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UNITED STATES

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, 2010

OR



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

For the transition period from  to

Commission file number:
000-18188





PAULSON CAPITAL CORP.

(Exact name of registrant as specified in its charter)







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

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





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

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

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



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

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

Indicate
the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.



|                           |  |                                   
|-------------------------- |  | ----------------------------------
|Common stock, no par value |  | 5,769,985                         
|(Class)                    |  | (Outstanding at November 12, 2010)









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PAULSON CAPITAL CORP. AND SUBSIDIARY

FORM 10-Q

INDEX



|                               |  |                                                                                                             |    |      |    | 
|------------------------------ |  | ----------------------------------------------------------------------------------------------------------- | -- | ---- | -- | 
|                               |  |                                                                                                             |    | Page |   
|PART I - FINANCIAL INFORMATION |  |                                                                                                             |    |     
|                               |  |                                                                                                            
|Item 1.                        |  | Financial Statements                                                                                        |    |      |    | 
|                               |  |                                                                                                            
|                               |  | Consolidated Balance Sheets - September 30, 2010 and December 31, 2009 (unaudited)                          |    |      | 2  | 
|                               |  |                                                                                                            
|                               |  | Consolidated Statements of Operations - Three and Nine Months Ended September 30, 2010 and 2009 (unaudited) |    |      | 3  | 
|                               |  |                                                                                                            
|                               |  | Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2010 and 2009 (unaudited)           |    |      | 4  | 
|                               |  |                                                                                                            
|                               |  | Notes to Consolidated Financial Statements (unaudited)                                                      |    |      | 5  | 
|                               |  |                                                                                                            
|Item 2.                        |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                       |    |      | 7  | 
|                               |  |                                                                                                            
|Item 3.                        |  | Quantitative and Qualitative Disclosures About Market Risk                                                  |    |      | 14 | 
|                               |  |                                                                                                            
|Item 4.                        |  | Controls and Procedures                                                                                     |    |      | 14 | 
|                               | 
|PART II - OTHER INFORMATION    |  |                                                                                                             |    |     
|                               |  |                                                                                                            
|Item 6.                        |  | Exhibits                                                                                                    |    |      | 14 | 
|                               | 
|Signatures                     |  |                                                                                                             | 15 |     



1



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PART I - FINANCIAL INFORMATION



|Item 1. | Financial Statements
|------- | --------------------

Paulson Capital Corp. and Subsidiaries

Consolidated Balance Sheets

(Unaudited)



|                                                                                                                 |  |                   |            |  |                  |   |            | 
|---------------------------------------------------------------------------------------------------------------- |  | ----------------- | ---------- |  | ---------------- | - | ---------- | 
|                                                                                                                 |  | September 30,2010 |            |  | December 31,2009 |  
|Assets                                                                                                           |  |                   |            |  |                  |   |            | 
|Cash                                                                                                             |  | $                 | 232,987    |  |                  | $ | 245,292    | 
|Receivable from clearing organization                                                                            |  |                   | 8,380,263  |  |                  |   | 10,505,232 | 
|Notes and other receivables                                                                                      |  |                   | 1,029,878  |  |                  |   | 524,231    | 
|Income taxes receivable                                                                                          |  |                   | 164,320    |  |                  |   | 2,181,895  | 
|Trading and investment securities owned, at fair value                                                           |  |                   | 7,901,368  |  |                  |   | 7,848,363  | 
|Underwriter warrants, at fair value                                                                              |  |                   | 1,179,000  |  |                  |   | 1,290,000  | 
|Prepaid and deferred expenses                                                                                    |  |                   | 532,589    |  |                  |   | 844,211    | 
|Furniture and equipment, at cost, net of accumulated depreciation and amortization of $914,719 and $898,107      |  |                   | 26,715     |  |                  |   | 41,767     | 
|                                                                                                                 |  |                   |            |  |                  |   |            | 
|Total Assets                                                                                                     |  | $                 | 19,447,120 |  |                  | $ | 23,480,991 | 
|                                                                                                                 |  |                   |            |  |                  |   |            | 
|Liabilities and Shareholders Equity                                                                             |  |                   |            |  |                  |   |            | 
|Accounts payable and accrued liabilities                                                                         |  | $                 | 651,365    |  |                  | $ | 742,641    | 
|Payable to clearing organization                                                                                 |  |                   | 153,765    |  |                  |   | 2,288,945  | 
|Compensation, employee benefits and payroll taxes                                                                |  |                   | 851,373    |  |                  |   | 767,574    | 
|Trading securities sold, not yet purchased, at fair value                                                        |  |                   | 591        |  |                  |   | 284        | 
|Income taxes payable                                                                                             |  |                   | 516,460    |  |                  |   | 508,460    | 
|Deferred revenue                                                                                                 |  |                   | 420,915    |  |                  |   | 275,000    | 
|Underwriter warrantsemployee and independent contractor, at fair value                                          |  |                   | 4,000      |  |                  |   | 10,000     | 
|                                                                                                                 |  |                   |            |  |                  |   |            | 
|Total Liabilities                                                                                                |  |                   | 2,598,469  |  |                  |   | 4,592,904  | 
|Commitments and Contingencies                                                                                    |  |                   |           |  |                  |   |           | 
|                                                                                                                 |  |                  
|Shareholders Equity                                                                                             |  |                   |            |  |                  |   |            | 
|Preferred stock, no par value; 500,000 shares authorized; none issued                                            |  |                   |           |  |                  |   |           | 
|Common stock, no par value; 20,000,000 shares authorized; shares issued and outstanding: 5,769,985 and 5,891,785 |  |                   | 2,164,401  |  |                  |   | 2,190,435  | 
|Retained earnings                                                                                                |  |                   | 14,684,250 |  |                  |   | 16,697,652 | 
|                                                                                                                 |  |                   |            |  |                  |   |            | 
|Total Shareholders Equity                                                                                       |  |                   | 16,848,651 |  |                  |   | 18,888,087 | 
|                                                                                                                 |  |                   |            |  |                  |   |            | 
|Total Liabilities and Shareholders Equity                                                                       |  | $                 | 19,447,120 |  |                  | $ | 23,480,991 | 
|                                                                                                                 |  |                   |            |  |                  |   |            | 

See accompanying Notes to Consolidated Financial Statements.



2



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Paulson Capital Corp. and Subsidiaries

Consolidated Statements of Operations

(Unaudited)



|                                       |  |                                         |            |   |                                        |   |           |      |  |   |            |   |  |   |            |  
|-------------------------------------- |  | --------------------------------------- | ---------- | - | -------------------------------------- | - | --------- | ---- |  | - | ---------- | - |  | - | ---------- | -
|                                       |  | For the Three Months EndedSeptember 30, |            |   | For the Nine Months EndedSeptember 30, |  
|                                       |  | 2010                                    |            |   | 2009                                   |   |           | 2010 |  |   | 2009       |  
|Revenues:                              |  |                                         |            |   |                                        |   |           |      |  |   |            |   |  |   |            |  
|Commissions                            |  | $                                       | 3,815,600  |   |                                        | $ | 3,690,445 |      |  | $ | 12,119,251 |   |  | $ | 9,906,201  |  
|Corporate finance                      |  |                                         | 31,951     |   |                                        |   | 38,714    |      |  |   | 2,879,383  |   |  |   | 526,224    |  
|Investment income (loss)               |  |                                         | 13,591     |   |                                        |   | 266,512   |      |  |   | (1,575,848 | ) |  |   | 847,669    |  
|Trading income (loss)                  |  |                                         | (602,173   | ) |                                        |   | 805,858   |      |  |   | (725,406   | ) |  |   | 2,713,300  |  
|Interest and dividends                 |  |                                         | 4,427      |   |                                        |   | 55,410    |      |  |   | 13,731     |   |  |   | 155,989    |  
|Other                                  |  |                                         | 38,640     |   |                                        |   | 25,333    |      |  |   | 121,502    |   |  |   | 75,659     |  
|                                       |  |                                         |            |   |                                        |   |           |      |  |   |            |   |  |   |            |  
|                                       |  |                                         | 3,302,036  |   |                                        |   | 4,882,272 |      |  |   | 12,832,613 |   |  |   | 14,225,042 |  
|                                       |  |                                         |            |  
|Expenses:                              |  |                                         |            |   |                                        |   |           |      |  |   |            |   |  |   |            |  
|Commissions and salaries               |  |                                         | 3,807,955  |   |                                        |   | 3,570,015 |      |  |   | 11,768,445 |   |  |   | 9,533,860  |  
|Underwriting expenses                  |  |                                         | 1,825      |   |                                        |   | 31,896    |      |  |   | 254,548    |   |  |   | 157,525    |  
|Rent, telephone and quotation services |  |                                         | 274,043    |   |                                        |   | 290,976   |      |  |   | 841,081    |   |  |   | 884,591    |  
|Professional fees                      |  |                                         | 106,766    |   |                                        |   | 143,978   |      |  |   | 713,741    |   |  |   | 559,024    |  
|Travel and entertainment               |  |                                         | 56,385     |   |                                        |   | 45,640    |      |  |   | 128,872    |   |  |   | 96,345     |  
|Advertising and promotion              |  |                                         | 13,711     |   |                                        |   | 62,700    |      |  |   | 107,003    |   |  |   | 140,150    |  
|Settlement expense                     |  |                                         | 11,786     |   |                                        |   | 342,128   |      |  |   | 73,431     |   |  |   | 503,144    |  
|Bad debt expense                       |  |                                         |           |   |                                        |   | 223,961   |      |  |   | 337        |   |  |   | 227,847    |  
|Depreciation and amortization          |  |                                         | 5,148      |   |                                        |   | 11,090    |      |  |   | 20,520     |   |  |   | 45,583     |  
|Other                                  |  |                                         | 274,003    |   |                                        |   | 250,274   |      |  |   | 787,997    |   |  |   | 758,511    |  
|                                       |  |                                         |            |   |                                        |   |           |      |  |   |            |   |  |   |            |  
|                                       |  |                                         | 4,551,622  |   |                                        |   | 4,972,658 |      |  |   | 14,695,975 |   |  |   | 12,906,580 |  
|                                       |  |                                         |            |   |                                        |   |           |      |  |   |            |   |  |   |            |  
|                                       |  |                                         |            |  
|Income (loss) before income taxes      |  |                                         | (1,249,586 | ) |                                        |   | (90,386   | )    |  |   | (1,863,362 | ) |  |   | 1,318,462  |  
|                                       |  |                                         |            |  
|Income tax expense (benefit):          |  |                                         |            |   |                                        |   |           |      |  |   |            |   |  |   |            |  
|Current                                |  |                                         | (4,000     | ) |                                        |   | (509,363  | )    |  |   |           |   |  |   | (367,433   | )
|Deferred                               |  |                                         |           |   |                                        |   | 616,000   |      |  |   |           |   |  |   | 841,000    |  
|                                       |  |                                         |            |   |                                        |   |           |      |  |   |            |   |  |   |            |  
|                                       |  |                                         | (4,000     | ) |                                        |   | 106,637   |      |  |   |           |   |  |   | 473,567    |  
|                                       |  |                                         |            |   |                                        |   |           |      |  |   |            |   |  |   |            |  
|Net income (loss)                      |  | $                                       | (1,245,586 | ) |                                        | $ | (197,023  | )    |  | $ | (1,863,362 | ) |  | $ | 844,895    |  
|                                       |  |                                         |            |   |                                        |   |           |      |  |   |            |   |  |   |            |  
|Basic net income (loss) per share      |  | $                                       | (0.21      | ) |                                        | $ | (0.03     | )    |  | $ | (0.32      | ) |  | $ | 0.14       |  
|                                       |  |                                         |            |   |                                        |   |           |      |  |   |            |   |  |   |            |  
|Diluted net income (loss) per share    |  | $                                       | (0.21      | ) |                                        | $ | (0.03     | )    |  | $ | (0.32      | ) |  | $ | 0.14       |  
|                                       |  |                                         |            |   |                                        |   |           |      |  |   |            |   |  |   |            |  
|Shares used in per share calculations: |  |                                         |            |   |                                        |   |           |      |  |   |            |   |  |   |            |  
|Basic                                  |  |                                         | 5,863,463  |   |                                        |   | 5,921,569 |      |  |   | 5,842,030  |   |  |   | 5,910,226  |  
|                                       |  |                                         |            |   |                                        |   |           |      |  |   |            |   |  |   |            |  
|Diluted                                |  |                                         | 5,863,463  |   |                                        |   | 5,921,569 |      |  |   | 5,842,030  |   |  |   | 5,958,503  |  
|                                       |  |                                         |            |   |                                        |   |           |      |  |   |            |   |  |   |            |  

See accompanying Notes to Consolidated Financial Statements.



3



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Paulson Capital Corp. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)



|                                                                                                         |  |                                        |            |   |      |   |            |  
|-------------------------------------------------------------------------------------------------------- |  | -------------------------------------- | ---------- | - | ---- | - | ---------- | -
|                                                                                                         |  | For the Nine Months EndedSeptember 30, |           
|                                                                                                         |  | 2010                                   |            |   | 2009 |  
|Cash flows from operating activities:                                                                    |  |                                        |            |   |      |   |            |  
|Net income (loss)                                                                                        |  | $                                      | (1,863,362 | ) |      | $ | 844,895    |  
|Adjustments to reconcile net income (loss) to net cash flows provided by (used in) operating activities: |  |                                        |            |   |      |   |            |  
|Receipt of underwriter warrants                                                                          |  |                                        | (1,681,000 | ) |      |   | (217,000   | )
|Unrealized (appreciation) depreciation/expiration of underwriter warrants                                |  |                                        | 1,792,000  |   |      |   | (585,000   | )
|Unrealized depreciation/expiration of underwriter warrants - employee and independent contractor         |  |                                        | (6,000     | ) |      |   | (75,000    | )
|Stock-based compensation                                                                                 |  |                                        |           |   |      |   | 241,000    |  
|Depreciation and amortization                                                                            |  |                                        | 20,520     |   |      |   | 45,583     |  
|Deferred income taxes                                                                                    |  |                                        |           |   |      |   | 841,000    |  
|Bad debt expense                                                                                         |  |                                        |           |   |      |   | 227,847    |  
|Loss on asset disposition                                                                                |  |                                        | 433        |   |      |   | 134        |  
|Change in assets and liabilities:                                                                        |  |                                        |            |   |      |   |            |  
|Receivables from/payable to clearing organization, net                                                   |  |                                        | (10,211    | ) |      |   | (5,052,701 | )
|Notes and other receivables                                                                              |  |                                        | (505,647   | ) |      |   | (923,766   | )
|Income taxes receivable                                                                                  |  |                                        | 2,017,575  |   |      |   | 5,910,426  |  
|Trading and investment securities owned                                                                  |  |                                        | (53,005    | ) |      |   | (2,215,740 | )
|Prepaid and deferred expenses                                                                            |  |                                        | 311,622    |   |      |   | 232,741    |  
|Deferred revenue                                                                                         |  |                                        | 145,915    |   |      |   | (75,000    | )
|Accounts payable, accrued liabilities and compensation payables                                          |  |                                        | (7,477     | ) |      |   | 730,224    |  
|Trading securities sold, not yet purchased                                                               |  |                                        | 307        |   |      |   | 550        |  
|Income taxes payable - long-term                                                                         |  |                                        | 8,000      |   |      |   | 11,000     |  
|                                                                                                         |  |                                        |            |   |      |   |            |  
|Net cash provided by (used in) operating activities                                                      |  |                                        | 169,670    |   |      |   | (58,807    | )
|                                                                                                         |  |                                       
|Cash flows from investing activities:                                                                    |  |                                        |            |   |      |   |            |  
|Additions to furniture and equipment                                                                     |  |                                        | (5,901     | ) |      |   | (2,481     | )
|                                                                                                         |  |                                        |            |   |      |   |            |  
|Net cash used in investing activities                                                                    |  |                                        | (5,901     | ) |      |   | (2,481     | )
|                                                                                                         |  |                                       
|Cash flows from financing activities:                                                                    |  |                                        |            |   |      |   |            |  
|Proceeds from stock option exercises                                                                     |  |                                        | 2,486      |   |      |   | 5,650      |  
|Payments to retire common stock                                                                          |  |                                        | (178,560   | ) |      |   | (43,200    | )
|                                                                                                         |  |                                        |            |   |      |   |            |  
|Net cash used in financing activities                                                                    |  |                                        | (176,074   | ) |      |   | (37,550    | )
|                                                                                                         |  |                                        |            |   |      |   |            |  
|Decrease in cash                                                                                         |  |                                        | (12,305    | ) |      |   | (98,838    | )
|                                                                                                         |  |                                       
|Cash:                                                                                                    |  |                                        |            |   |      |   |            |  
|Beginning of period                                                                                      |  |                                        | 245,292    |   |      |   | 318,810    |  
|                                                                                                         |  |                                        |            |   |      |   |            |  
|End of period                                                                                            |  | $                                      | 232,987    |   |      | $ | 219,972    |  
|                                                                                                         |  |                                        |            |   |      |   |            |  
|Supplemental cash flow information:                                                                      |  |                                        |            |   |      |   |            |  
|Cash received during the period for income tax refunds, net                                              |  | $                                      | 1,991,075  |   |      | $ | 6,288,859  |  
|                                                                                                         |  |                                       
|Supplemental non-cash information:                                                                       |  |                                        |            |   |      |   |            |  
|Conversion of corporate finance client note receivable to equity investment                              |  | $                                      |           |   |      | $ | 404,959    |  

See accompanying Notes
to Consolidated Financial Statements.



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PAULSON CAPITAL CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Basis of Presentation

The financial information for Paulson Capital Corp. and its wholly-owned subsidiaries, Paulson Investment Company and Paulson Capital Properties, LLC,
included herein as of September 30, 2010 and December 31, 2009 and for the three and nine-month periods ended September 30, 2010 and 2009 is unaudited; however, such information reflects all adjustments, consisting only of normal
recurring adjustments, which, in the opinion of management, are necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods. The financial information as of December 31, 2009 is
derived from the audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2009. The interim consolidated financial statements should be read in conjunction with the consolidated
financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2009. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected
for the full year.

Note 2. Earnings Per Share

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



|                                                                                                                    |  |                                 |           |  |                                |  |           |      |  |  |           |  |  |  |           | 
|------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | --------- |  | ------------------------------ |  | --------- | ---- |  |  | --------- |  |  |  | --------- | 
|                                                                                                                    |  | Three Months EndedSeptember 30, |           |  | Nine Months EndedSeptember 30, | 
|                                                                                                                    |  | 2010                            |           |  | 2009                           |  |           | 2010 |  |  | 2009      | 
|Shares used for basic net income (loss) per share                                                                   |  |                                 | 5,863,463 |  |                                |  | 5,921,569 |      |  |  | 5,842,030 |  |  |  | 5,910,226 | 
|Effect of dilutive stock options                                                                                    |  |                                 |          |  |                                |  |          |      |  |  |          |  |  |  | 48,277    | 
|                                                                                                                    |  |                                 |           |  |                                |  |           |      |  |  |           |  |  |  |           | 
|Shares used for diluted net income (loss) per share                                                                 |  |                                 | 5,863,463 |  |                                |  | 5,921,569 |      |  |  | 5,842,030 |  |  |  | 5,958,503 | 
|                                                                                                                    |  |                                 |           |  |                                |  |           |      |  |  |           |  |  |  |           | 
|Stock options not included in diluted net income (loss) per share because their effect would have been
antidilutive |  |                                 | 448,800   |  |                                |  | 482,500   |      |  |  | 448,800   |  |  |  |          | 
|                                                                                                                    |  |                                 |           |  |                                |  |           |      |  |  |           |  |  |  |           | 

Note 3. Fair Value Measurements

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



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



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



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

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



5



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Following are the disclosures related
to our assets and (liabilities) carried at fair value (in thousands):



|                                                           |  |                    |       |   |                   |  |         |            |  |   |             |   |  |  |         | 
|---------------------------------------------------------- |  | ------------------ | ----- | - | ----------------- |  | ------- | ---------- |  | - | ----------- | - |  |  | ------- | 
|                                                           |  | September 30, 2010 |       |   | December 31, 2009 | 
|                                                           |  | Fair Value         |       |   | Input Level       |  |         | Fair Value |  |   | Input Level |  
|Trading and investment securities owned:                   |  |                    |       |   |                   |  |         |            |  |   |             |   |  |  |         | 
|Corporate equities, marketable                             |  | $                  | 4,650 |   |                   |  | Level 1 |            |  | $ | 4,693       |   |  |  | Level 1 | 
|Corporate equities, not readily marketable                 |  |                    | 2,965 |   |                   |  | Level 3 |            |  |   | 2,776       |   |  |  | Level 3 | 
|Corporate options/warrants, marketable                     |  |                    | 286   |   |                   |  | Level 1 |            |  |   | 379         |   |  |  | Level 1 | 
|Underwriter warrants                                       |  |                    | 1,179 |   |                   |  | Level 3 |            |  |   | 1,290       |   |  |  | Level 3 | 
|Trading securities sold, not yet purchased:                |  |                    |       |   |                   |  |         |            |  |   |             |   |  |  |         | 
|Corporate equities, marketable                             |  |                    | (1    | ) |                   |  | Level 1 |            |  |   |            |   |  |  |        | 
|Underwriter warrants  employee and independent contractor |  |                    | (4    | ) |                   |  | Level 3 |            |  |   | (10         | ) |  |  | Level 3 | 

Following is a summary of activity
related to our Level 3 assets and liabilities carried at fair value (in thousands):



|                                                                                                                                |  |                                         |       |  |                     |   |        |                                                        |  |   |     |  
|------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------------------- | ----- |  | ------------------- | - | ------ | ------------------------------------------------------ |  | - | --- | -
|                                                                                                                                |  | CorporateEquities, NotReadilyMarketable |       |  | UnderwriterWarrants |   |        | UnderwriterWarrants Employee andIndependentContractor | 
|Balance, December 31, 2009                                                                                                      |  | $                                       | 2,776 |  |                     | $ | 1,290  |                                                        |  | $ | (10 | )
|Fair value of underwriter warrants received included as a component of corporate finance income                                 |  |                                         |      |  |                     |   | 1,681  |                                                        |  |   |    |  
|Net unrealized gain (loss), included as a component of investment income (loss) related to securities held at December 31,
2009 |  |                                         | 189   |  |                     |   | (1,786 | )                                                      |  |   | 5   |  
|Underwriter warrants exercised or expired included as a component of investment income                                          |  |                                         |      |  |                     |   | (6     | )                                                      |  |   | 1   |  
|                                                                                                                                |  |                                         |       |  |                     |   |        |                                                        |  |   |     |  
|Balance, September 30, 2010                                                                                                     |  | $                                       | 2,965 |  |                     | $ | 1,179  |                                                        |  | $ | (4  | )
|                                                                                                                                |  |                                         |       |  |                     |   |        |                                                        |  |   |     |  

Valuation of Marketable Trading and Investment Securities Owned

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

Valuation of Not Readily Marketable Investment Securities

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

Valuation of Underwriter Warrants

We estimate the fair value of our underwriter warrants using the Black-Scholes Option Pricing Model. The warrants generally have a five-year expiration date and vest immediately. The warrants are
generally subject to a restriction period of six months to one-year in which we cannot exercise the warrants. The Black-Scholes model requires us to use five inputs including: stock price, risk free rate, exercise price, time remaining on the
warrant and price volatility. After stock price, the most influential factor in this model is price volatility, which we calculate for each companys warrants based on each companys own historical closing stock prices as well as an index
of historical prices for comparable companies. When we initially receive a new underwriter warrant from an initial public offering, its calculated volatility factor is entirely based on the volatility of an index of comparable companies, since there
is no price history for a new publicly traded company. As each underwriter warrant approaches its expiration date, its volatility



6



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factor is derived primarily from the historical prices of its underlying common stock. We cannot assure you that we will ultimately be able to exercise any of our warrants in a way that will
realize the value that we attribute to them in our financial statements based on this model.

Valuation of Trading Securities Sold, Not
Yet Purchased

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

Note 4. Repurchase of Common Stock

During 2010, we repurchased 124,000 shares of our common stock at an average price of $1.44 per share for a total of $179,000; all of these repurchases occurred during the second quarter. These shares
were repurchased pursuant to stock repurchase programs approved by our Board of Directors, pursuant to which we are authorized to repurchase up to 800,000 shares of our common stock. Through September 30, 2010, a total of 728,989 shares had
been repurchased and, as of September 30, 2010, 71,011 shares remained available for repurchase. These repurchase programs do not have an expiration date.



|Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations
|------- | -------------------------------------------------------------------------------------

FORWARD LOOKING STATEMENTS AND RISK FACTORS

This report, including, without limitation, Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations, contains or incorporates both historical
and forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Words such as anticipates,
believes, expects, intends, future and similar expressions identify forward-looking statements. Any such forward-looking statements in this report reflect our current views with respect to future
events and financial performance and are subject to a variety of factors that could cause our actual results to differ materially from historical results or from anticipated results expressed or implied by such forward-looking statements. Because of
such factors, we cannot assure you that the results anticipated in this report will be realized. As noted elsewhere in this report, various aspects of our business are subject to extreme volatility, often as a result of factors beyond our ability to
anticipate or control. In particular, factors, such as the condition of the securities markets, which are in turn based on popular perceptions of the health of the economy generally, can be expected to affect the volume of our business as well as
the value of the securities maintained in our trading and investment accounts. Other factors that may affect our future financial condition or results of operations include the following:



| |  |  | Aspects of our business are volatile and affected by factors beyond our control.
| | - |  | --------------------------------------------------------------------------------



| |  |  | Our ability to attract and retain customers may be affected by our reputation.
| | - |  | ------------------------------------------------------------------------------



| |  |  | We are subject to extensive regulation that could result in investigations, fines or other penalties.
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | We face intense competition in our industry.
| | - |  | --------------------------------------------



| |  |  | Our future success depends on retaining existing management and hiring and assimilating new key employees, and our inability to attract or retain key
personnel would materially harm our business and results of operations.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We are subject to an increased risk of legal proceedings, which may result in significant losses to us that we cannot recover. Claimants in these
proceedings may be customers, employees, investors or regulatory agencies, among others, seeking damages for mistakes, errors, negligence or acts of fraud by our employees.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | As a public company, we are subject to complex legal and accounting requirements that require us to incur substantial expense and expose us to risk of
non-compliance.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Our directors control approximately 60% of our common stock and may have interests differing from those of other stockholders.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------



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OVERVIEW

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



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



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



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



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

In addition, Paulson Capital Properties, LLC, a 100% owned subsidiary, was established for the purpose of purchasing, improving and remarketing
underappreciated real estate. Through September 30, 2010, we had not purchased any real estate.

Because we operate in the financial
services industry, our revenues and earnings are substantially affected by general conditions in financial markets. Further, past performance is not necessarily indicative of results to be expected in future periods. In our securities brokerage
business, the amount of our revenues depends on levels of market activity requiring the services we provide. Our corporate finance activity, which consists of acting as the managing underwriter of initial and follow-on public offerings, private
investments in public equity (PIPEs) and private placements for smaller companies, is similarly affected by the strength of the market for new equity offerings, which has historically experienced substantial cyclical
fluctuation. Global IPO volume has increased significantly in 2010 with China and the U.S. being the most active markets. During the first nine months of 2010, there were 97 IPOs in the U.S., with proceeds totaling $14.2 billion and
the outlook is strong. This compares to 31 IPOs in the U.S. during the first nine months of 2009 with proceeds totaling $8.9 billion. During all of 2009, there were 63 U.S. IPOs with gross proceeds totaling $22.8 billion. Although we attempt to
match operating costs with activity levels, many of our expenses are either fixed or difficult to change on short notice. Accordingly, fluctuations in brokerage and corporate finance revenues tend to result in sharper fluctuations, on a percentage
basis, in net income or loss.

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

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



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CURRENT EVENTS

For 2010, we suspended the Summer 2010 investment banking conference and are suspending the November 2010 Westergaard Conference and we plan to continue
only essential business expenditures.

CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES

We reaffirm the critical accounting policies and estimates as reported in our Annual Report on Form 10-K for the year ended December 31, 2009, which
was filed with the Securities and Exchange Commission on March 31, 2010.

RESULTS OF OPERATIONS

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



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



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



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



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



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The following tables set forth the
changes in our operating results in the three and nine-month periods ended September 30, 2010 compared to the three and nine-month periods ended September 30, 2009 (dollars in thousands):



|                                       |  |                                 |        |   |                              |   |        |                  |  |   |        |   |  |  |        |   
|-------------------------------------- |  | ------------------------------- | ------ | - | ---------------------------- | - | ------ | ---------------- |  | - | ------ | - |  |  | ------ | --
|                                       |  | Three Months EndedSeptember 30, |        |   | Favorable(Unfavorable)Change |   |        | PercentageChange | 
|                                       |  | 2010                            |        |   | 2009                         |   |        |                 
|Revenues:                              |  |                                 |        |   |                              |   |        |                  |  |   |        |   |  |  |        |   
|Commissions                            |  | $                               | 3,815  |   |                              | $ | 3,690  |                  |  | $ | 125    |   |  |  | 3.4    | % 
|Corporate finance                      |  |                                 | 32     |   |                              |   | 39     |                  |  |   | (7     | ) |  |  | (17.9  | ) 
|Investment income                      |  |                                 | 14     |   |                              |   | 267    |                  |  |   | (253   | ) |  |  | (94.8  | ) 
|Trading income (loss)                  |  |                                 | (602   | ) |                              |   | 806    |                  |  |   | (1,408 | ) |  |  | (174.7 | ) 
|Interest and dividends                 |  |                                 | 4      |   |                              |   | 55     |                  |  |   | (51    | ) |  |  | (92.7  | ) 
|Other                                  |  |                                 | 39     |   |                              |   | 25     |                  |  |   | 14     |   |  |  | 56.0   |   
|                                       |  |                                 |        |   |                              |   |        |                  |  |   |        |   |  |  |        |   
|Total revenues                         |  |                                 | 3,302  |   |                              |   | 4,882  |                  |  |   | (1,580 | ) |  |  | (32.4  | ) 
|Expenses:                              |  |                                 |        |   |                              |   |        |                  |  |   |        |   |  |  |        |   
|Commissions and salaries               |  |                                 | 3,808  |   |                              |   | 3,570  |                  |  |   | (238   | ) |  |  | (6.7   | ) 
|Underwriting expenses                  |  |                                 | 2      |   |                              |   | 32     |                  |  |   | 30     |   |  |  | 93.8   |   
|Rent, telephone and quotation services |  |                                 | 274    |   |                              |   | 291    |                  |  |   | 17     |   |  |  | 5.8    |   
|Professional fees                      |  |                                 | 107    |   |                              |   | 144    |                  |  |   | 37     |   |  |  | 25.7   |   
|Travel and entertainment               |  |                                 | 56     |   |                              |   | 46     |                  |  |   | (10    | ) |  |  | (21.7  | ) 
|Advertising and promotion              |  |                                 | 14     |   |                              |   | 63     |                  |  |   | 49     |   |  |  | 77.8   |   
|Settlement expense                     |  |                                 | 12     |   |                              |   | 342    |                  |  |   | 330    |   |  |  | 96.5   |   
|Bad debt expense                       |  |                                 |       |   |                              |   | 224    |                  |  |   | 224    |   |  |  | 100.0  |   
|Depreciation and amortization          |  |                                 | 5      |   |                              |   | 11     |                  |  |   | 6      |   |  |  | 54.5   |   
|Other                                  |  |                                 | 274    |   |                              |   | 250    |                  |  |   | (24    | ) |  |  | (9.6   | ) 
|                                       |  |                                 |        |   |                              |   |        |                  |  |   |        |   |  |  |        |   
|Total expenses                         |  |                                 | 4,552  |   |                              |   | 4,973  |                  |  |   | 421    |   |  |  | 8.5    |   
|                                       |  |                                 |        |   |                              |   |        |                  |  |   |        |   |  |  |        |   
|Loss before income taxes               |  | $                               | (1,250 | ) |                              | $ | (91    | )                |  | $ | (1,159 | ) |  |  | *      | % 
|                                       |  |                                 |        |   |                              |   |        |                  |  |   |        |   |  |  |        |   
|                                       |  |                                 |       
|                                       |  | Nine Months EndedSeptember 30,  |        |   | Favorable(Unfavorable)Change |   |        | PercentageChange | 
|                                       |  | 2010                            |        |   | 2009                         |   |        |                 
|Revenues:                              |  |                                 |        |   |                              |   |        |                  |  |   |        |   |  |  |        |   
|Commissions                            |  | $                               | 12,119 |   |                              | $ | 9,906  |                  |  | $ | 2,213  |   |  |  | 22.3   | % 
|Corporate finance                      |  |                                 | 2,879  |   |                              |   | 526    |                  |  |   | 2,353  |   |  |  | 447.3  |   
|Investment income (loss)               |  |                                 | (1,576 | ) |                              |   | 848    |                  |  |   | (2,424 | ) |  |  | (285.8 | ) 
|Trading income (loss)                  |  |                                 | (725   | ) |                              |   | 2,713  |                  |  |   | (3,438 | ) |  |  | (126.7 | ) 
|Interest and dividends                 |  |                                 | 14     |   |                              |   | 156    |                  |  |   | (142   | ) |  |  | (91.0  | ) 
|Other                                  |  |                                 | 122    |   |                              |   | 76     |                  |  |   | 46     |   |  |  | 60.5   |   
|                                       |  |                                 |        |   |                              |   |        |                  |  |   |        |   |  |  |        |   
|Total revenues                         |  |                                 | 12,833 |   |                              |   | 14,225 |                  |  |   | (1,392 | ) |  |  | (9.8   | ) 
|Expenses:                              |  |                                 |        |   |                              |   |        |                  |  |   |        |   |  |  |        |   
|Commissions and salaries               |  |                                 | 11,768 |   |                              |   | 9,534  |                  |  |   | (2,234 | ) |  |  | (23.4  | ) 
|Underwriting expenses                  |  |                                 | 255    |   |                              |   | 158    |                  |  |   | (97    | ) |  |  | (61.4  | ) 
|Rent, telephone and quotation services |  |                                 | 841    |   |                              |   | 885    |                  |  |   | 44     |   |  |  | 5.0    |   
|Professional fees                      |  |                                 | 714    |   |                              |   | 559    |                  |  |   | (155   | ) |  |  | (27.7  | ) 
|Travel and entertainment               |  |                                 | 129    |   |                              |   | 96     |                  |  |   | (33    | ) |  |  | (34.4  | ) 
|Advertising and promotion              |  |                                 | 107    |   |                              |   | 140    |                  |  |   | 33     |   |  |  | 23.6   |   
|Settlement expense                     |  |                                 | 73     |   |                              |   | 503    |                  |  |   | 430    |   |  |  | 85.5   |   
|Bad debt expense                       |  |                                 |       |   |                              |   | 228    |                  |  |   | 228    |   |  |  | 100.0  |   
|Depreciation and amortization          |  |                                 | 21     |   |                              |   | 46     |                  |  |   | 25     |   |  |  | 54.3   |   
|Other                                  |  |                                 | 788    |   |                              |   | 758    |                  |  |   | (30    | ) |  |  | (4.0   | ) 
|                                       |  |                                 |        |   |                              |   |        |                  |  |   |        |   |  |  |        |   
|Total expenses                         |  |                                 | 14,696 |   |                              |   | 12,907 |                  |  |   | (1,789 | ) |  |  | (13.9  | ) 
|                                       |  |                                 |        |   |                              |   |        |                  |  |   |        |   |  |  |        |   
|Income (loss) before income taxes      |  | $                               | (1,863 | ) |                              | $ | 1,318  |                  |  | $ | (3,181 | ) |  |  | (241.4 | )%
|                                       |  |                                 |        |   |                              |   |        |                  |  |   |        |   |  |  |        |   



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

Revenues

The continued improvement in the global economy and increases in the major market indices have had a positive effect on our corporate
finance and retail commissions revenues in the first three quarters of 2010. For the period from December 31, 2009 to September 30, 2010, the Dow Jones Industrial average (the Dow) and the NASDAQ composite indices increased
3.4% and 4.3%, respectively. The Dow and the NASDAQ indices increased 10.3% and 12.2%, respectively, between June 30, 2010 and September 30, 2010.



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Commissions increased 3.4% and 22.3%,
respectively, in the three and nine-month periods ended September 30, 2010 compared to the same periods of 2009, primarily due to an increase in the number of registered representatives. We had 104 registered representatives at
September 30, 2010 compared to 92 at December 31, 2009.

Corporate finance revenue in the first nine months of 2010 included:



| |  |  | underwriting fees earned from a follow-on public offering in the first quarter of 2010, in which we, together with a co-underwriter, raised $6.5
million for BioCurex, Inc., as well as the Black-Scholes value of the underwriter warrants received in connection with that offering; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | underwriting fees earned from an initial public offering in the second quarter of 2010, in which we raised $15.4 million for S&W Seed Company, as
well as the Black-Scholes value of the underwriter warrants received in connection with that offering.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Corporate finance
revenue in the first nine months of 2009 included:



| |  |  | placement agent fees earned from a bridge offering in the third quarter of 2009 in which we raised $450,000;
| | - |  | ------------------------------------------------------------------------------------------------------------



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



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

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



|                                                                                                                                                                                 |  |                                 |     |   |                                |   |        |      |  |   |        |   |  |   |        |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | --- | - | ------------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                                                                                                                                 |  | Three Months EndedSeptember 30, |     |   | Nine Months EndedSeptember 30, |  
|                                                                                                                                                                                 |  | 2010                            |     |   | 2009                           |   |        | 2010 |  |   | 2009   |  
|Net unrealized appreciation (depreciation) related to underwriter warrants                                                                                                       |  | $                               | 3   |   |                                | $ | 198    |      |  | $ | (1,792 | ) |  | $ | 585    |  
|Net unrealized (appreciation) depreciation of underwriter warrants  employee and independent contractor                                                                         |  |                                 | 8   |   |                                |   | (26    | )    |  |   | 6      |   |  |   | 75     |  
|Net unrealized appreciation (depreciation) of securities held based on quoted market prices or, for securities that are not
readily marketable, our estimate of their fair value |  |                                 | 34  |   |                                |   | 1,616  |      |  |   | 214    |   |  |   | 1,959  |  
|Net realized gains (losses) on the sale of securities with quoted market prices, securities that are not readily marketable and
gains from the exercise of underwriter warrants  |  |                                 | (31 | ) |                                |   | (1,521 | )    |  |   | (4     | ) |  |   | (1,771 | )
|                                                                                                                                                                                 |  |                                 |     |   |                                |   |        |      |  |   |        |   |  |   |        |  
|                                                                                                                                                                                 |  | $                               | 14  |   |                                | $ | 267    |      |  | $ | (1,576 | ) |  | $ | 848    |  
|                                                                                                                                                                                 |  |                                 |     |   |                                |   |        |      |  |   |        |   |  |   |        |  

We did not exercise any underwriter warrants during the three or nine-month periods ended September 30, 2010 or 2009.
Generally, when we exercise a warrant to obtain the underlying common stock, the common stock is subsequently sold in the near term and the related gain is reflected as a component of investment income. In connection with a follow-on offering in the
second quarter of 2009, we returned 75,750 ICOP Digital, Inc. (units) underwriter warrants and 17,875 ICOP Digital, Inc. (common and warrant) underwriter warrants to ICOP Digital, Inc.; these warrants were out of the money at the time.

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

Trading income decreased $1.4 million and $3.4 million, respectively, in the three and nine-month periods ended September 30, 2010 compared to the same periods of 2009. In the first nine months of
2010, trading income was negatively affected by the market value of certain securities in which we make a market. Our focus is on very small capitalization issues, especially those tied to our corporate finance clients.



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Expenses

Total expenses decreased $0.4 million and increased $1.8 million, respectively, in the three and nine-month periods ended September 30, 2010 compared
to the same periods of 2009, as described in more detail below.

Commissions and salaries increased $0.2 million and $2.2 million,
respectively, in the three and nine-month periods ended September 30, 2010 compared to the same periods of 2009. The increases were primarily due to higher commissions earned on higher commission revenue, increased compensation earned as a
result of increased investment banking activity in the nine-month period and the termination of salary cuts that were in effect from February 2009 through November 2009.

Underwriting expenses decreased $30,000 and increased $97,000, respectively, in the three and nine-month periods ended September 30, 2010 compared to the same periods of 2009 as a result of the
timing and level of investment banking activity in the 2010 and 2009 periods.

Professional fees decreased $37,000 and increased $155,000,
respectively, in the three and nine-month periods ended September 30, 2010 compared to the same periods of 2009 as a result of legal fees on open claims.

Settlement expense of $12,000 and $73,000, respectively, in the three and nine-month periods ended September 30, 2010 was related to the settlement of two claims during the second quarter of 2010,
and an accrual for one claim in the third quarter of 2010. Settlement expense of $342,000 and $503,000, respectively, in the three and nine-month periods ended September 30, 2009 was primarily related to a failed corporate finance transaction,
partially offset by insurance recoveries.

Bad debt expense is recorded when amounts are determined to be uncollectible. There was no bad debt
expense recognized in the three-month period ended September 30, 2010 and an immaterial amount was recognized in the nine-month period ended September 30, 2010. Bad debt expense totaled $224,000 and $228,000, respectively, in the three and
nine-month periods ended September 30, 2009 and was related to the write-off of a note receivable from a corporate finance client.

LIQUIDITY AND CAPITAL RESOURCES

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

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

We believe our cash and receivables from our clearing organization at September 30, 2010 are sufficient to meet our cash and regulatory net capital needs for at least the next twelve-month period
from September 30, 2010. Our liquidity could be negatively affected by protracted unfavorable market conditions.

As a securities
broker-dealer, we are required by SEC regulations to meet certain liquidity and capital standards. We believe we were in compliance with these standards at September 30, 2010.



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

At September 30, 2010, we owned 9 underwriter warrants from 9 issuers,
all but 2 of which were exercisable. None of the warrants had an exercise price below the September 30, 2010 market price of the securities receivable upon exercise. There is little or no direct relationship between the intrinsic value of our
underwriter warrants at the end of any given period and the fair value calculated using the Black-Scholes option pricing model. The prices of the securities underlying the underwriter warrants are very volatile, and substantial fluctuations in their
fair value can be expected in the future.

Cash provided by operating activities totaled $170,000 in the first nine months of 2010, primarily
due to our net loss of $1.9 million offset by net non-cash expense items of $126,000 and changes in our operating assets and liabilities as discussed in more detail below.

Our net receivable from our clearing organization totaled $8.2 million at both September 30, 2010 and December 31, 2009. Our net receivable from our clearing organization is affected by the
results of the activity in our trading and investment accounts, as well as the timing of general corporate expenditures and cash flow requirements.

Notes and other receivables increased $0.5 million to $1.0 million at September 30, 2010 from $0.5 million at December 31, 2009, primarily due to loans to our registered representatives.

Income taxes receivable decreased $2.0 million to $0.2 million at September 30, 2010 from $2.2 million at December 31, 2009, due to
the receipt of a $2.1 million income tax refund in July 2010.

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

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



|                                         |  |   |        |  
|---------------------------------------- |  | - | ------ | -
|Balance, December 31, 2009               |  | $ | 1,290  |  
|Receipt of underwriter warrants          |  |   | 1,681  |  
|Net unrealized loss on value of warrants |  |   | (1,786 | )
|Warrants exercised or expired            |  |   | (6     | )
|                                         |  |   |        |  
|Balance, September 30, 2010              |  | $ | 1,179  |  
|                                         |  |   |        |  

Prepaid and deferred expenses decreased $0.3 million to $0.5 million at September 30, 2010 from $0.8 million at
December 31, 2009, primarily due to prepaid regulatory registration fees and insurance at December 31, 2009 that were utilized during the first three quarters of 2010.

Deferred revenue of $0.4 million at September 30, 2010 was related to amounts received from our clearing firm pursuant to a five-year agreement with two, one-year extensions, and is being amortized
at the rate of $12,755 per month through June 2013.

Underwriter warrants  employee and independent contractor liability of $4,000 at
September 30, 2010 represented the fair value of underwriter warrants held for which the gain from the sale of the related stock upon exercise is due to certain employees.



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In September 2001, our Board of
Directors approved a stock repurchase program pursuant to which we are authorized to repurchase up to 600,000 shares of our common stock. In June 2008, our Board of Directors approved the repurchase of up to a total of an additional 200,000 shares
of our common stock. We repurchased a total of 124,000 shares of our common stock during the first three quarters of 2010 at an average price of $1.44 per share for a total of $179,000. Through September 30, 2010, 728,989 shares had been
repurchased and, as of September 30, 2010, 71,011 shares remained available for repurchase. These repurchase programs do not have an expiration date.

OFF-BALANCE SHEET ARRANGEMENTS

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

NEW ACCOUNTING GUIDANCE

There is no new
accounting guidance to be reported.



|Item 3. | Quantitative and Qualitative Disclosures About Market Risk
|------- | ----------------------------------------------------------

Not required for Smaller Reporting Companies.



|Item 4. | Controls and Procedures
|------- | -----------------------

Disclosure Controls and Procedures

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

Changes in Internal Control Over Financial Reporting

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

PART II - OTHER INFORMATION



|Item 6. | Exhibits
|------- | --------

The following exhibits
are filed herewith and this list is intended to constitute the exhibit index:



|     |  |                                                                                                                                                             
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.1 |  | Third Amendment, dated September 21, 2010, to Office Lease dated as of May 6, 1997                                                                          
|31.1 |  | Certification of Principal Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934.                           
|31.2 |  | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934.                               
|32.1 |  | Certification of Principal Executive Officer pursuant to Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.
|32.2 |  | Certification of Chief Financial Officer pursuant to Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.    



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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.



|                        |  |  |  |                       |  |                                      
|----------------------- |  |  |  | --------------------- |  | -------------------------------------
|Date: November 15, 2010 |  |  |  | PAULSON CAPITAL CORP.
|                        |  |  | 
|                        |  |  |  | By                    |  | /s/ CHESTER L. F. PAULSON            
|                        |  |  |  |                       |  | Chester L. F. Paulson                
|                        |  |  |  |                       |  | President and Chief Executive Officer
|                        |  |  |  |                       |  | Principal Executive Officer          
|                        |  |  | 
|                        |  |  |  | By                    |  | /s/ MURRAY G. SMITH                  
|                        |  |  |  |                       |  | Murray G. Smith                      
|                        |  |  |  |                       |  | Interim Chief Financial Officer      
|                        |  |  |  |                       |  | Principal Financial Officer          



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