              
              -
              
              
              -
              
              
              -Asset
                  management
              
              
              3,459
              
              
              624
              
              
              5,637
              
              
              3,386Prime
                  brokerage
              
              
              -
              
              
              -
              
              
              -
              
              
              -Investment
                  banking
              
              
              -
              
              
              -
              
              
              -
              
              
              -Corporate
                  and other
              
              
              709
              
              
              152
              
              
              932
              
              
              220Total
              
              $
              4,168
              
              $
              776
              
              $
              6,569
              
              $
              3,606Minority
                  interests in net (income) loss ofconsolidated
                  companies:Retail
                  brokerage
              
              $
              -
              
              $
              -
              
              $
              -
              
              $
              -Institutional
                  brokerage
              
              
              -
              
              
              -
              
              
              -
              
              
              -Asset
                  management
              
              
              (2,698
              )
              
              (747
              )
              
              (4,251
              )
              
              (2,146
              )Prime
                  brokerage
              
              
              -
              
              
              -
              
              
              -
              
              
              -Investment
                  banking
              
              
              -
              
              
              -
              
              
              -
              
              
              -Corporate
                  and other
              
              
              (116
              )
              
              6
              
              
              (187
              )
              
              20Total
              
              $
              (2,814
              )
              $
              (741
              )
              $
              (4,438
              )
              $
              (2,126
              )Income
                  (loss) before income taxes:Retail
                  brokerage
              
              $
              136
              
              $
              473
              
              $
              927
              
              $
              1,091Institutional
                  brokerage
              
              
              966
              
              
              1,210
              
              
              2,605
              
              
              3,996Asset
                  management
              
              
              4,157
              
              
              3,109
              
              
              9,134
              
              
              8,820Prime
                  brokerage
              
              
              390
              
              
              856
              
              
              1,388
              
              
              2,485Investment
                  banking
              
              
              2,140
              
              
              884
              
              
              4,756
              
              
              5,477Corporate
                  and other
              
              
              (1,649
              )
              
              (2,103
              )
              
              (5,810
              )
              
              (7,153
              )Total
              
              $
              6,140
              
              $
              4,429
              
              $
              13,000
              
              $
              14,716




-14-




**11.**
            **EMPLOYEE
                BENEFIT PLANS**





Under
      its
      1998 Incentive Plan, as amended, 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 1,378,425 shares of common stock available for grant under
      the
      Incentive Plan at September 30, 2005.





**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 varying periods
      and have an exercise price equal to the closing price of the Company’s stock on
      the date of the grant.





**Restricted
      Stock and Capital Incentive Plan (“CIP”)**





Effective
      January 2, 2001, the Company adopted the CIP under its Incentive Plan in which
      eligible employees and consultants may 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 are
      issued.





All
      shares issued are valued at the closing price on the date the shares are issued.
      Consideration paid through the deferral of salaries, commissions, or
      discretionary bonuses is recorded as compensation expense on the date that
      the
      salaries, commissions, and bonuses are deferred. The difference between the
      value of the shares issued and the consideration paid is recorded as unearned
      compensation and is shown as a separate component of shareholders’ equity.
      Additionally, shares are issued under the CIP in conjunction with notes
      receivable. Restricted shares and shares issued under the CIP are amortized
      to
      compensation expense over the one to five year vesting periods.





The
      following summarizes certain information related to the restricted stock and
      the
      CIP for the three and nine months ended September 30, 2005 and
      2004:


**Three
                  Months Ended**
              
              **Nine
                  Months Ended****September
                  30,**
              
              **September
                  30,****2005**
              
              **2004**
              
              **2005**
              
              **2004**(in
                  thousands, except shares)Number
                  of shares issued
              
              
              30,957
              
              
              1,119
              
              
              116,371
              
              
              266,570Value
                  of shares issued
              
              $
              560
              
              $
              13
              
              $
              2,012
              
              $
              3,265Additions
                  to unearned compensation
              
              
              305
              
              
              4
              
              
              1,701
              
              
              1,690(Forfeitures)
                  additions to notes receivable
              
              
              (2
              )
              
              -
              
              
              4
              
              
              1,566Amortization
                  of unearned compensation
              
              
              331
              
              
              266
              
              
              885
              
              
              726Amortization
                  of notes receivable
              
              
              213
              
              
              311
              
              
              581
              
              
              937





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





The
      Company had receivables from related parties totaling $4.5 million at September
      30, 2005, primarily consisting of $3.5 million of notes receivable from
      employees and consultants.





The
      Company has recorded a payable in the amount of $876,000 to the minority
      shareholder of an acquired subsidiary representing the post closing collection
      of receivables, net of related expenses that existed on the date on which the
      subsidiary was acquired.





-15-





**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.





**General**





We
      provide a broad range of financial and other professional services, including
      institutional, retail, and prime brokerage, principal trading, investment
      banking, merchant banking, financial advisory, trust related services,
      investment management, financial planning, and sports representation and
      management. All of these activities are highly competitive and are sensitive
      to
      many factors outside our control, including those factors listed under "Factors
      Affecting Forward-Looking Statements."





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 for any specific period should not be considered
      representative of future performance.





**Components
      of Revenues and Expenses**





*Revenues* .  Our
      revenues are comprised primarily of (1) commission revenue from retail, prime,
      and institutional brokerage transactions, (2) fees from asset-based advisory
      services, (3) principal and agent transactions, (4) investment banking revenue
      from corporate finance fees, public and private offerings, mergers and
      acquisitions, and merchant banking, and (5) fees from asset management,
      financial planning, and fiduciary services. We also earn interest on the cash
      held and dividends received from the equity and debt securities held by us
      for
      our corporate capital accounts and have realized and unrealized gains (or
      losses) on securities in our inventory account.





*Expenses.*  Our
      expenses consist of (1) employee compensation and benefits, (2) 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. The investment banking group and the
      research group receive salaries 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
      third quarter of 2005, compensation and benefits represented 67% of total
      expenses and 58% of total revenues compared to 66% of total expenses, and 56%
      of
      total revenues during the same period in 2004. During the first nine months
      of
      2005, compensation and benefits represented 67% of total expenses and 59% of
      total revenues, compared to 69% of total expenses and 59% of total revenues
      during the same period in 2004.





Brokerage
      and clearance expenses include clearing and trade execution costs associated
      with the retail, prime, and institutional brokerage business at SMH. SMH clears
      its transactions primarily through Pershing LLC, a member of BNY Securities
      Group and a subsidiary of The Bank of New York, and other clearing
      brokers.





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, market data, and software program providers.





-16-





**Overview**





Our
      financial services business is affected by general economic conditions. The
      instability in the overall stock market, lower trading volume, and reduced
      commission rates have had a negative impact on our commission revenues,
      underwriting fees derived from public offerings, and advisory fees from private
      placements.





Our
      revenues relating to asset-based advisory services and managed accounts are
      typically from fees based on the market value of assets under management. The
      growth in assets under management resulted in higher management fees for the
      Company.





We
      have
      organized a number of private equity funds for the purpose of investing in
      public and private companies that we believe are either significantly
      undervalued relative to their growth potential or have substantial prospects
      for
      capital growth. We invest in these funds along with our clients and earn
      management fees based on capital commitments, net assets or capital
      contributions. We also receive incentive compensation of a portion of the profit
      if the profit exceeds specified hurdle rates.





We
      invest
      a portion of our excess cash in public equity and debt securities that we feel
      are undervalued. Additionally, we may receive warrants as a part of our
      compensation for investment banking services.





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 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.





**Results
      of Operations**





*Three
      Months Ended September 30, 2005 Compared to Three Months Ended September 30,
      2004*





Total
      revenues were $34.4 million in the third quarter of 2005 compared to $28.6
      million for the same quarter in 2004. An increase in revenues from fiduciary,
      custodial, and advisory fees, investment banking services, and principal
      transactions was partially offset by a decline in revenues from commissions.
      Total expenses for the third quarter of 2005 increased to $29.6 million from
      $24.2 million in the same quarter of the previous year. We experienced increases
      in employee compensation and benefits, occupancy costs, and other general and
      administrative expenses mainly due to our growth. Equity in income of limited
      partnerships increased to $4.2 million during the third quarter of 2005 from
      $776,000 during the prior year period, reflecting larger gains on the investment
      portfolios in the limited partnerships. Income attributable to minority
      interests, which reduces SMHG’s pretax income increased to $2.8 million from
      $741,000, principally due to larger income from two of the limited partnerships
      that are accounted for under the equity method. Net income for the three month
      period ended September 30, 2005 increased to $3.7 million from $2.7 million
      in
      the same period in 2004. Basic and diluted income per share was $0.19 for the
      three months ended September 30, 2005, compared to $0.15 for the same period
      in
      2004.





Commissions
      revenue declined to $11.8 million in the third quarter of 2005 from $13.4
      million for the same period in 2004, primarily as a result of reduced trading
      volume and reduced commission rates in our retail, prime, and institutional
      divisions. Principal transactions revenue totaled $3.1 million during the third
      quarter of 2005, compared to $2.0 million for the third quarter of 2004 due
      to
      gains on trades made by both our in-house trading desks and the independent
      professional traders associated with our prime brokerage division, as well
      as
      improved revenues from our institutional fixed income department. Investment
      banking revenue increased to $8.3 million during the third quarter of 2005
      from
      $5.8 million in the same period of 2004, principally due to an increase in
      private placement fees. Revenues from fiduciary, custodial, and advisory fees
      increased to $9.2 million in the third quarter of 2005 from $5.5 million in
      the
      same quarter of 2004 primarily due to the acquisition, of Edelman and SMH
      Colorado during the second quarter of 2005 and growth in assets under management
      at Salient and Kissinger Financial Services, (“Kissinger”). Other income
      increased from $715,000 during the third quarter of 2004 to $820,000 during
      the
      same period in 2005, due to an increase in fees earned on the Company’s cash
      balances and customer credit balances at its clearing banks resulting from
      higher deposit balances.





-17-


During
      the three months ended September 30, 2005, employee compensation and benefits
      increased to $19.8 million from $16.0 million in the same period last year
      due
      to higher revenues during 2005. Floor brokerage, exchange, and clearance fees
      declined to $1.3 million in the third quarter of 2005 from $1.5 million in
      the
      same quarter of 2004 reflecting lower clearing and execution costs resulting
      from the reduced trading volume and negotiated lower cost per trade. Occupancy
      costs totaled $2.2 million during the third quarter of 2005, compared to $1.8
      million in the prior year quarter due to expansion of several of our offices
      and
      the addition of Edelman. Interest expense totaled $223,000 during the third
      quarter of 2005, compared to $10,000 during the prior year period due to the
      revolving credit facility entered into by the Company during May 2005. Other
      general and administrative expenses increased to $4.3 million during the third
      quarter of 2005 from $2.5 million in the third quarter of last year mainly
      due
      to our growth.





Our
      effective tax rate was 40% for the three months ended September 30, 2005 and
      September 30, 2004.





Results
      by Segment




*Retail
      Brokerage*


**Three
                  Months Ended September 30,****2005**
              
              **2004**(in
                  thousands)Revenues
              
              $
              3,765
              
              $
              4,377Income
                  before income taxes
              
              $
              136
              
              $
              473





Revenues
      from retail brokerage decreased to $3.8 million from $4.4 million, and income
      before income taxes decreased to $136,000 from $473,000. Commission revenue
      declined to $2.2 million from $2.3 million due to lower trading volume during
      2005. Sales credits from investment banking transactions declined to $754,000
      from $1.1 million due to a decrease in fees from syndicate transactions.
      Compensation expense declined to $2.7 million from $3.1 million in 2004,
      primarily due to the revenue decline, as well as reduced amortization of
      employee loans, which were paid to brokers upon their hire and then amortized
      to
      compensation expense over a specified employment term.





*Institutional
      Brokerage*


**Three
                  Months Ended September 30,****2005**
              
              **2004**(in
                  thousands)Revenues
              
              $
              6,547
              
              $
              6,756Income
                  before income taxes
              
              $
              966
              
              $
              1,210


Revenues
      from institutional brokerage declined to $6.5 million from $6.8 million, and
      income before taxes declined to $966,000 from $1.2 million. Commission revenue
      declined to $4.2 million from $5.2 million due to a slowdown in institutional
      equity commission transactions mainly due to closure of our Denver office in
      the
      fourth quarter of 2004 and a decline in commission rates. Revenues from
      principal transactions increased to $1.2 million from $586,000, due to higher
      revenues from fixed income transactions and improved profitability from
      institutional trading accounts.




-18-





*Asset
      Management*


**Three
                  Months Ended September 30,****2005**
              
              **2004**(in
                  thousands)Revenues
              
              $
              12,340
              
              $
              8,122Income
                  before income taxes
              
              $
              4,157
              
              $
              3,109





Revenues
      from asset management increased to $12.3 million from $8.1 million, and income
      before taxes increased to $4.2 million from $3.1 million. Fiduciary, custodial,
      and advisory fees increased to $9.0 million from $5.3 million. The acquisitions
      of Edelman in May 2005, and SMH Colorado in May 2005, and growth in assets
      under
      management at Salient and Kissinger have contributed to the increase in revenues
      from advisory fees. Total expenses rose to $9.0 million from $4.9 million due
      to
      the higher revenues and the acquisition of Edelman. The change in value of
      our
      investments in limited partnerships resulted in a gain of $3.5 million in 2005,
      compared to $624,000 in 2004. Minority interests in net income of consolidated
      companies reflect the portion of net income attributable to minority interest
      ownership of entities included in the Company’s consolidated financial
      statements. Income attributable to minority interests, which reduces our pretax
      income, increased to $2.7 million in 2005 from $747,000 in 2004, principally
      due
      to increased income from two of the Company’s limited partnerships and the
      acquisition of Edelman.




*Prime
      Brokerage*


**Three
                  Months Ended September 30,****2005**
              
              **2004**(in
                  thousands)Revenues
              
              $
              4,978
              
              $
              5,153Income
                  before income taxes
              
              $
              390
              
              $
              856





Revenues
      from prime brokerage declined to $5.0 million from $5.2 million, and income
      before taxes decreased to $390,000 from $856,000. Commission revenue decreased
      to $3.6 million from $4.4 million reflecting an overall reduction in commission
      rates. Revenues from principal transactions, primarily gains on trades made
      by
      the independent professional traders, increased to $1.2 million from $381,000
      reflecting higher trading profitability during 2005. Compensation expense
      decreased to $2.0 million from $2.4 million due to reduced personnel. The
      percentage decline in income before taxes was greater than the percentage
      decline in revenues principally due to increases in those costs of the business
      that are not directly related to revenue variances.





-19-





*Investment
      Banking*


**Three
                  Months Ended September 30,****2005**
              
              **2004**(in
                  thousands)Revenues
              
              $
              5,465
              
              $
              2,692Income
                  before income taxes
              
              $
              2,140
              
              $
              884





Revenues
      from investment banking increased to $5.5 million from $2.7 million, and income
      before taxes increased to $2.1 million from $884,000. The revenue increase
      is
      primarily due to greater revenues from private placement commissions during
      2005. Compensation expense increased to $2.6 million from $1.3 million in 2004
      due to the increase in revenues and the addition of personnel in the investment
      banking department.





*Corporate
      and Other*


**Three
                  Months Ended September 30,****2005**
              
              **2004**(in
                  thousands)Revenues
              
              $
              1,316
              
              $
              1,461Loss
                  before income taxes
              
              $
              (1,649
              )
              $
              (2,103
              )





Revenues
      from corporate and other declined to $1.3 million from $1.5 million. The loss
      before taxes decreased to $1.6 million from $2.1 million in 2004. The 2004
      period included a goodwill impairment charge in the amount of $400,000 related
      to the Company’s investment in Brava Therapeutics.





*Nine
      Months Ended September 30, 2005 Compared to Nine Months Ended September 30,
      2004*





Total
      revenues were $91.3 million in the first nine months of 2005 compared to $87.0
      million for the same period in 2004. A decline in revenues from commissions
      was
      offset by an increase in fiduciary, custodial, and advisory fees and principal
      transactions. Equity in income of limited partnerships increased to $6.6 million
      from $3.6 million, reflecting larger gains on the investment portfolios in
      the
      limited partnerships. Income attributable to minority interests, which reduces
      SMHG’s pretax income increased to $4.4 million during 2005 from $2.1 million
      during 2004, due to the higher income from two of the limited partnerships
      that
      are accounted for under the equity method and the acquisitions of Charlotte
      Capital and Edelman. Total expenses for the 2005 period increased to $80.4
      million from $73.8 million in the same period of the previous year. Net income
      for the nine month period ended September 30, 2005 declined to $7.7 million
      from
      $8.9 million in the same period in 2004. Basic income per share was $0.42 for
      the nine months ended September 30, 2005, compared to $0.51 for the same period
      in 2004. Diluted income per share was $0.40 for the nine months ended September
      30, 2005, compared to $0.49 for the same period in 2004.





Commissions
      revenue declined to $33.3 million in the first nine months of 2005 from $39.5
      million for the same period in 2004, primarily due to reduced trading volume
      in
      our retail and institutional divisions as well as an overall reduction in
      commission rates in our institutional and prime brokerage divisions.
      Principal transactions revenue totaled $7.2 million for the first nine months
      of
      2005 versus $5.5 million in the comparable 2004 period, principally due to
      gains
      on trades made by both our in-house trading desks and the independent
      professional traders associated with our prime broker division. Investment
      banking revenue declined to $22.5 million during the first nine months of 2005
      from $23.1 million in the same period of 2004, principally due to a reduction
      in
      private placement commissions and advisory fees. Revenues from fiduciary,
      custodial, and advisory fees increased to $22.3 million in the first nine months
      of 2005 from $14.3 million in the same period of 2004 primarily due to the
      acquisitions of Charlotte Capital and Edelman and growth in assets under
      management at Salient, Kissinger, and SMCA. Interest and dividend income
      increased to $3.4 million in the first three quarters of 2005 from $2.9 million
      in the same period last year, due to higher margin interest reflecting an
      increase in margin balances. Other income increased from $1.8 million during
      the
      first three quarters of 2004 to $2.5 million during the same period in 2005,
      due
      to an increase in fees earned on the Company’s cash balances and customer credit
      balances at its clearing banks resulting from higher deposit balances.





-20-


During
      the nine months ended September 30, 2005, employee compensation and benefits
      increased to $54.0 million from $51.0 million in the same period last year
      due
      to higher revenues and increased personnel, primarily resulting from the
      addition of Edelman during May 2005. Floor brokerage, exchange, and clearance
      fees declined to $3.5 million in the first nine months of 2005 from $4.1 million
      in the same period of 2004 reflecting lower clearing and execution costs
      resulting from the reduced trading volume and negotiated lower cost per trade.
      Communication and data processing costs increased to $5.8 million in 2005 from
      $5.3 million in the same period last year resulting primarily from increased
      personnel and additional offices. Occupancy costs totaled $6.2 million during
      the first nine months of 2005, compared to $5.2 million in the prior year
      quarter due to expansion of several of our offices, and the additions of
      Charlotte Capital and Edelman. Interest expense totaled $265,000 during the
      first nine months of 2005, compared to $30,000 during the prior year period
      due
      to the revolving credit facility entered into by the Company during May 2005.
      Other general and administrative expenses increased to $10.6 million during
      the
      first nine months of 2005 from $7.8 million in the same period of last year
      mainly due to our growth.





Our
      effective tax rate was 41% for the nine months ended September 30, 2005 compared
      to 40% for the nine months ended September 30, 2004.





Results
      by Segment





*Retail
      Brokerage*


**Nine
                    Months Ended September 30,****2005**
                
                **2004**(in
                    thousands)Revenues
                
                $
                11,794
                
                $
                12,843Income
                    before income taxes
                
                $
                927
                
                $
                1,091


Revenues
      from retail brokerage declined to $11.8 million from $12.8 million, and income
      before income taxes declined to $927,000 from $1.1 million. Commission revenue
      declined to $6.6 million from $7.1 million due to lower trading volume during
      2005. Sales credits from investment banking transactions declined to $2.4
      million during 2005 from $2.9 million in 2004 due to a decline in fees from
      syndicate transactions. Compensation expense declined to $8.2 million from
      $9.2
      million, principally due to lower revenues as well as reduced amortization
      of
      employee loans, which are paid to brokers upon their hire and then amortized
      to
      compensation expense over a specified employment term.




-21-





*Institutional
      Brokerage*


**Nine
                  Months Ended September 30,****2005**
              
              **2004**(in
                  thousands)Revenues
              
              $
              19,404
              
              $
              23,062Income
                  before income taxes
              
              $
              2,605
              
              $
              3,996





Revenues
      from institutional brokerage declined to $19.4 million from $23.1 million,
      and
      income before taxes declined to $2.6 million from $4.0 million. Commission
      revenue declined to $12.2 million from $15.3 million due to a slowdown in
      institutional equity commission transactions mainly caused by the closure of
      our
      Denver office in the fourth quarter of 2004 and a decline in commission rates.
      Sales credits from investment banking transactions declined to $4.2 million
      from
      $5.5 million, due to a decrease in fees earned from the Company’s participation
      in underwriting syndicates. Revenues from principal transactions increased
      to
      $2.7 million from $2.0 million, due to higher revenues from fixed income
      transactions and improved profitability from institutional trading accounts.
      Compensation expense declined from $14.8 million during 2004 to $12.7 million
      during 2005 primarily due to the revenue decline.





*Asset
      Management*


**Nine
                  Months Ended September 30,****2005**
              
              **2004**(in
                  thousands)Revenues
              
              $
              29,534
              
              $
              21,754Income
                  before income taxes
              
              $
              9,134
              
              $
              8,820





Revenues
      from asset management increased to $29.5 million from $21.8 million, and income
      before taxes increased to $9.1 million from $8.8 million. Fiduciary, custodial,
      and advisory fees increased to $21.5 million from $13.4 million. The
      acquisitions of Charlotte Capital in April 2004 and Edelman in May 2005, and
      growth in assets under management at Salient, Kissinger, and SMCA have
      contributed to the increase in revenues from advisory fees. Total expenses
      rose
      to $21.8 million from $14.2 million due to the higher revenues and the
      acquisitions of Charlotte Capital and Edelman. The change in value of our
      investments in limited partnerships resulted in a gain of $5.6 million in 2005,
      compared to $3.4 million in 2004. Minority interests in net income of
      consolidated companies reflect the portion of net income attributable to
      minority interest ownership of entities included in the Company’s consolidated
      financial statements. Income attributable to minority interests, which reduces
      SMHG’s pretax income, increased to $4.3 million in 2005 from $2.1 million in
      2004, principally due to higher equity income of limited partnerships and
      increased income from the Company’s ownership of 69% of Charlotte Capital and
      51% of Edelman.




-22-





*Prime
      Brokerage*


**Nine
                  Months Ended September 30,****2005**
              
              **2004**(in
                  thousands)Revenues
              
              $
              13,855
              
              $
              14,984Income
                  before income taxes
              
              $
              1,388
              
              $
              2,485





Revenues
      from prime brokerage declined to $13.9 million from $15.0 million, and income
      before taxes decreased to $1.4 million from $2.5 million. Commission revenue
      decreased to $10.3 million from $12.6 million reflecting an overall reduction
      in
      commission rates. Revenues from principal transactions increased to $2.7 million
      in 2005 from $1.4 million in 2004 due to gains on trades made by the independent
      professional traders. Compensation expense decreased to $6.0 million from $7.3
      million due to lower revenues and reduced personnel. The percentage decline
      in
      income before taxes was greater than the percentage decline in revenues
      principally due to increases in those costs of the business that are not
      directly related to revenue variances.





*Investment
      Banking*


**Nine
                  Months Ended September 30,****2005**
              
              **2004**(in
                  thousands)Revenues
              
              $
              13,414
              
              $
              11,664Income
                  before income taxes
              
              $
              4,756
              
              $
              5,477





Revenues
      from investment banking increased to $13.4 million from $11.7 million, and
      income before taxes decreased to $4.8 million from $5.5 million. The revenue
      increase is primarily due to higher revenues from private placement transactions
      during 2005. Compensation expense increased from $4.8 million during 2004 to
      $6.6 million during 2005 due to higher revenues and additional investment
      banking personnel. All other expenses increased by approximately $660,000 during
      2005 due to additional office space and personnel.





*Corporate
      and Other*


**Nine
                  Months Ended September 30,****2005**
              
              **2004**(in
                  thousands)Revenues
              
              $
              3,249
              
              $
              2,716Loss
                  before income taxes
              
              $
              (5,810
              )
              $
              (7,153
              )





Revenues
      from corporate and other increased to $3.2 million from $2.7 million due to
      an
      increase in interest income reflecting higher margin interest caused by an
      increase in margin balances. The loss before taxes declined to $5.8 million
      from
      $7.2 million, primarily due to the revenue increase. Compensation expense
      declined to $5.3 million from $5.8 million due to lower incentive compensation
      related to the decline in overall Company profitability. Interest expense
      totaled $253,000 during 2005 due to the Company’s entry into a revolving credit
      facility during the second quarter of 2005.





-23-


**Liquidity
      and Capital Resources**





We
      intend
      to satisfy a large portion of our funding needs with our own capital resources,
      consisting largely of internally generated earnings and liquid assets we
      currently hold. We will use borrowed funds as necessary to supplement our own
      capital resources.





At
      September 30, 2005, we had approximately $15.5 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 about 23% of our total assets at the end of the third quarter.





For
      the
      nine months ended September 30, 2005, net cash provided by operations totaled
      $2.9 million versus net cash used in operations of $4.8 million during the
      first
      nine months of 2004. Accounts payable and accrued liabilities decreased by
      $3.9
      million during the nine months ended September 30, 2005, principally due to
      the
      payment of accrued compensation during the first quarter of 2005. Equity in
      income of limited partnerships totaled $6.6 million during the first nine months
      of 2005, compared to $3.6 million during the same period in 2004, reflecting
      larger gains on the investment portfolios in the limited partnerships. Minority
      interests in income of consolidated companies totaled $4.4 million during 2005
      compared to $2.1 million during 2004, due to the higher income from two of
      the
      limited partnerships that we account for under the equity method and the
      acquisitions of Charlotte and Edelman.





Capital
      expenditures for the first nine months of 2005 were $1.9 million, mainly for
      the
      purchase of furniture, computer equipment, and software, as well as for
      leasehold improvements, necessary for our growth.





Short
      term borrowings increased by $10.5 million during 2005 reflecting the Company’s
      entry into a revolving credit arrangement with a bank.





At
      September 30, 2005, 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 "Exchange Act"),
      known collectively as (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; (11) demand for the Company's
      services; and (12) litigation and securities law liabilities. The Company does
      not undertake to publicly update or revise any forward-looking
      statements.





-24-


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





Risk
      is
      an inherent part of our business. The extent to which we properly and
      effectively identify, assess, monitor, and manage each of the various types
      of
      risk involved in our activities is critical to our soundness and profitability.
      The primary risks that we seek to manage are credit, operational, legal,
      and market.





We
      manage
      risk exposure through the involvement of various levels of management. Position
      limits in trading and inventory accounts are established and monitored on an
      ongoing basis. Current and proposed underwriting and other commitments are
      subject to due diligence reviews by senior management, as well as professionals
      in the appropriate business and support units involved. We monitor our exposure
      to counter-party risk through the use of credit exposure information, the
      monitoring of collateral values, and the establishment of credit limits.




**Credit
      Risk**





Credit
      risk arises from the potential nonperformance by counter-parties, customers,
      or
      issuers of debt securities or other instrument that we hold. We are exposed
      to
      credit risk as a trading counter-party to dealers and customers and as a holder
      of securities. Since we clear all securities transactions through Pershing
      LLC
      and other clearing brokers on a fully disclosed basis we are not subject to
      the
      credit exposure associated with customer margin accounts.




**Operational
      Risk**





Operational
      risk refers generally to risk of loss resulting from our operations, including
      but not limited to, improper or unauthorized execution and processing of
      transactions, deficiencies in our operating systems, business disruptions,
      and
      inadequacies or breaches in our control processes. We operate different
      businesses in diverse markets and rely on the ability of our employees and
      systems to process large numbers of transactions in limited time frames. In
      order to mitigate and control operational risk, we have developed and continue
      to enhance specific policies and procedures that are designed to identify and
      manage operational risk at appropriate levels.





Disaster
      recovery plans exist for our critical systems. We believe that our disaster
      recovery program, including off-site back-up technology and operational
      facilities, is adequate to handle a reasonable business disruption. However,
      there is no assurance that a disaster affecting our headquarters, our operations
      centers, or the operations of our clearing brokers would not have a material
      adverse impact.




**Legal
      Risk**





Legal
      risk includes the risk of non-compliance with applicable legal and regulatory
      requirements. We are subject to extensive regulation in the different
      jurisdictions in which we conduct business. We have established procedures
      based
      on legal and regulatory requirements that are designed to ensure compliance
      with
      all applicable statutory and regulatory requirements. We also have established
      procedures that are designed to ensure that executive management’s policies
      relating to conduct, ethics, and business practices are followed. In connection
      with our business, we have various procedures addressing significant issues
      such
      as regulatory capital requirements, sales and trading practices, new products,
      use and safekeeping of customer funds and securities, money-laundering,
      protection of client information, and record keeping.





-25-





**Market
      Risk**





Market
      risk generally represents the risk of loss that may result from the potential
      change in value of a financial instrument as a result of fluctuations in
      interest rates, equity prices, indices, and liquidity, and changes in credit
      ratings of issuers. Our exposure to market risk is directly related to our
      role
      as a financial intermediary in customer-related transactions and as a market
      maker for certain securities traded on the Nasdaq Stock Market, and to our
      proprietary trading activities.




Interest
      rate risk is a consequence of maintaining inventory positions and trading in
      interest-rate-sensitive financial instruments. Our fixed income activities
      also
      expose us to the risk of loss related to changes in credit spreads. Credit
      spread risk arises from the potential that changes in an issuer’s credit rating
      or credit perception could affect the value of financial instruments.





We
      are
      exposed to equity price risk as a result of making markets and taking
      proprietary positions in equity securities. Equity price risk results from
      changes in the level or volatility of equity prices, which affect the value
      of
      equity securities or instruments that derive their value from a particular
      stock, a basket of stocks, or a stock index.





Virtually
      all of our trading inventory is denominated in U.S. dollars, therefore
      minimizing foreign exchange risk. We do not deal in, or hold, interest rate
      or
      currency swaps or other similar off-balance sheet instruments. We generally
      do
      not deal in, or hold, commodity futures.





At
      September 30, 2005, securities owned by the Company were recorded at a fair
      value of $64.4 million, including $24.8 million in marketable securities, $32.0
      million representing the Company’s investments in limited partnerships, and $7.6
      million representing other not readily marketable securities.





At
      September 30, 2005, Salient had securities available for sale with a fair value
      of $4.0 million. These securities have an original cost of $4.0 million, and
      are
      subject to price risk. At September 30, 2005, the unrealized increase in market
      value totaling $15,000 less tax of $6,000 has been included as a separate
      component of shareholders’ equity.




Management
      evaluates the realizability of securities available for sale to determine if
      a
      decline in value is other than temporary. Such evaluation considers the length
      of time and the extent to which market value has been less than cost, the
      financial condition and near-term prospects of the issuer, and the intent and
      ability of the Company to retain its investment in the issuer for a period
      of
      time sufficient to allow for any anticipated recovery in market value.
      Management believes the unrealized losses in the portfolio are temporary
      at
      September 30, 2005. However, a write-down accounted for as a realized loss
      may
      be necessary in the future.





**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.





-26-





**PART
      II. OTHER INFORMATION**





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





We
      are a
      party to various legal proceedings that are of an ordinary or routine nature
      incidental to our operations. Certain of our litigation and claims are covered
      by insurance with a maximum deductible per occurrence of $150,000. 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.





**Item
      2.** ***Unregistered
      Sales of Equity Securities and Use of Proceeds***





On
      April
      15, 2005, the Company contributed 69,950 shares of common stock to SMH Colorado
      LLC in connection with the acquisition of 50% of the investment advisory
      business of two financial advisers based in Colorado Springs, Colorado. SMH
      Colorado LLC distributed such shares to Steven D. Rodemer and Richard A. Walsh.
      Both Mr. Rodemer and Mr. Walsh are “accredited investors” as defined by
      Regulation D. The issuance of such shares was exempt from registration under
      Section 4(2) of the Securities Act of 1933 as a transaction not involving a
      public offering.





-27-





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





**Exhibit**


**Number**
            **Description**





2.1
            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, and incorporated
                herein by reference).


3.1
            Articles
                of Incorporation of the Company, as amended (Filed as Exhibit 3.2
                to the
                Company’s Quarterly report on Form 10Q for the quarter ended June 30, 2004
                (File No. 000-30066), filed on August 9, 2004, and incorporated herein
                by
                reference).


3.2
            Amended
                and Restated Bylaws of the Company (Filed as Exhibit 3.2 to the Company's
                Annual Report on Form 10-K for the year ended December 31, 1998 (File
                No.
                333-65417), and incorporated herein by
                reference).


†10.01
            1998
                Incentive Plan of the Company, as amended (Filed as Appendix A to
                the
                Definitive Proxy Statement on Schedule 14A of the Company dated May
                3,
                2002, 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
            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
                Amend-ment 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).


10.04
            Letter
                Agreement dated April 7, 1999, between the Pershing Division of Donaldson,
                Lufkin Jenrette Securities Corporation and Harris Webb & Garrison,
                Inc. (Filed as Exhibit 10.20 to the Company’s Annual Report on Form 10-K
                for the year ended December 31, 1999 (File No. 000-30066), and
                incorporated herein by reference).


*10.05
            On-Line
                Services Agreement dated as of June 1, 2005, between Innovest Systems,
                LLC
                and Pinnacle Trust Co., LTA.


10.06
            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 10Q for the quarter ended March
                31, 2000 (File No. 000-30066), and incorporated herein by
                reference).


10.07
            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 10Q for the quarter ended June
                30, 2005 (File No. 000-30066), and incorporated herein by
                reference).


*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 on compensation plan or arrangement.





-28-





**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:  November
      8, 2005





-29-