**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON D.C. 20549**

 

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**FORM 10-QSB**

 

**ý****QUARTERLY REPORT PURSUANTTO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended September 30, 2003**

 

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

 

**For the transition period from               to               **

 

**Commission file number: 0-18188**

 

| **PAULSON CAPITAL CORP.**                                         |
|-------------------------------------------------------------------|
| (Exact name of small business issuer as specified in its charter) |

 

| **Oregon**                                                     |
|----------------------------------------------------------------|
| (state or other jurisdiction of incorporation or organization) |
|                                                           |
| **93-0589534**                                                 |
| (IRS employer identification number)                           |
|                                                           |
| **811 S.W. Naito Parkway  Portland, OR 97204**                 |
| (Address of principal executive offices)                       |
|                                                           |
| **(503) 243-6000**                                             |
| (Issuer’s telephone number)                               |

 

Number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date:

 

Common stock, no par value—3,110,811 shares as of November 7, 2003

 

Transitional Small Business Disclosure Format (check  one): Yes  o    No  ý

 

 

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**PART I —FINANCIAL INFORMATION**

 

ITEM 1. FINANCIAL STATEMENTS

 

PAULSON CAPITAL CORP. AND SUBSIDIARYCONSOLIDATED BALANCESHEETS

 
|                                                                                                                                |   | **09/30/03**    |       | **12/31/02** |       |
|-------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------|------------|--------------|------------|
|                                                                                                                                |   | **(unaudited)** |       |         |       |
| **ASSETS**                                                                                                                          |   |            | ** ** |         | ** ** |
|                                                                                                                                |   |            | ** ** |         | ** ** |
| Cash and cash equivalents                                                                                                           |   | $               | 141,259    |         | $          | 97,630 |   |
| Receivable from clearing organization                                                                                               |   | 8,447,502       |       | 3,926,749    |       |
| Notes and other receivables                                                                                                         |   | 788,277         |       | 681,655      |       |
| Income taxes receivable                                                                                                             |   | 2,532           |       | 1,894,000    |       |
| Trading securities, at market value                                                                                                 |   | 2,135,370       |       | 2,725,081    |       |
| Investment securities, at market value                                                                                              |   | 16,066,302      |       | 15,656,235   |       |
| Underwriter warrants, at estimated fair value                                                                                       |   | 4,739,500       |       | 2,714,000    |       |
| Prepaid and deferred expenses                                                                                                       |   | 1,253,421       |       | 1,158,738    |       |
| Furniture and equipment,  net                                                                                                       |   | 213,279         |       | 257,559      |       |
|                                                                                                                                |   |            |       |         |       |
| Total assets                                                                                                                        |   | $               | 33,787,442 |         | $          | 29,111,647 |   |
|                                                                                                                                |   |            |       |         |       |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**                                                                                      |   |            |       |         |       |
|                                                                                                                                |   |            |       |         |       |
| **LIABILITIES**                                                                                                                     |   |            |       |         |       |
| Accounts payable and accrued liabilities                                                                                            |   | $               | 311,369    |         | $          | 524,886 |   |
| Payable to clearing organization                                                                                                    |   | 901,493         |       | 2,087,907    |       |
| Compensation, employee benefits and payroll taxes                                                                                   |   | 2,119,663       |       | 595,052      |       |
| Securities sold, not yet purchased, at market value                                                                                 |   | 120,395         |       | 60,843       |       |
| Income taxes payable                                                                                                                |   | 247,587         |       | —       |       |
| Deferred income taxes                                                                                                               |   | 1,552,413       |       | —       |       |
|                                                                                                                                |   |            |       |         |       |
| Total liabilities                                                                                                                   |   | 5,252,920       |       | 3,268,688    |       |
|                                                                                                                                |   |            |       |         |       |
| **SHAREHOLDERS’ EQUITY**                                                                                                       |   |            |       |         |       |
| Preferred stock, no par value; authorized, 500,000  shares; issued and outstanding, no shares                                       |   | —          |       | —       |       |
| Common stock, no par value; authorized, 10,000,000  shares; issued and outstanding, 3,110,811 at 9/30/03 and 3,125,811 at  12/31/02 |   | 1,082,990       |       | 1,086,740    |       |
| Retained earnings                                                                                                                   |   | 27,451,532      |       | 24,756,219   |       |
|                                                                                                                                |   |            |       |         |       |
| Total shareholders’  equity                                                                                                    |   | 28,534,522      |       | 25,842,959   |       |
|                                                                                                                                |   |            |       |         |       |
| Total liabilities and  shareholders’ equity                                                                                    |   | $               | 33,787,442 |         | $          | 29,111,647 |   |

 

The accompanying notes are an integral part of these statements.

 

2

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PAULSON CAPITAL CORP. AND SUBSIDIARYCONSOLIDATED STATEMENTS OF OPERATIONS(unaudited)

 
|                                                    |   | **Three  months ended** |      | **Nine months  ended** |   |
|---------------------------------------------------------|--------|-------------------------|-----------|------------------------|--------|
|                                                    |   | **9/30/03**             |      | **9/30/02**            |   | **9/30/03** |   | **9/30/02** |   |
|                                                    |   |                    |      |                   |   |   |   |   |   |
| **Revenues**                                            |   |                    |      |                   |   |   |   |   |   |
| Commissions                                             |   | $                       | 4,625,295 |                   | $      | 1,649,922 |   | $ | 11,352,034 |   | $ | 4,975,376 |   |
| Corporate finance                                       |   | 2,513,121               |      | 32,016                 |   | 4,875,912 |   | 117,671 |   |
| Investment income (loss)                                |   | 2,467,777               |      | (286,417               | )      | 3,016,495 |   | (8,720,809 | ) |
| Trading income (loss)                                   |   | 541,819                 |      | (261,261               | )      | 976,282 |   | (689,615 | ) |
| Interest and dividends                                  |   | 17,145                  |      | 12,542                 |   | 47,698 |   | 52,215 |   |
| Other                                                   |   | 340                     |      | 446                    |   | 1,983 |   | 1,180 |   |
|                                                    |   |                    |      |                   |   |   |   |   |   |
|                                                    |   | 10,165,497              |      | 1,147,248              |   | 20,270,404 |   | (4,263,982 | ) |
| **Expenses**                                            |   |                    |      |                   |   |   |   |   |   |
| Commissions and salaries                                |   | 5,173,758               |      | 1,871,466              |   | 12,407,210 |   | 5,678,656 |   |
| Underwriting expenses                                   |   | 142,421                 |      | —                 |   | 253,719 |   | — |   |
| Rent, telephone and quotation services                  |   | 301,378                 |      | 236,794                |   | 853,685 |   | 701,489 |   |
| Interest expense                                        |   | 16,678                  |      | 780                    |   | 16,678 |   | 7,910 |   |
| Professional fees                                       |   | 132,020                 |      | 103,065                |   | 451,505 |   | 410,079 |   |
| Bad debt expense                                        |   | 30,000                  |      | 30,000                 |   | 190,000 |   | 90,000 |   |
| Travel and entertainment                                |   | 73,310                  |      | 61,692                 |   | 191,744 |   | 224,806 |   |
| Settlements                                             |   | —                  |      | —                 |   | 21,849 |   | 85,000 |   |
| Other                                                   |   | 657,059                 |      | 286,499                |   | 1,326,551 |   | 990,763 |   |
|                                                    |   |                    |      |                   |   |   |   |   |   |
|                                                    |   | 6,526,624               |      | 2,590,296              |   | 15,712,941 |   | 8,188,703 |   |
|                                                    |   |                    |      |                   |   |   |   |   |   |
| Earnings (loss) before income taxes                     |   | 3,638,873               |      | (1,443,048             | )      | 4,557,463 |   | (12,452,685 | ) |
|                                                    |   |                    |      |                   |   |   |   |   |   |
| Income tax expense (benefit)                            |   |                    |      |                   |   |   |   |   |   |
| Current                                                 |   | 247,587                 |      | (580,000               | )      | 247,587 |   | (1,500,000 | ) |
| Deferred                                                |   | 1,202,413               |      | 180,000                |   | 1,552,413 |   | (3,300,000 | ) |
|                                                    |   |                    |      |                   |   |   |   |   |   |
| **Net Earnings (Loss)**                                 |   | $                       | 2,188,873 |                   | $      | (1,043,048 | ) | $ | 2,757,463 |   | $ | (7,652,685 | ) |
|                                                    |   |                    |      |                   |   |   |   |   |   |
| Earnings (loss) per share, basic and diluted            |   | $                       | 0.70      |                   | $      | (0.33 | ) | $ | 0.88 |   | $ | (2.43 | ) |
|                                                    |   |                    |      |                   |   |   |   |   |   |
| Weighted average number of shares outstanding,  basic   |   | 3,117,811               |      | 3,136,240              |   | 3,117,979 |   | 3,146,237 |   |
|                                                    |   |                    |      |                   |   |   |   |   |   |
| Weighted average number of shares outstanding,  diluted |   | 3,120,501               |      | 3,136,240              |   | 3,124,186 |   | 3,146,237 |   |

 

The accompanying notes are an integral part of these statements

 

3

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PAULSON CAPITAL CORP. AND SUBSIDIARYCONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITYFor the years ended December 31, 2001 and 2002and the nine month period ended September 30, 2003

 
|                                           |   | **Common  Stock** |   | **Retained  Earnings** |      |
|------------------------------------------------|--------|-------------------|--------|------------------------|-----------|
|                                           |   | **Shares**        |   | **Amount**             |      |   |
| Balance at December 31, 2000              |   | 3,367,366         |   | $                      | 1,080,011 |   | $ | 26,104,819 |   |
|                                           |   |              |   |                   |      |   |   |
| Stock options exercised                        |   | 7,000             |   | 31,063                 |      | — |   |
|                                           |   |              |   |                   |      |   |   |
| Redemption of common stock                     |   | (211,304          | )      | (48,646                | )         | (1,073,350 | ) |
|                                           |   |              |   |                   |      |   |   |
| Net earnings for the year                      |   | —            |   | —                 |      | 7,037,062 |   |
|                                           |   |              |   |                   |      |   |   |
| Balance at December 31, 2001              |   | 3,163,062         |   | $                      | 1,062,428 |   | $ | 32,068,531 |   |
|                                           |   |              |   |                   |      |   |   |
| Stock options exercised                        |   | 8,000             |   | 35,500                 |      | — |   |
|                                           |   |              |   |                   |      |   |   |
| Redemption of common stock                     |   | (45,251           | )      | (11,188                | )         | (301,158 | ) |
|                                           |   |              |   |                   |      |   |   |
| Net loss for year                              |   | —            |   | —                 |      | (7,011,154 | ) |
|                                           |   |              |   |                   |      |   |   |
| Balance at December 31, 2002              |   | 3,125,811         |   | $                      | 1,086,740 |   | $ | 24,756,219 |   |
|                                           |   |              |   |                   |      |   |   |
| Redemption of common stock (unaudited)         |   | (15,000           | )      | (3,750                 | )         | (62,150 | ) |
|                                           |   |              |   |                   |      |   |   |
| Net earnings for the year to date (unaudited)  |   | —            |   | —                 |      | 2,757,463 |   |
|                                           |   |              |   |                   |      |   |   |
| Balance at September 30, 2003 (unaudited) |   | 3,110,811         |   | $                      | 1,082,990 |   | $ | 27,451,532 |   |
|                                           |   |              |   |                   |      |   |   |   |   |

 

The accompanying notes are an integral part of these statements

 

4

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PAULSON CAPITAL CORP. AND SUBSIDIARYCONSOLIDATED STATEMENTS OF CASH FLOWS(unaudited)

 
|                                                                                        |   | **Nine months  ended** |      |
|---------------------------------------------------------------------------------------------|--------|------------------------|-----------|
|                                                                                        |   | **9/30/03**            |      | **9/30/02** |   |
| Increase (Decrease) in Cash and Cash Equivalents                                            |   |                   |      |   |   |
|                                                                                        |   |                   |      |   |   |
| Cash flows from operating activities                                                        |   |                   |      |   |   |
| Net earnings (loss)                                                                         |   | $                      | 2,757,463 |   | $ | (7,652,685 | ) |
| Adjustments to reconcile net earnings (loss) to net  cash provided by operating activities: |   |                   |      |   |   |
| Receipt of underwriter warrants                                                             |   | (3,217,453             | )         | (68,391 | ) |
| Unrealized depreciation and expiration of  underwriter warrants                             |   | 255,846                |      | 4,526,691 |   |
| Noncash compensation associated with underwriter  warrants                                  |   | 936,107                |      | — |   |
| Depreciation and amortization                                                               |   | 106,394                |      | 138,567 |   |
| Deferred income taxes                                                                       |   | 1,552,413              |      | (3,300,000 | ) |
| Change in assets and liabilities                                                            |   |                   |      |   |   |
| Receivables                                                                                 |   | (4,627,375             | )         | 3,638,110 |   |
| Trading and investment securities                                                           |   | 179,644                |      | 4,231,002 |   |
| Prepaid and deferred expenses                                                               |   | (94,683                | )         | 76,542 |   |
| Accounts payable and accrued liabilities                                                    |   | 124,680                |      | (1,247,201 | ) |
| Securities sold, not yet purchased                                                          |   | 59,552                 |      | (839 | ) |
| Income taxes payable/receivable                                                             |   | 2,139,055              |      | 722 |   |
|                                                                                        |   |                   |      |   |   |
| Net cash provided by operating activities                                                   |   | 171,643                |      | 342,518 |   |
|                                                                                        |   |                   |      |   |   |
| Cash flows from investing activities  Additions to furniture and equipment                  |   | (62,114                | )         | (88,915 | ) |
|                                                                                        |   |                   |      |   |   |
| Net cash used in investing activities                                                       |   | (62,114                | )         | (88,915 | ) |
|                                                                                        |   |                   |      |   |   |
| Cash flows from financing activities                                                        |   |                   |      |   |   |
| Proceeds from exercise of stock options                                                     |   | —                 |      | 35,500 |   |
| Payments to retire common stock                                                             |   | (65,900                | )         | (287,147 | ) |
|                                                                                        |   |                   |      |   |   |
| Net cash used in financing activities                                                       |   | (65,900                | )         | (251,647 | ) |
|                                                                                        |   |                   |      |   |   |
| NET INCREASE IN CASH AND CASH EQUIVALENTS                                                   |   | 43,629                 |      | 1,956 |   |
|                                                                                        |   |                   |      |   |   |
| Cash and cash equivalents at beginning of period                                            |   | 97,630                 |      | 42,938 |   |
|                                                                                        |   |                   |      |   |   |
| Cash and cash equivalents at end of period                                                  |   | $                      | 141,259   |   | $ | 44,894 |   |
|                                                                                        |   |                   |      |   |   |
| Cash paid during the period for:                                                            |   |                   |      |   |   |
|                                                                                        |   |                   |      |   |   |
| Interest                                                                                    |   | $                      | 16,678    |   | $ | 780 |   |
| Income taxes                                                                                |   | $                      | 36,388    |   | $ | 2,009 |   |

 

The accompanying notes are an integral part of these statements

 

5

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**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**(unaudited)

 

1.Basis of Presentation

 

Theaccompanying unaudited consolidated financial statements have been prepared inaccordance with the instructions for interim financial statements in Item310(b) of Regulation S-B, and therefore do not include all information andfootnotes required by generally accepted accounting principles for completefinancial statements.  In the opinion ofmanagement, the interim financial statements include all adjustments(consisting only of normal recurring adjustments) necessary to state fairly theinformation shown therein.  The natureof the Company’s business is such that the results of any interim period arenot necessarily indicative of results for a full fiscal year.

 

2.Securities Owned

 

Gainsand losses from the disposition of securities are reflected as trading revenuesin the income statement for the period.

 

3.Commitments and Contingencies

 

On November 7, 2001, theCompany and its wholly owned subsidiary, Paulson Investment Company, Inc., orPIC, were named as defendants in a lawsuit filed by Spirit Partners, L.P. andTech-Trade Capital LLC.  The lawsuit wasfiled in the Supreme Court of the State of New York for the County of NewYork.  The lawsuit alleges that PICcommitted fraud and was unjustly enriched in connection with the redemption ofwarrants issued in the initial public offering of audiohighway.com, for whichPIC served as underwriter.  According toplaintiffs, the warrant agreement and prospectus contain different provisionsgoverning the redemption of the warrants. This allegedly occurred because the redemption provisions were changedduring the registration process, and the warrant agreement was not amended to reflectthe change in provisions. audiohighway.com’s redemption was proper under the terms of theprospectus, which contains the updated redemption provisions and allowed theissuer to redeem when the closing bid price of the common stock was at least$13.50 for 10 calendar days.  Plaintiffsallegethat the redemptionwas improper under the terms of the warrant agreement, which they allegecontains the original redemption provisions and allows the issuer to redeemwhen the closing bid price of the common stock exceeded $13.50 for 20consecutive trading days.  Plaintiffsalso allege that counsel for audiohighway.com and PIC fraudulently concealedthe alleged discrepancy between the prospectus and warrant agreement by amendingthe warrant agreement to be consistent with the prospectus.  Plaintiffs claim unspecified monetarydamages and seek $3 million in punitive damages. The lawsuit has been stayed,pending mandatory arbitration before the NASD. The Company and PIC are currently conducting discovery.  The case is scheduled for bindingarbitration in Portland, Oregon beginning February 17, 2004.  The Company and PIC believe that they havemeritorious defenses to these claims and intend to defend the case vigorously.

 

In January 2002, PIC wasserved in an arbitration brought by one of its former customers, PatriciaWeber, against PIC and its registered representative Melvin Vukcevich.  The arbitration claim alleges unsuitablesecurities recommendations, misrepresentation, breach of fiduciary duty andnegligence.  The claimant is seekingdamages of $255,000, interest, an additional return on her portfolio, punitivedamages and attorney fees.  PIC hasfiled its answer.  The case is scheduledfor binding arbitration in Los Angeles, California beginning May 25, 2004. PIC believes it has meritoriousdefenses and intends to defend these matters vigorously.

 

In March 2002, PIC andone of its registered representatives, Marvin Cox, were named as defendants inlawsuits filed by Louis Barinaga and Stuart Mackenzie, former PICcustomers.  The claims of Barinaga andMackenzie relate to purchases of convertible notes of E.com, which werepurchased directly from E.com.  Barinagaand Mackenzie allege that PIC and Mr. Cox participated in and materially aidedthe sale of the notes and, therefore, are liable under state securitieslaw.  Barinaga and Mackenzie allegedamages of $717,000 and $165,000, respectively, plus interest and attorneyfees. PIC asserted that the claims are subject to arbitration. Plaintiffs haveabated their lawsuit and refiled their claims before the NASD.  Claimant Barinaga has filed a motion toamend his arbitration statement of claim to include claims for breach offiduciary duty, violations of federal and state securities laws, fraud andnegligence relating to transactions in stock of e.Digital.  Barinaga’s proposed amended statement ofclaim also names UBS PaineWebber, Inc. as a respondent.  Barinaga claims that Cox, PIC and UBS PaineWebber,Inc.’s actions prevented him from realizing in excess of 12 million dollars onsales of e.Digital stock.  The e.Digitalstock in question was subject to an agreement entered into between Barinaga andUBS PaineWebber, Inc.  Discovery intothese new claims is in a very early stage. Given the proposed amendments, the current hearing date ofNovember 3, 2003, will be rescheduled to a later date.  PIC believes it has meritorious defenses andintends to defend this matter vigorously.

 

In October 2002, PIC wasnamed as a defendant in a lawsuit filed by Special Situations Fund III, LP andSpecial Situations Cayman Fund, LP.  Thelawsuit was filed in U.S. Federal District Court for the State of NewJersey.  It asserts various federalsecurities law claims and common law fraud and negligence against numerousdefendants, including PIC, arising out of two secondary offerings of SupremaSpecialties, Inc.  PIC participated inone of the two offerings, the August 25, 2000 secondary offering ofSuprema Specialities, Inc., as a member of the underwriting syndicate,underwriting 75,000 shares in total. The plaintiffs seek damages for the purchase of 399,151 shares ofSuprema Specialities, Inc. stock between August 25, 2000 andNovember 14, 2001. On January 15, 2003, PIC filed a motion to dismissall claims brought by plaintiffs.  PIC’smotion to dismiss was argued April 14, 2003.  On June 25, 2003, all claims against PIC were dismissed.

 

6

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Plaintiffs were given 60 daysto formally move to amend their complaint by the submission of a proposed amendedcomplaint.  Plaintiffs have filed amotion to amend and PIC’s opposition is due November 14, 2003.  PIC believes it has meritorious defenses andintends to defend this matter vigorously.

 

In December 2002, PICand its former registered representative, Wayde Newman, were named asrespondents in arbitration claims filed by Eugene V. Doty.  Mr. Doty asserts claims for fraud, breach offiduciary duty, and violations of Colorado consumer and securities acts and violationsof NASD rules.  Mr. Doty seeks $2,300,000,interest, attorney fees and punitive and treble damages.  The arbitration in this case is scheduledfor December 2, 2003.  PIC isinvestigating this claim, but believes it has meritorious defenses and intendsto defend this matter vigorously.

 

In January 2003, JoanneThies, a former PIC customer, filed an arbitration claim with the NASD, namingPIC and Peter Jones, a current PIC registered representative, asrespondents.  Ms. Thies asserts claimsfor negligence, failure to supervise, fraud and securities law violationsrelating to her account.  The claimantseeks damages of $457,000, attorney fees, costs and expenses.  PIC believes it has meritorious defenses andintends to defend this matter vigorously. This matter is scheduled for binding arbitration in Portland, Oregonbeginning December 15, 2003.

 

In February 2003, Brockand Julie Belt, former PIC customers, filed an arbitration claim with the NASD,naming PIC as a respondent.  Thestatement of claim alleges unsuitable securities recommendations and seeks$700,000 in damages, plus attorney fees and interest.  PIC has not had an opportunity to fully investigate this claim,but believes it has meritorious defenses and intends to defend this mattervigorously.  This matter is scheduledfor binding arbitration in Portland, Oregon beginning February 2, 2004.

 

In May 2003, Tony andToby Velarde, former PIC customers, filed an arbitration claim with the NASD,naming PIC as a respondent.  Thestatement of claim alleges negligence, churning, breach of fiduciary duty,failure to supervise and securities law violations and seeks $710,000 indamages, plus interest and attorney fees. PIC has not had an opportunity to fully investigate this claim, butbelieves it has meritorious defenses and intends to defend this mattervigorously.  This matter is scheduledfor binding arbitration in Portland, Oregon beginning April 5, 2004.

 

In addition to the mattersdescribed above, PIC has information that certain former customers may fileclaims against it; however, no such claims have been asserted at thistime.  PIC has no information regardingwhat amounts, if any, may be sought from PIC but believes the amounts may bematerial.  PIC has not had anopportunity to fully investigate these claims, but believes it has meritoriousdefenses and intends to defend these matters vigorously if any claims arefiled.

 

Anadverse outcome in certain of the matters described above could have a materialadverse effect on PIC or the Company. PIC also has been named in certain otherlegal proceedings and has received notice that certain customers may commencelegal proceedings against PIC. The Company believes, based upon informationreceived to date and, where the Company believes it appropriate, discussionswith legal counsel, that resolution of this additional pending or threatenedlitigation will have no material adverse effect on the consolidated financialcondition, results of operations, or business of the Company.

 

4.Stock Options

 

TheCompany has a stock-based employee compensation plan. As allowed under SFAS No.123 “Accounting for Stock-Based Compensation,” the Company continues to accountfor stock options for employees under APB No. 25, “Accounting for Stock Issuedto Employees,” and has adopted the disclosure only requirements of SFAS No.123.

Therewere no stock option grants in the three month periods ended September 30, 2003and September 30, 2002.  In the ninemonth period ended September 30, 2002, no stock-based employeecompensation cost is reflected in net income, since all options granted underthe plan had an exercise price equal to the market value of the underlyingcommon stock on the date of grant. The following table illustrates the effecton net income and earnings per share if the Company had applied the fair valuerecognition provisions of SFAS No. 123, *Accountingfor Stock-Based Compensation*, to stock-based employee compensationfor the nine months ended September 30, 2002.  The fair value of each option grant is estimated on the date ofgrant using the Black-Scholes option-pricing model with the followingweighted-average assumption: no dividends; expected volatility of 68%;risk-free interest rate of 4.8%; and expected life of 5 years. There would beno effect on net income and earnings per share for the nine months endedSeptember 30, 2003 because there was no vesting of options during the ninemonth period.

 
|                                                                                                                                          |   | **Three  Months Ended  09/30/02** |       | **Nine Months Ended  09/30/02** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|------------|---------------------------------|--------|
| Net loss, as reported                                                                                                                         |   | $                                 | (1,043,048 | )                               | $      | (7,652,685 | ) |
| Deduct: Total stock-based  employee compensation expense determined under fair value based method for  all awards, net of related tax effects |   | —                            |       | (130,000                        | )      |
| Pro forma net loss                                                                                                                            |   | $                                 | (1,043,048 | )                               | $      | (7,782,685 | ) |
| Loss per share:                                                                                                                               |   |                              |       |                            |   |
| Basic and diluted - as reported                                                                                                               |   | $                                 | (0.33      | )                               | $      | (2.43 | ) |
| Basic and diluted - pro forma                                                                                                                 |   | $                                 | (0.33      | )                               | $      | (2.47 | ) |

 

7

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ITEM2.  MANAGEMENT’S DISCUSSION AND ANALYSISOR PLAN OF OPERATION

 

**General**

 

FORWARD-LOOKINGSTATEMENTS

 

Thisreport, including, without limitation, “Item 2: Management’s Discussion andAnalysis or Plan of Operation,” contains or incorporates both historical and“forward-looking” statements within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the Securities ExchangeAct of 1934, as amended.  Words such as“anticipates”, “believes”, “expects”, “intends”, “future” and similarexpressions identify forward-looking statements.  Any such forward-looking statements in this report reflect ourcurrent views with respect to future events and financial performance and aresubject to a variety of factors that could cause our actual results to differmaterially from historical results or from anticipated results expressed orimplied by such forward-looking statements. Because of such factors, we cannot assure you that the resultsanticipated in this report will be realized. As noted elsewhere in this report, various aspects of our business aresubject to extreme volatility often as a result of factors beyond our abilityto anticipate or control.  Inparticular, factors, such as the condition of securities markets, which are inturn based on popular perceptions of the health of the economy generally, canbe expected to affect the volume of our business as well as the value of thesecurities maintained in our trading and investment accounts.  Other factors that may affect our futurefinancial condition or results of operations include the following:

 

•                  The performance of companies whose securitieswe have underwritten or otherwise sold to our customers may affect ourreputation with other potential syndicate and selling group members andinstitutional and other retail accounts and may also affect the amount of moneyin our customers’ portfolios available for the kinds of investments that we offer.

 

•                  The value of our investment portfolio,including the value of securities without a readily ascertainable market value,that we have estimated for the purpose of reporting on our financial conditionand results of operations, may be significantly and adversely affected bychanges in the value of the companies themselves or of comparable companieswhose stock values we use in estimating the value of our portfolio securities.

 

•                  We are subject to a very high degree ofregulation and are responsible for compliance with applicable regulations byall of our personnel.  A significantregulatory infraction by us or any of our registered representatives couldresult in significant penalties, including the loss of our license to conductsecurities business in one or more jurisdictions.

 

•                  Alternatives available to our customers totransact securities trades could affect our ability to continue to execute ourbrokerage customers’ transactions.

 

•                  The loss of our Chairman, Chester Paulson,could have a material adverse impact on our business.

 

**Overview**

 

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

 

•                                          securities brokerage activities for which PICearns commission revenues;

 

•                                          corporate finance revenues consistingprincipally of underwriting discounts, underwriter warrants received, and othercompensation from investment banking activities;

 

•                                          securities trading from which PIC recordsprofit or loss, depending on trading results; and

 

•                                          investment income resulting from profits from,and increases or decreases in the value of, PIC’s investment portfolio.

 

Becausewe operate in the financial services industry, our revenues and earnings aresubstantially affected by conditions in financial markets generally. In oursecurities brokerage and corporate finance businesses, the amount of ourrevenues depends substantially on levels of market activity requiring theservices we provide. For example, our investment banking activity, whichconsists primarily of acting as managing or participating underwriter ofinitial and follow-on public offerings for smaller companies, depends on themarket for new equity offerings, which has historically experienced substantialcyclical fluctuation. Although we attempt to match operating costs withactivity levels, many of our expenses are either fixed or difficult to changeon short notice. Accordingly, fluctuations in brokerage and corporate financerevenues tend to result in sharper fluctuations, on a percentage basis, in netincome or loss.

 

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Ourinvestment income or loss and, to a lesser extent, our trading income or lossare affected by changes in market valuation of securities generally and, inparticular, by changes in valuation of the equity securities of microcapcompanies in which our investments and trading activities tend to beconcentrated. Equity markets in general, and microcap equity markets inparticular, have always experienced significant volatility and this volatilityhas in recent years been extreme. The results of this volatility on the valueof our investment portfolio and securities held in connection with our tradingand investment activities include large quarterly fluctuations in income orloss from these operations and substantial increases or decreases in our networth as our securities holdings are marked to market.

 

Asubstantial portion of our investment banking business consists of acting asmanaging underwriter of initial and follow-on public offerings for microcapcompanies. As a part of our underwriter compensation for this activity, wetypically receive warrants exercisable to purchase securities identical tothose that we offer and sell to the public. The underwriter warrants generallyare not exercisable for the first year after the offering in which they are earnedand are thereafter generally exercisable for four years, after which theyexpire. The exercise price is typically 120% of the price at which we initiallysold the securities to the public. Accordingly, unless there is at least a 20%increase in the price of these securities at some time more than one and lessthan five years after the offering, the warrants will remain “under water” andwill ultimately expire unexercised.

 

**Critical Accounting Policies**

 

Thefollowing discussion and analysis of our financial condition and results ofoperations is based upon our consolidated financial statements, which have beenprepared in accordance with accounting principles generally accepted in theUnited States of America (US GAAP).  Inpreparing our consolidated financial statements, we must make estimates andjudgments that affect the reported amounts of assets and liabilities, revenuesand expenses, and related disclosure of contingent assets and liabilities atthe date of our financial statements. Actual results are likely to differ from these estimates under differentassumptions and conditions.

 

Thecritical accounting policies described below include those that reflectsignificant judgments and uncertainties, which potentially could producematerially different results under different assumptions and conditions.  We believe our most critical accountingpolicies are those described below.

 

*Use of Estimates*. We are required to estimate the value of allderivative securities that we hold at the date of any financial statements andto include that value, and changes in such value, in those financialstatements.  Accordingly, the aggregateestimated value of our underwriter warrants as of the date of any balance sheetis recorded as an asset on that balance sheet. When a new warrant is earned asa result of our investment banking activity, its estimated value is included incorporate finance revenue for the period in which it is earned. In subsequentperiods, any change in estimated value is recorded as investment income or lossfor the period. If, and when, an underwriter warrant is exercised, the bookvalue is adjusted to reflect the value of the securities purchased, net of theexercise price, and the adjustment amount is recorded as investment income orloss for the relevant period. If the warrant expires unexercised, the bookvalue is adjusted to zero and the decrease is recorded as a loss in therelevant period.

 

Weestimate the value of our underwriter warrants using the Black-Scholes OptionPricing Model.  The Black-Scholes modelrequires us to use historical price data combined with various otherassumptions and judgments as inputs for the model.  The most influential factor in this model is price volatility,which we calculate for each company’s warrants, based on each company’s ownhistorical stock price movements as well as an index of comparablecompanies.  When we initially receive anew underwriter warrant, from an initial public offering, its calculatedvolatility factor is entirely based on the volatility of an index of comparablecompanies, since there is no price history for a new publicly traded company.As each underwriter warrant approaches its expiration date, its volatilityfactor is derived primarily from the historical prices of its underlying commonstock. We cannot assure you that we will ultimately be able to exercise any ofour warrants in a way that will realize the value that we attribute to them inour financial statements based on this model. As of September 30, 2003, our underwriter warrants, based on theBlack-Scholes Option Pricing Model, were valued at approximately $4.7 million,up from a $4.4 million estimated value at June 30, 2003, and $2.7 millionestimated value at December 31, 2002.

 

Inaddition to our underwriter warrants, we hold other securities, some of whichhave very limited liquidity and some of which do not have a readilyascertainable market value.  Accordingto US GAAP, we are required to carry these securities at estimated fair value.

 

Asa result of the factors described above, our revenues and earnings are subjectto substantial fluctuation from period to period based on circumstances thatoften are beyond our control. An increase in financial market activitygenerally, and/or an increase in equity valuations generally, will normallyresult in increases in revenue, earnings and net worth as our activity levelsand the value of our investment portfolio increase. Conversely, a generalmarket retrenchment will typically lead to decreased revenue, earnings and networth as a result of both decreased activity and the need to adjust higherinvestment portfolio values to lower levels. Accordingly, results for anyhistorical period are not necessarily indicative of similar results for anyfuture period.

 

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**Results of Operations**

 

PIC’srevenues and operating results are influenced by fluctuations in the equityunderwriting markets as well as general economic and market conditions,particularly conditions in the over-the-counter market, where PIC’s investmentaccount, trading inventory positions and underwriter warrants are heavilyconcentrated.  Significant fluctuationscan occur in PIC’s revenues and operating results from one period to another.  PIC’s financial results depend upon manyfactors, such as the number of companies that are seeking public financing, thequality and financial condition of those companies, market conditions ingeneral, the performance of previous PIC underwritings and interest in certainindustries by investors.  As a result,revenues and income derived from these activities may vary significantly fromperiod to period.  In the tablebelow,  “corporate finance” revenues area function of total proceeds from offerings done during the period,compensation per offering, and the fair value of underwriter warrantsreceived.  “Investment income” includesrealized gains from exercise of underwriter warrants, gains and losses from thesales of investment securities, and unrealized gains and losses fromunderwriter warrants and other investment securities.  “Trading income” is the net gain or loss from trading positionsbefore commissions paid to the representatives in the trading department.

 

**Summary ofChanges in Major Categoriesof Revenues and Expenses**increase/(decrease)

 
|                                   |   | **Three  Months Ended September 30  2003 vs. 2002** |       | **Nine Months  Ended September 30  2003 vs. 2002** |       |
|----------------------------------------|--------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| **Revenues:**                          |   |                                                     | ** ** |                                                    | ** ** |   | ** ** |   | ** ** |
| Commissions                            |   | $                                                        | 2,975,373  |                                                    | 180.3      | % | $ | 6,376,658 |   | 128.2 | % |
| Corporate finance                      |   | 2,481,105                                                |       | 7,749.6                                                 | %          | 4,758,241 |   | 4,043.7 | % |
| Investment income                      |   | 2,754,194                                                |       | N/A                                                     |       | 11,737,304 |   | N/A |   |
| Trading income                         |   | 803,080                                                  |       | N/A                                                     |       | 1,665,897 |   | N/A |   |
| Other                                  |   | 4,497                                                    |       | 34.6                                                    | %          | (3,714 | ) | (7.0 | )% |
|                                   |   |                                                     |       |                                                    |       |   |   |   |   |
| Total                                  |   | $                                                        | 9,018,249  |                                                    | 786.1      | % | $ | 24,534,386 |   | N/A |   |
|                                   |   |                                                     |       |                                                    |       |   |   |   |   |
| **Expenses:**                          |   |                                                     |       |                                                    |       |   |   |   |   |
| Commissions and salaries               |   | $                                                        | 3,302,292  |                                                    | 176.5      | % | $ | 6,728,554 |   | 118.5 | % |
| Underwriting expenses                  |   | 142,421                                                  |       | N/A                                                     |       | 253,719 |   | N/A |   |
| Rent, telephone and quotation services |   | 64,584                                                   |       | 27.3                                                    | %          | 152,196 |   | 21.7 | % |
| Other                                  |   | 427,031                                                  |       | 88.6                                                    | %          | 389,769 |   | 21.6 | % |
|                                   |   |                                                     |       |                                                    |       |   |   |   |   |
| Total                                  |   | $                                                        | 3,936,328  |                                                    | 152.0      | % | $ | 7,524,238 |   | 91.9 | % |
|                                   |   |                                                     |       |                                                    |       |   |   |   |   |
| Earnings before income taxes           |   | $                                                        | 5,081,921  |                                                    | N/A        |   | $ | 17,010,148 |   | N/A |   |

 

**Three Months Ended September 30, 2003 vs. Three MonthsEnded September 30, 2002**

 

Revenuesfor the third quarter of 2003 increased $9,018,249, to revenues of  $10,165,497, from revenues of $1,147,248 forthe third quarter of 2002. As shown in the table above, commissions increased$2,975,373, or 180.3 percent, from $1,649,922 in the third quarter of 2002 to$4,625,295 in the comparable 2003 period. This increase resulted from a highervolume of transactions in the 2003 quarter compared to the same period in 2002.Corporate finance revenues rose $2,481,105 in the third quarter of 2003, to$2,513,121, from $32,016 for the third quarter of 2002.  One corporate finance transaction wascompleted in the third quarter of 2003, compared with no corporate financetransactions in the third quarter of 2002. Investment income increased from a loss of $286,417 in the third quarterof 2002 to a profit of $2,467,777 in the third quarter of 2003.  Investment income in the 2003 periodconsisted of unrealized gains in the value of investment securities unrelatedto underwriter warrants and an increase in the estimated fair value ofunderwriter warrants. During the third quarter of 2003, underwriter warrantswere exercised and sold which resulted in a realized gain of $1,758,237. Nounderwriter warrants were exercised in the third quarter of 2002. Tradingincome increased by $803,080, to a profit of $541,819 in the third quarter of2003, from a trading loss of $261,261 in the comparable 2002 period.  The improvement in trading income wasprimarily due to higher prices of securities held and profits realized onsecurities sold.  Other income, includinginterest and dividends, increased $4,497, to $17,485 in the third quarter of2003 from $12,988 in the 2002 quarter.

 

Improvingmarket conditions and greater optimism regarding general business conditionshave resulted in increased equity securities prices across many sectors. TheNasdaq composite showed an increase of 9.3 percent in the third quarter of 2003compared to a decrease of 19.9 percent for the third quarter of 2002.

 

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Totalexpenses increased $3,936,328 in the third quarter of 2003 from the comparable2002 period, an increase of 152.0 percent, from $2,590,296 to $6,526,624.Commissions and salaries increased $3,302,292, or 176.5 percent, from$1,871,466 in the 2002 period to $5,173,758 in 2003. This increase wasprimarily due to higher commissions paid on increased commission revenues.  There were underwriting expenses of $142,241during the third quarter of 2003 as one corporate finance transaction was completed.  In the third quarter of 2002 there were nocorporate finance transactions completed and no underwriting expenses.  Rent, telephone and quote expenses increasedto $301,378 in the third quarter of 2003 compared to $236,794 in the samequarter of 2002, an increase of 27.3 percent, primarily due to increasedbusiness activity and increased rental space in our Manhattan office.  The aggregate of all other expensesincreased 88.6 percent, from $482,036 in the third quarter of 2002 to $909,067in the third quarter of 2003, primarily due to increased advertising andpromotion and profit sharing expense.

 

TheCompany had a pretax profit of $3,638,873 in the third quarter of 2003 comparedto a pretax loss of $1,443,048 in the comparable 2002 period.  The pretax profit was due to increases inall revenue categories.  Exclusive ofinvestment income (loss), the Company would have had a pretax profit of$1,171,096 for the third quarter of 2003 compared to a pretax loss of$1,156,631 in third quarter of 2002. Significant fluctuations can occur inPIC’s revenues and operating results from one period to another, particularlywhen market conditions improve or decline substantially.

 

TheCompany had an estimated tax expense of $1,450,000 for the third quarter of2003, compared to estimated tax benefits in the third quarter of 2002 of$400,000.

 

**Nine Months Ended September 30,2003 vs. Nine Months Ended September 30, 2002**

 

Total revenues for the first nine months of 2003increased $24,534,386, to  $20,270,404,from negative revenues of $4,263,982 for the first nine months of 2002.  As shown in the table above, salescommissions increased $6,376,658, or 128.2 percent, to $11,352,034 for thefirst nine months of 2003 from $4,975,376 for the first nine months of 2002.  This increase resulted from higher transactionvolume and increased price levels, particularly in the very smallcapitalization sector, which is the primary focus of the Company’s business,during the first nine months of 2003 compared to the same period in 2002.  As noted above, improving market andbusiness conditions during the first three quarters of 2003 contributed to ourimproved results.  The Nasdaq compositeincreased 33.8 percent from January 1, 2003 through September 30,  2003, compared to a decrease of 39.9 percentduring the first nine months of 2002. Corporate finance revenues increased $4,758,241, or 4,043.7 percent, forthe first three quarters of 2003, to $4,875,912, from $117,671 for the firstthree quarters of 2002. Two corporate finance transactions with gross proceedstotaling $32.0 million were completed during the first nine months of  2003, as compared to no corporate financetransactions completed during the same period in 2002.  Corporate finance revenues are directlyrelated to the amount of money raised in completed transactions.  Investment income increased by $11,737,304,to a profit of $3,016,495 for the first nine months of 2003 compared to a lossof $8,720,809 for the first nine months of 2002. During the first nine monthsof 2003, the market value of investment securities and the fair value ofunderwriter warrants increased significantly compared to the same period in2002 when both investment securities and the fair value of underwriter warrantsshowed decreases.  Underwriter warrantswere exercised in the first three quarters of 2003 resulting in a realized gainof $1,758,237. No underwriter warrants were exercised in 2002. Trading incomeincreased $1,665,897 to a profit of $976,282 for the first nine months of 2003compared to a loss of $689,615 during the first nine months of 2002. Thisincrease was the result of higher trading volume and higher price levels formany securities during the 2003 period. Other income, including interest and dividends, for the first ninemonths of 2003 decreased to $49,681 compared to $53,395 for the first ninemonths of 2002, primarily due to decreases in dividend and interest income.

 

Total expenses for the first nine months of 2003increased $7,524,238, or 91.9 percent, to $15,712,941 from $8,188,703 for thefirst nine months of 2002.  Commissionand salary expenses increased 118.5 percent, or $6,728,554, from $5,678,656 forthe first three quarters of 2002 to $12,407,210 for the first three quarters of2003.  This increase was primarily dueto larger commissions paid on higher commission revenues during the 2003period.  Underwriting expenses totaled$253,719 for the first three quarters of 2003 as a result of the closingof  two corporate finance transactionsas compared to no underwriting expenses in the first three quarters of 2002 duringwhich no corporate finance transactions were completed.  Rent, telephone and quote expenses were up$152,196, or 21.7 percent, for the first nine months of 2003 to $853,685 from$701,489 for the first nine months of 2002. This increase was due to the expansion of the office in Manhattan.  The aggregate of all other expensesincreased $389,769, or 21.6 percent, for the first nine months of 2003, to$2,198,327 from $1,808,558 for the first nine months of 2002.  The increase for the first nine months of2003 is due primarily to an increase in estimated bad debt expense and profitsharing expense.

 

The Company had pretax earnings of $4,557,463 forthe first nine months of 2003 compared to a pretax loss of $12,452,685 for thefirst nine months of 2002, primarily due to significant increases in commissionrevenues, corporate finance revenues, estimated value of underwriter warrants,and investment and trading income during the first nine months of 2003.  Independent of investment income (loss), theCompany would have had pretax earnings of $1,540,968 for the nine months of2003 compared to a pretax loss of $3,731,876 for the first nine months of2002.  Significant fluctuations canoccur in PIC’s revenues and operating results from one period to another.

 

The Company also accrued $1,800,000 in income taxesfor the first nine months of 2003, compared to an estimated tax benefit of$4,800,000 for the first nine months of 2002.

 

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**Liquidity and Capital Resources**

 

The majority of PIC’s assets are cash and assetsreadily convertible to cash.  PIC’ssecurities inventory is stated at market value.  The liquidity of the market for many of PIC’s securitiesholdings, however, varies with trends in the stock market.  Since many of the securities held by PIC arethinly traded, and PIC is in many cases a primary market maker in the issuesheld, any significant sales of PIC’s positions could adversely affect theliquidity of the issues held.  Ingeneral, falling prices in OTC securities (which make up most of PIC’s tradingpositions) lead to decreased liquidity in the market for these issues, whilerising prices in OTC issues tend to increase the liquidity of the market forthese securities.

 

PICborrows money from its clearing firm in the ordinary course of its business,pursuant to an understanding under which the clearing firm agrees to financePIC’s trading accounts.  As ofSeptember 30, 2003, no net loans were outstanding pursuant to thisarrangement.  PIC and the Company aregenerally able to meet their compensation and other obligations out of currentliquid assets.

 

Anothersource of capital to PIC and the Company has been the underwriter warrantsissued to PIC in connection with its corporate finance activities and the saleof the underlying securities. The underwriter warrants are not exercisable forthe first year after the offerings in which they are earned and are thereaftergenerally exercisable for four years, after which they expire.  The exercise price is typically 120% of theprice at which we initially sold the securities to the public.  Accordingly, unless there is at least a 20%increase in the price of these securities at some time more than one and lessthan five years after the offering, the warrants will remain “under water” andwill ultimately expire unexercised. There is no public market for the underwriter warrants. The securitiesreceivable upon exercise of the underwriter warrants cannot be resold unlessthe issuer has registered these securities with the SEC and with the states inwhich the securities will be sold unless exemptions are available.  Any delay or other problem in theregistration of these securities would have an adverse impact upon PIC’sability to obtain funds from the exercise of the underwriter warrants and theresale of the underlying securities.  AtSeptember 30, 2003, PIC owned 21 underwriter warrants (from 16 issuers),all but three of which were currently exercisable; two had an exercise pricebelow the current market price of the securities receivable upon exercise.  The intrinsic value of these two warrants is$386,784. There is little or no direct relationship between the intrinsic valueof PIC’s underwriter warrants at the end of any given period and the fair valuecalculated using the Black-Scholes pricing model, as described more fully inCritical Accounting Policies above. The prices of these securities areinfluenced by general movements in the prices of OTC securities as well as thesuccess of the issuers of the underwriter warrants.  The prices of the securities underlying the underwriter warrantsare very volatile, and substantial fluctuations in the Company’s estimate oftheir value can be expected in the future.

 

Inthe nine months ended September 30, 2003, $171,643 of net cash wasprovided by operating activities of the Company.  The major adjustments to reconcile this result to the Company’snet earnings of $2,757,463 include the receipt of underwriter warrants, anincrease in deferred income taxes, a decrease in receivables, and an increasein income taxes payable/receivable. In the most recent period, $62,114 of netcash was used by the Company’s investing activities, consisting of purchases offurniture and equipment.  The Companyused cash of $65,900 in financing activities during the nine months endedSeptember 30, 2003, for payments to retire common stock.

 

Asa securities broker-dealer, PIC is required by SEC regulations to meet certainliquidity and capital standards.  Webelieve we are in compliance with these standards.

 

AtSeptember 30, 2003, the Company had no material commitments for capitalexpenditures.

 

Ingeneral, the primary ongoing sources of PIC’s, and therefore the Company’s,liquidity, including PIC’s trading positions, borrowings on those positions andprofits recognized from underwriter warrants, all depend in large part on thetrend in the general markets for OTC securities.  Rising OTC price levels will tend to increase the value andliquidity of PIC’s trading positions, the amount that can be borrowed from itsclearing firm based upon those positions, and the value of PIC’s underwriterwarrants.  The Company believes itsliquidity is sufficient to meet its needs for the foreseeable future.

 

**Inflation**

 

BecausePIC’s assets are primarily liquid, they are not significantly affected byinflation.  The rate of inflationaffects PIC’s expenses, such as employee compensation, office leasing andcommunications costs.  These costs maynot readily be recoverable in the price of services offered by the Company.  To the extent inflation results in risinginterest rates and has other adverse effects in the securities markets and thevalue of securities held in inventory or PIC’s investment account, it mayadversely affect the Company’s financial position and results of operations.

 

ITEM3.  CONTROLS AND PROCEDURES

 

(a)                                  Under the supervision and with theparticipation of our management, our President and Chief Financial Officerconducted an evaluation of our disclosure controls and procedures, as such termis defined under Rules 13a-14(c) and 15d-14(c) promulgated under the SecuritiesExchange Act of 1934, as amended, within 90 days of the filing date of thisreport.  Based on their evaluation, ourPresident and Chief Financial Officer concluded that our disclosure controlsand procedures are effective.

 

(b)                                 There have been no significant changes(including corrective actions with regard to significant deficiencies ormaterial weaknesses) in our internal controls or in other factors that couldsignificantly affect these controls subsequent to the date of the evaluationreferenced in paragraph (a) above.

 

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**PART IIOTHER INFORMATION**

 

Item1. Legal Proceedings.

 

SeeNote 3 to Condensed Consolidated Financial Statements in Part 1.

 

Item2. Changes in Securities.

 

None

 

Item3. Defaults upon Senior Securities.

 

None

 

Item4. Submission of Matters to a Vote of Security Holders.

 

None

 

Item5. Other Information.

 

None

 

Item6. Exhibits and Reports on Form 8-K

 

(a)Exhibits

 
| 31.1   |   | Certification  of Principal Executive Officer Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                      |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                               |
| 31.2   |   | Certification  of Principal Financial Officer Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                      |
|   |   |                                                                                                                               |
| 32.2   |   | Certification  Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 |

 

(b)No Reports on Form 8-K were filed during the quarter ended September 30,2003.

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 
|                         | PAULSON  CAPITAL CORP. |
|------------------------------|------------------------|
|                         |                   |
|                         |                   |
| Date:  November 7, 2003 | By:                    | /s/  CHESTER L.F. PAULSON |   |
|                         |                   | Chester  L.F. Paulson |
|                         |                   | President  Principal Executive Officer |
|                         |                   |   |
| Date:  November 7, 2003 | By:                    | /s/  CAROL RICE |   |
|                         |                   | Carol  Rice |
|                         |                   | Chief  Financial Officer  Principal Financial Officer |

 

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**EXHIBIT INDEX**

 
| 31.1   |   | Certification  of Principal Executive Officer Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                      |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                               |
| 31.2   |   | Certification  of Principal Financial Officer Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                      |
|   |   |                                                                                                                               |
| 32.2   |   | Certification  Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 |

 

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