**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON,D.C.  20549**

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**FORM 10-Q**

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**(Mark One)**

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

**For thequarterly period ended June 30, 2007**

**OR**

**o**** TRANSITION REPORT PURSUANT TO SECTION 13 OR15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**For thetransition period from        to      **

**Commissionfile number: 0-18188**

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**PAULSON CAPITAL CORP.**

(Exact name ofregistrant 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’stelephone number, including area code:**503-243-6000**

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Indicate by checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes  x   No o

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated fileror a non-accelerated filer. See definition of “accelerated filer” and “largeaccelerated filer” in Rule 12b-2 of the Exchange Act. Large accelerated filer o   Accelerated filer o   Non-accelerated filer x

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

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock,as of the latest practicable date.
| **Common stock, no par value** | ** ** | **6,089,446**                     |
|--------------------------------|------------|-----------------------------------|
| (Class)                        |       | (Outstanding at  August 10, 2007) |

 

 

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**PAULSON CAPITAL CORP. ANDSUBSIDIARY**

**FORM 10-Q**

**INDEX**
| PART I - FINANCIAL  INFORMATION |   |                                                                                                    |
|---------------------------------|--------|---------------------------------------------------------------------------------------------------------|
|                            |   |                                                                                                    |   |   |
| Item 1.                         |   | Financial Statements                                                                                    |   |   |
|                            |   |                                                                                                    |   |   |
|                            |   | Consolidated Balance  Sheets - June 30, 2007 and December 31, 2006 (unaudited)                          |   |   |
|                            |   |                                                                                                    |   |   |
|                            |   | Consolidated  Statements of Operations - Three and Six Months Ended June 30, 2007 and 2006  (unaudited) |   |   |
|                            |   |                                                                                                    |   |   |
|                            |   | Consolidated  Statements of Cash Flows - Six Months Ended June 30, 2007 and 2006  (unaudited)           |   |   |
|                            |   |                                                                                                    |   |   |
|                            |   | Notes to  Consolidated Financial Statements (unaudited)                                                 |   |   |
|                            |   |                                                                                                    |   |   |
| Item 2.                         |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations             |   |   |
|                            |   |                                                                                                    |   |   |
| Item 3.                         |   | Quantitative  and Qualitative Disclosures About Market Risk                                             |   |   |
|                            |   |                                                                                                    |   |   |
| Item 4.                         |   | Controls and  Procedures                                                                                |   |   |
|                            |   |                                                                                                    |   |   |
| PART II - OTHER  INFORMATION    |   |                                                                                                    |
|                            |   |                                                                                                    |   |   |
| Item 1.                         |   | Legal Proceedings                                                                                       |   |   |
|                            |   |                                                                                                    |   |   |
| Item  1A.                       |   | Risk  Factors                                                                                           |   |   |
|                            |   |                                                                                                    |   |   |
| Item 2.                         |   | Unregistered  Sales of Equity Securities and Use of Proceeds                                            |   |   |
|                            |   |                                                                                                    |   |   |
| Item 4.                         |   | Submission of  Matters to a Vote of Security Holders                                                    |   |   |
|                            |   |                                                                                                    |   |   |
| Item  6.                        |   | Exhibits                                                                                                |   |   |
|                            |   |                                                                                                    |   |   |
| Signatures                      |   |                                                                                                    |

 

1

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**PART I - FINANCIAL INFORMATION**

Item 1. FinancialStatements

**Paulson Capital Corp. andSubsidiary**

**Consolidated Balance Sheets**
| ** **                                                                                                         | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                         | ** ** | **2007**          | ** ** | **2006**              | ** ** |
| ** **                                                                                                         | ** ** | **(Unaudited)**   | ** ** | ** **            | ** ** |
| **Assets**                                                                                                         | ** ** | ** **        | ** ** | ** **            | ** ** |
| Cash and cash  equivalents                                                                                         |       | $                 | 120,730    |                  | $          | 219,341 |   |
| Receivable from  clearing organization                                                                             |       | 14,311,661        |       | 7,748,968             |       |
| Notes and other  receivables                                                                                       |       | 1,622,367         |       | 1,651,002             |       |
| Income taxes  receivable                                                                                           |       | —            |       | 304,695               |       |
| Trading  securities, at market value                                                                               |       | 8,769,088         |       | 2,363,824             |       |
| Investment  securities, at market or estimated fair value                                                          |       | 12,774,205        |       | 19,542,643            |       |
| Underwriter  warrants, at estimated fair value                                                                     |       | 12,645,000        |       | 5,650,000             |       |
| Prepaid and  deferred expenses                                                                                     |       | 269,865           |       | 711,827               |       |
| Furniture and  equipment, at cost, net of accumulated depreciation and amortization of  $804,086 and $747,759      |       | 248,813           |       | 271,766               |       |
| Total Assets                                                                                                       |       | $                 | 50,761,729 |                  | $          | 38,464,066 |   |
|                                                                                                               |       |              |       |                  |       |
| **Liabilities and Shareholders’  Equity**                                                                     | ** ** | ** **        | ** ** | ** **            | ** ** |
| Accounts payable  and accrued liabilities                                                                          |       | $                 | 653,105    |                  | $          | 570,823 |   |
| Payable to  clearing organization                                                                                  |       | 4,096,771         |       | —                |       |
| Compensation,  employee benefits and payroll taxes                                                                 |       | 1,173,064         |       | 954,981               |       |
| Securities sold,  not yet purchased, at market value                                                               |       | 2,686,879         |       | 17,244                |       |
| Income taxes  payable - current                                                                                    |       | 279,298           |       | —                |       |
| Income taxes  payable - long-term                                                                                  |       | 190,000           |       | —                |       |
| Deferred revenue                                                                                                   |       | 425,000           |       | 475,000               |       |
| Deferred income  taxes                                                                                             |       | 3,307,773         |       | 1,670,000             |       |
| Total  Liabilities                                                                                                 |       | 12,811,890        |       | 3,688,048             |       |
|                                                                                                               |       |              |       |                  |       |
| **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: 6,089,446  and 6,179,011 |       | 1,972,747         |       | 1,920,293             |       |
| Retained  earnings                                                                                                 |       | 35,977,092        |       | 32,855,725            |       |
| Total  Shareholders’ Equity                                                                                   |       | 37,949,839        |       | 34,776,018            |       |
|                                                                                                               |       |              |       |                  |       |
| Total Liabilities and  Shareholders’ Equity                                                                   |       | $                 | 50,761,729 |                  | $          | 38,464,066 |   |

 

See accompanyingNotes to Consolidated Financial Statements.

2

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**Paulson Capital Corp. andSubsidiary**

**ConsolidatedStatements of Operations**

**(Unaudited)**
| ** **                              | ** ** | **For the Three Months Ended June 30,** | ** ** | **For the Six Months Ended June 30,** | ** ** |
|-----------------------------------------|------------|-----------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                              | ** ** | **2007**                                                              | ** ** | **2006**                                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                    |       |                                                                  |       |                                                                |       |   |   |   |   |
|                                    |       |                                                                  |       |                                                                |       |   |   |   |   |
| **Revenues**                            | ** ** | ** **                                                            | ** ** | ** **                                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Commissions                             |       | $                                                                     | 4,603,971  |                                                                | $          | 4,076,360 |   | $ | 8,720,539 |   | $ | 8,179,394 |   |
| Corporate finance                       |       | 3,450,296                                                             |       | 3,178,920                                                           |       | 4,445,807 |   | 3,232,188 |   |
| Investment income (loss)                |       | (628,508                                                              | )          | 75,735                                                              |       | 2,555,836 |   | (5,089,031 | ) |
| Trading income (loss)                   |       | 370,687                                                               |       | (254,547                                                            | )          | 1,710,763 |   | (218,710 | ) |
| Interest and dividends                  |       | 36,826                                                                |       | 12,996                                                              |       | 70,999 |   | 26,164 |   |
| Other                                   |       | 146,700                                                               |       | 440                                                                 |       | 172,075 |   | 1,614 |   |
|                                    |       | 7,979,972                                                             |       | 7,089,904                                                           |       | 17,676,019 |   | 6,131,619 |   |
|                                    |       |                                                                  |       |                                                                |       |   |   |   |   |
|                                    |       |                                                                  |       |                                                                |       |   |   |   |   |
| **Expenses**                            | ** ** | ** **                                                            | ** ** | ** **                                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Commissions and salaries                |       | 4,818,382                                                             |       | 4,727,534                                                           |       | 8,783,091 |   | 8,444,543 |   |
| Underwriting expenses                   |       | 149,509                                                               |       | 132,446                                                             |       | 309,464 |   | 167,446 |   |
| Rent, telephone and quotation services  |       | 303,945                                                               |       | 289,758                                                             |       | 617,180 |   | 586,266 |   |
| Professional fees                       |       | 141,228                                                               |       | 226,090                                                             |       | 345,173 |   | 450,377 |   |
| Bad debt expense                        |       | 107,160                                                               |       | 101                                                                 |       | 154,849 |   | 1,618 |   |
| Travel and entertainment                |       | 41,804                                                                |       | 211,307                                                             |       | 77,184 |   | 253,339 |   |
| Advertising and promotion expense       |       | 36,720                                                                |       | 49,669                                                              |       | 84,726 |   | 85,703 |   |
| Settlement expense                      |       | 230,000                                                               |       | 4,750                                                               |       | 309,717 |   | 4,750 |   |
| Depreciation and amortization           |       | 27,363                                                                |       | 22,604                                                              |       | 56,327 |   | 44,477 |   |
| Other                                   |       | 461,811                                                               |       | 361,963                                                             |       | 775,859 |   | 699,415 |   |
|                                    |       | 6,317,922                                                             |       | 6,026,222                                                           |       | 11,513,570 |   | 10,737,934 |   |
|                                    |       |                                                                  |       |                                                                |       |   |   |   |   |
| Income (loss)  before income taxes      |       | 1,662,050                                                             |       | 1,063,682                                                           |       | 6,162,449 |   | (4,606,315 | ) |
|                                    |       |                                                                  |       |                                                                |       |   |   |   |   |
| Income tax  expense (benefit):          |       |                                                                  |       |                                                                |       |   |   |   |   |
| Current                                 |       | 259,647                                                               |       | 14,749                                                              |       | 746,602 |   | 2,114,639 |   |
| Deferred                                |       | 401,526                                                               |       | 327,524                                                             |       | 1,637,773 |   | (3,915,625 | ) |
|                                    |       | 661,173                                                               |       | 342,273                                                             |       | 2,384,375 |   | (1,800,986 | ) |
|                                    |       |                                                                  |       |                                                                |       |   |   |   |   |
| Net income  (loss)                      |       | $                                                                     | 1,000,877  |                                                                | $          | 721,409 |   | $ | 3,778,074 |   | $ | (2,805,329 | ) |
|                                    |       |                                                                  |       |                                                                |       |   |   |   |   |
| Basic net income  (loss) per share      |       | $                                                                     | 0.16       |                                                                | $          | 0.12 |   | $ | 0.61 |   | $ | (0.45 | ) |
|                                    |       |                                                                  |       |                                                                |       |   |   |   |   |
| Diluted net  income (loss) per share    |       | $                                                                     | 0.16       |                                                                | $          | 0.12 |   | $ | 0.61 |   | $ | (0.45 | ) |
|                                    |       |                                                                  |       |                                                                |       |   |   |   |   |
| Shares used in  per share calculations: |       |                                                                  |       |                                                                |       |   |   |   |   |
| Basic                                   |       | 6,144,599                                                             |       | 6,183,719                                                           |       | 6,151,100 |   | 6,186,441 |   |
| Diluted                                 |       | 6,154,496                                                             |       | 6,231,599                                                           |       | 6,161,051 |   | 6,186,441 |   |

 

See accompanying Notes toConsolidated Financial Statements.

3

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**Paulson Capital Corp. andSubsidiary**

**ConsolidatedStatements of Cash Flows**

**(Unaudited)**
| ** **                                                                                      | ** ** | **For the Six Months Ended June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                                                                      | ** ** | **2007**                                                            | ** ** | **2006** | ** ** |
|                                                                                            |       |                                                                |       |   |   |
| **Cash  flows from operating activities:**                                                      | ** ** | ** **                                                          | ** ** | ** ** | ** ** |
| Net income (loss)                                                                               |       | $                                                                   | 3,778,074  |   | $ | (2,805,329 | ) |
| Adjustments to reconcile net income (loss) to net  cash flows provided by operating activities: |       |                                                                |       |   |   |
| Receipt of underwriter warrants                                                                 |       | (2,449,787                                                          | )          | (2,312,907 | ) |
| Unrealized (appreciation) depreciation/expiration of  underwriter warrants                      |       | (5,233,941                                                          | )          | 1,939,144 |   |
| Non-cash compensation associated with underwriter  warrants                                     |       | 688,728                                                             |       | 788,763 |   |
| Depreciation and amortization                                                                   |       | 56,327                                                              |       | 44,477 |   |
| Deferred income taxes                                                                           |       | 1,637,773                                                           |       | (3,915,625 | ) |
| Loss on asset disposition                                                                       |       | —                                                              |       | 1,486 |   |
| Recognition of deferred revenue                                                                 |       | (50,000                                                             | )          | — |   |
| Change in assets and liabilities                                                                |       |                                                                |       |   |   |
| Receivables from/payable to clearing organization                                               |       | (2,465,922                                                          | )          | 3,713,633 |   |
| Notes and other receivables                                                                     |       | 28,635                                                              |       | 412,991 |   |
| Income taxes receivable                                                                         |       | 304,695                                                             |       | — |   |
| Trading and investment securities                                                               |       | 363,174                                                             |       | 6,627,654 |   |
| Prepaid and deferred expenses                                                                   |       | 441,962                                                             |       | 281,935 |   |
| Accounts payable, accrued liabilities and  compensation payables                                |       | 300,365                                                             |       | (2,185,393 | ) |
| Securities sold, not yet purchased                                                              |       | 2,669,635                                                           |       | (22,122 | ) |
| Income taxes payable - current                                                                  |       | 279,298                                                             |       | (1,377,136 | ) |
| Income taxes payable - long-term                                                                |       | 100,000                                                             |       | — |   |
| Net cash provided by operating activities                                                       |       | 449,016                                                             |       | 1,191,571 |   |
|                                                                                            |       |                                                                |       |   |   |
| **Cash  flows from investing activities:**                                                      | ** ** | ** **                                                          | ** ** | ** ** | ** ** |
| Additions to furniture and equipment                                                            |       | (33,374                                                             | )          | (85,232 | ) |
|                                                                                            |       |                                                                |       |   |   |
| **Cash  flows from financing activities:**                                                      | ** ** | ** **                                                          | ** ** | ** ** | ** ** |
| Proceeds from stock option exercise                                                             |       | 77,110                                                              |       | 21,030 |   |
| Dividends paid to common shareholders                                                           |       | —                                                              |       | (928,972 | ) |
| Payments to retire common stock                                                                 |       | (591,363                                                            | )          | (203,454 | ) |
| Net cash used in financing activities                                                           |       | (514,253                                                            | )          | (1,111,396 | ) |
|                                                                                            |       |                                                                |       |   |   |
| Decrease in cash  and cash equivalents                                                          |       | (98,611                                                             | )          | (5,057 | ) |
|                                                                                            |       |                                                                |       |   |   |
| **Cash  and cash equivalents:**                                                                 | ** ** | ** **                                                          | ** ** | ** ** | ** ** |
| Beginning of period                                                                             |       | 219,341                                                             |       | 129,549 |   |
|                                                                                            |       |                                                                |       |   |   |
| End of period                                                                                   |       | $                                                                   | 120,730    |   | $ | 124,492 |   |
|                                                                                            |       |                                                                |       |   |   |
| **Supplemental  cash flow information:**                                                        | ** ** | ** **                                                          | ** ** | ** ** | ** ** |
| Cash paid during the  period for income taxes                                                   |       | $                                                                   | 412,690    |   | $ | 3,491,775 |   |

 

**Supplementalnon-cash information:**

As of January 1, 2007, we adopted FASB InterpretationNo. 48, “Accounting for Uncertainty in Income Taxes.” As a result,we recordedan adjustment of $90,000 from retained earnings to income taxes payable -long-term.

See accompanying Notes toConsolidated Financial Statements.

4

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**PAULSON CAPITAL CORP. ANDSUBSIDIARY**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

**Note1.  Basis of Presentation**

The financialinformation for Paulson Capital Corp. and its wholly-owned subsidiary, PaulsonInvestment Company, included herein as of June 30, 2007 and December 31, 2006and for the three and six-month periods ended June 30, 2007 and 2006 isunaudited; however, such information reflects all adjustments, consisting onlyof normal recurring adjustments, which, in the opinion of management, arenecessary for a fair presentation of the financial position, results ofoperations and cash flows for the interim periods. The financial information asof December 31, 2006 is derived from our Annual Report on Form 10-K for theyear ended December 31, 2006. The interim consolidated financial statementsshould be read in conjunction with the consolidated financial statements andthe notes thereto included in our Annual Report on Form 10-K for the year endedDecember 31, 2006. The results of operations for the interim periods presentedare not necessarily indicative of the results to be expected for the full year.

**Note2.  Commitments and Contingencies**

# In December 2005, wereceived notice of possible claims being asserted against us by two individualswho invested in Wood River Partners LP (“Wood River”). The investors purchasedtheir interests in Wood River directly from Wood River. One of the individualswas a customer of ours. Along with his brother, they have indicated that theypaid $1,050,000 for their interests in Wood River. The Securities and ExchangeCommission (“SEC”) sued Wood River in October 2005, and a receiver currentlyruns Wood River.  At this point, it isnot known how much the individuals might recover through the receivership. Theindividuals have indicated that they believe they may have claims against usunder the Oregon Securities Law for rescission, interest and attorney fees. Ina letter dated July 20, 2007, the attorney for the investors indicated that theinvestors are now prepared to file suit against us for their alleged losses of$1,050,000.  We believe we havemeritorious defenses and, if litigation is filed, we intend to defend thismatter vigorously.

On March 30, 2007, Dow Jones & Company (“Dow Jones”)sent us a demand for payment of $122,640, allegedly due as a termination feepursuant to a Newswires Subscription Agreement, dated February 1, 2005. DowJones claims that we did not timely terminate prior to the date the NewswiresSubscription Agreement purports to automatically renew. We rejected Dow Jones’demand. We believe the automatic renewal provision is unenforceable and that,even if it is enforceable, Dow Jones’ increase of our 2007 subscription ratesprovided us with the right to terminate the Newswires Subscription Agreement.We believe we have meritorious defenses, and, if Dow Jones initiates legalaction, we are prepared immediately to file a motion for summary judgment.Thereafter, if necessary, we intend to defend the matter vigorously.

An adverse outcome in certain of thematters described above could have a material adverse effect on ourconsolidated financial position or results of operations. We also have beennamed in or threatened with certain other legal proceedings. We believe, basedupon information received to date and, where we believe it appropriate,discussions with legal counsel, that resolution of additional pending orthreatened litigation will not have a material adverse effect on ourconsolidated financial condition, results of operations, or business.

**Note3.  Stock-Based Compensation**

During the firstsix months of 2007, 22,000 options were exercised at a weighted averageexercise price of $3.51 per share.  AtJune 30, 2007, we had 95,000 options outstanding at a weighted average exerciseprice of $4.20 per share.

5

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**Note4.  Earnings Per Share**

Following is areconciliation of our shares used for our basic net income (loss) per share andour diluted net income (loss) per share:
| ** **                                                                                                            | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                                            | ** ** | **2007**                                            | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
| Shares used for  basic income (loss) per share                                                                        |       | 6,144,599                                           |       | 6,183,719                                         |       | 6,151,100 |   | 6,186,441 |   |
| Effect of  dilutive stock options                                                                                     |       | 9,897                                               |       | 47,880                                            |       | 9,951 |   | — |   |
| Shares used for  diluted net income (loss) per share                                                                  |       | 6,154,496                                           |       | 6,231,599                                         |       | 6,161,051 |   | 6,186,441 |   |
|                                                                                                                  |       |                                                |       |                                              |       |   |   |   |   |
| Stock options not  included in diluted net income (loss) per share because their effect would  have been antidilutive |       | —                                              |       | —                                            |       | — |   | 187,000 |   |

 

**Note 5.Repurchases of Common Stock**

In the firstsix months of 2007, we repurchased a total of 111,565 shares of our commonstock for a weighted average price of $5.30 per share, which totaledapproximately $591,000. The amount paid above the original issue price, whichtotaled $567,000, was offset against retained earnings. The plan to repurchase up to a total of600,000 shares of our common stock was approved by our Board of Directors inSeptember 2001 and does not have an expiration date. As of June 30, 2007,204,172 shares remained available for purchase.

**Note 6.Adoption of Interpretation No. 48**

In July 2006,the FASB issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertaintyin Income Taxes,” which defines the threshold for recognizing the benefits oftax return positions in the financial statements as “more-likely-than-not” tobe sustained by the taxing authority. FIN 48 applies to all tax positionsaccounted for under SFAS No. 109, “Accounting for Income Taxes.” FIN 48 iseffective as of the beginning of the first fiscal year beginning after December15, 2006.

We adopted the provisions of FIN 48 onJanuary 1, 2007. In accordance with paragraph 19, we elected to treat interestand penalties accrued on unrecognized tax benefits as tax expense within ourfinancial statements. Upon adoption, weadjusted our financial statements to reflect those tax positions that aremore-likely-than-not to be sustained as of the adoption date. The adjustmenttotaled $90,000 and was recorded directly as a reduction to our retainedearnings balance on January 1, 2007.

On initial adoption of FIN 48, we hadunrecognized tax benefits of $174,000, all of which would have an impact on theeffective tax rate if recognized. Interest and penalties accrued onunrecognized tax benefits were $16,000. We do not believe it is reasonablypossible that the total amount of unrecognized benefits will significantlyincrease or decrease within the next 12 months.

During the three and six-month periodsended June 30, 2007, unrecognized tax benefits increased $4,000 and $8,000,respectively, as a result of tax positions taken in prior periods and $17,000and $22,000, respectively, as a result of tax positions taken during thecurrent periods.

The tax years which remain open toexamination in the U.S., our only major taxing jurisdiction, were 2003 through2006. An IRS examination for the 2004 and 2005 tax years was completed duringthe second quarter of 2007. There were no decreases in prior unrecognized taxbenefits resulting from settlements with taxing authorities or the lapse ofapplicable statutes of limitation.

6

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**Note 7.Settlement of Legal Claims**

On May 1, 2007, wepaid $210,000 in connection with a previously settled legal claim. Of thisamount, $190,000 was accrued as a component of accounts payable and accruedliabilities on our balance sheet as of December 31, 2006, and the full amountwas accrued as of March 31, 2007. We received $120,000 in insurance recovery onthis claim, which was recorded as other income in the second quarter of 2007.We received an additional $22,000 insurance recovery in the third quarter of2007.

On June 27, 2007,we paid $60,000 in connection with a legal claim. Of this amount, $50,000 wasaccrued as a component of accounts payable and accrued liabilities on ourbalance sheet as of March 31, 2007. In the third quarter of 2007, we received$17,000 in insurance recovery and expect to receive an additional $34,000.

See also Note 9, Subsequent Event.

**Note 8.Reclassifications**

Certain amountsin the prior period financial statements have been reclassified to conform tothe current period presentation.

**Note 9.Subsequent Event**

We settled an outstanding legal claim onJuly 16, 2007. We expect to pay $220,000 in connection with this settlement inthe third quarter of 2007. The full amount was accrued as a component ofaccounts payable and accrued liabilities on our balance sheet as of June 30,2007. We do not expect insurance recovery on this claim.

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

**ForwardLooking Statements and Risk Factors**

This report, including,without limitation, Item 2. “Management’s Discussion and Analysis of FinancialCondition and Results of Operations,” containsor incorporates both historical and “forward-looking” statements within themeaning of Section 27A of the Securities Act of 1933, as amended, andSection 21E of the Securities Exchange Act of 1934, as amended. Words suchas “anticipates,” “believes,” “expects,” “intends,” “future” and similarexpressions identify forward-looking statements. Any such forward-lookingstatements in this report reflect our current views with respect to futureevents and financial performance and are subject to a variety of factors thatcould cause our actual results to differ materially from historical results orfrom anticipated results expressed or implied by such forward-lookingstatements. 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 are subject to extreme volatility often as a resultof factors beyond our ability to anticipate or control. In particular, factors,such as the condition of the securities markets, which are in turn based onpopular perceptions of the health of the economy generally, can be expected toaffect the volume of our business as well as the value of the securitiesmaintained in our trading and investment accounts. Other factors thatmay affect our future financial condition or results of operations include thefollowing:

·                  Aspects of our business arevolatile and affected by factors beyond our control.

·                  Our ability to attract andretain customers may be affected by our reputation.

·                  We are subject to extensiveregulation that could result in investigations, fines or other penalties.

·                  We face intense competitionin our industry.

·                  Our future success dependson retaining existing management and hiring and assimilating new key employees,and our inability to attract or retain key personnel would materially harm ourbusiness and results of operations.

·                  We are subject to an increased risk of legalproceedings, which may result in significant losses to us that we cannotrecover. Claimants in these proceedings may be customers, employees, or 

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regulatoryagencies, among others, seeking damages for mistakes, errors, negligence oracts of fraud by our employees.

·                  As a public company, we aresubject to complex legal and accounting requirements that require us to incursubstantial expense and expose us to risk of non-compliance.

·                  Our directorscontrol approximately 60 percent of our common stock and may have interestsdiffering from those of other stockholders.

**Overview**

Substantially all of ourbusiness consists of the securities brokerage and corporate finance activitiesof our wholly-owned subsidiary, Paulson Investment Company, Inc., whichhas operations in four principal categories, all of them in the financialservices industry. These categories are:

·                  securitiesbrokerage activities for which we earn commission revenues;

·                  corporatefinance revenues consisting principally of underwriting discounts andunderwriter warrants;

·                  securitiestrading from which we record profit or loss, depending on trading results; and

·                  investment income resulting fromearnings on, and increases or decreases in the value of, our investmentportfolio.

Because we operatein the financial services industry, our revenues and earnings are substantiallyaffected by general conditions in financial markets. In our securitiesbrokerage business, the amount of our revenues depends on levels of marketactivity requiring the services we provide. Our corporate finance activity,which consists of acting as the managing underwriter of initial and follow-onpublic offerings, private investments in public equity (“PIPEs”) and privateplacements for smaller companies, is similarly affected by the strength of 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.

Our investmentincome or loss and, to a lesser extent, our trading income or loss is affectedby changes in market valuation of securities generally and, in particular, bychanges in valuation of the equity securities of microcap companies in whichour investments and trading activities tend to be concentrated. Equity marketsin general, and microcap equity markets in particular, have always experiencedsignificant volatility and this volatility has, in recent years, been extreme.The result of this volatility on the value of our investment portfolio and securitiesheld in connection with our trading and investment activities include largequarterly fluctuations in income or loss from these operations and substantialincreases or decreases in our net worth as our securities holdings are markedto market.

A substantialportion of our corporate finance business consists of acting as managingunderwriter of initial and follow-on public offerings for microcap and smallcapcompanies. As a part of our compensation for these activities, wetypically receive warrants exercisable to purchase securities similar to thosethat we offer and sell to the public. The warrants generally have a five-yearexpiration date and vest immediately. The warrants are generally subject to arestricted 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 wereinitially 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 andless than five years after the offering, the warrants will remain “under water”and will ultimately expire unexercised. We also receive warrants in connectionwith PIPEs, which have varying terms and conditions.

**CriticalAccounting Policies and Use of Estimates**

With the exceptionof the adoption of Interpretation No. 48 as described in Note 6 of Notes toConsolidated Financial Statements, we reaffirm the critical accounting policiesand estimates as reported 

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in our AnnualReport on Form 10-K for the year ended December 31, 2006, which was filed withthe Securities and Exchange Commission on April 2, 2007.

**Resultsof Operations**

Our revenues andoperating results are influenced by fluctuations in the equity markets as wellas general economic and market conditions, particularly conditions in theover-the-counter market, where our investment and trading positions and theunderlying stock for the underwriter warrants are heavily concentrated.Significant fluctuations can occur in our revenues and operating results fromone period to another. Our results of operations depend upon many factors, suchas the number of companies that are seeking financing, the quality andfinancial condition of those companies, market conditions in general, theperformance of our previous underwritings and interest in certain industries byinvestors. As a result, revenues and income derived from these activities mayvary significantly from year to year. Our revenues include the following:

·                  Commissions,which represent amounts earned from our retail securities brokerage activities;

·                  Corporatefinance revenues, which are a function of total proceeds from offerings doneduring the period, compensation per offering and the fair value of underwriterwarrants received;

·                  Investment income(loss), which includes (i) the unrealized appreciation and depreciation ofsecurities held based on quoted market prices, (ii) the unrealizedappreciation and depreciation of securities held that are not readilymarketable, based upon our estimate of their fair value, (iii) realizedgains and losses on the sale of securities with quoted market prices andsecurities that are not readily marketable, and (iv) the unrealizedappreciation and depreciation of underwriter warrants held; and

·                  Trading income (loss),which is the gain or loss from trading positions before commissions paid to therepresentatives in the trading department.

The following tables set forth the changes in our operating results inthe three and six-month periods ended June 30, 2007 compared to the three andsix-month periods ended June 30, 2006 (dollars in thousands):
| ** **                             | ** ** | **Three Months Ended  June 30,** | ** ** | **Increase** | ** ** | **%  Increase** | ** ** |
|----------------------------------------|------------|-------------------------------------------------|------------|--------------|------------|-----------------|------------|
| ** **                             | ** ** | **2007**                                        | ** ** | **2006**     | ** ** | **(Decrease)**  | ** ** | **(Decrease)** | ** ** |
| Revenues:                              |       |                                            |       |         |       |            |       |   |   |
| Commissions                            |       | $                                               | 4,604      |         | $          | 4,076           |       | $ | 528 |   | 13.0 | % |
| Corporate finance                      |       | 3,450                                           |       | 3,179        |       | 271             |       | 8.5 |   |
| Investment income (loss)               |       | (629                                            | )          | 76           |       | (705            | )          |   | * |
| Trading income (loss)                  |       | 371                                             |       | (255         | )          | 626             |       |   | * |
| Interest and dividends                 |       | 37                                              |       | 13           |       | 24              |       | 184.6 |   |
| Other                                  |       | 147                                             |       | 1            |       | 146             |       |   | * |
| Total revenues                         |       | 7,980                                           |       | 7,090        |       | 890             |       | 12.6 |   |
| Expenses:                              |       |                                            |       |         |       |            |       |   |   |
| Commissions and salaries               |       | 4,818                                           |       | 4,727        |       | 91              |       | 1.9 |   |
| Underwriting expenses                  |       | 150                                             |       | 132          |       | 18              |       | 13.6 |   |
| Rent, telephone and quotation services |       | 304                                             |       | 290          |       | 14              |       | 4.8 |   |
| Professional fees                      |       | 141                                             |       | 226          |       | (85             | )          | (37.6 | ) |
| Bad debt expense                       |       | 107                                             |       | —       |       | 107             |       |   | * |
| Travel and entertainment               |       | 42                                              |       | 211          |       | (169            | )          | (80.1 | ) |
| Advertising and promotion              |       | 37                                              |       | 50           |       | (13             | )          | (26.0 | ) |
| Settlement expense                     |       | 230                                             |       | 5            |       | 225             |       |   | * |
| Depreciation and amortization          |       | 27                                              |       | 23           |       | 4               |       | 17.4 |   |
| Other                                  |       | 462                                             |       | 362          |       | 100             |       | 27.6 |   |
| Total expenses                         |       | 6,318                                           |       | 6,026        |       | 292             |       | 4.8 |   |
| Income before income taxes             |       | $                                               | 1,662      |         | $          | 1,064           |       | $ | 598 |   | 56.2 | % |

 

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| ** **                             | ** ** | **Six Months Ended  June 30,** | ** ** | **Increase** | ** ** | **%  Increase** | ** ** |
|----------------------------------------|------------|-----------------------------------------------|------------|--------------|------------|-----------------|------------|
| ** **                             | ** ** | **2007**                                      | ** ** | **2006**     | ** ** | **(Decrease)**  | ** ** | **(Decrease)** | ** ** |
| Revenues:                              |       |                                          |       |         |       |            |       |   |   |
| Commissions                            |       | $                                             | 8,720      |         | $          | 8,179           |       | $ | 541 |   | 6.6 | % |
| Corporate finance                      |       | 4,446                                         |       | 3,232        |       | 1,214           |       | 37.6 |   |
| Investment income (loss)               |       | 2,556                                         |       | (5,089       | )          | 7,645           |       |   | * |
| Trading income (loss)                  |       | 1,711                                         |       | (218         | )          | 1,929           |       |   | * |
| Interest and dividends                 |       | 71                                            |       | 26           |       | 45              |       | 173.1 |   |
| Other                                  |       | 172                                           |       | 2            |       | 170             |       |   | * |
| Total revenues                         |       | 17,676                                        |       | 6,132        |       | 11,544          |       | 188.3 |   |
| Expenses:                              |       |                                          |       |         |       |            |       |   |   |
| Commissions and salaries               |       | 8,783                                         |       | 8,445        |       | 338             |       | 4.0 |   |
| Underwriting expenses                  |       | 310                                           |       | 168          |       | 142             |       | 84.5 |   |
| Rent, telephone and quotation services |       | 617                                           |       | 586          |       | 31              |       | 5.3 |   |
| Professional fees                      |       | 345                                           |       | 450          |       | (105            | )          | (23.3 | ) |
| Bad debt expense                       |       | 155                                           |       | 2            |       | 153             |       |   | * |
| Travel and entertainment               |       | 77                                            |       | 253          |       | (176            | )          | (69.6 | ) |
| Advertising and promotion              |       | 85                                            |       | 86           |       | (1              | )          | (1.2 | ) |
| Settlement expense                     |       | 310                                           |       | 5            |       | 305             |       |   | * |
| Depreciation and amortization          |       | 56                                            |       | 44           |       | 12              |       | 27.3 |   |
| Other                                  |       | 776                                           |       | 699          |       | 77              |       | 11.0 |   |
| Total expenses                         |       | 11,514                                        |       | 10,738       |       | 776             |       | 7.2 |   |
| Income (loss) before  income taxes     |       | $                                             | 6,162      |         | $          | (4,606          | )          | $ | 10,768 |   |   | * |

 

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*Not meaningful.

***Revenues***

Commissionsincreased 12.9% and 6.6%, respectively, in the three and six-month periodsended June 30, 2007 compared to the same periods of 2006. The total number oftrades, including mutual fund trades, executed by our brokers were 26,595 and51,995 in the three and six-month periods ended June 30, 2007, respectively,compared to 27,215 and 53,683, respectively, in the comparable periods of 2006.We had 84 brokers at June 30, 2007 compared to 96 brokers at June 30, 2006.

The decrease inthe number of brokers at June 30, 2007 compared to June 30, 2006, reflected ourstrategy of having fewer, but higher producing brokers. We expect to hireadditional experienced brokers over the next year.

Corporate finance income of $3.5 millionin the three-month period ended June 30, 2007 primarily representedunderwriting discounts earned from one initial public offering in which weraised $14.0 million for Vaughan Foods Incorporated, as well as theBlack-Scholes value of the underwriter warrants received inconnection with that offering. In addition, we also completed one privateoffering during the second quarter of 2007 in which we raised $2.8 million forour client.

Corporate finance income in the six-monthperiod ended June 30, 2007 also included underwriting discounts earned from oneinitial public offering in which we raised $9.8 million for Converted Organics Inc., as well asthe Black-Scholes value of the underwriter warrants received inconnection with that offering. Inaddition, it included income from one private transaction completed during thefirst quarter of 2007.

Corporate financeincome of $3.2 million in both the three and six-month periods ended June 30,2006 primarily represented underwriting discounts earned from one initialpublic offering in which we raised $19.5 million for American Mold Guard, Inc.,as well as the Black-Scholes value of the underwriter warrants received inconnection with that offering. In addition, we completed several privatetransactions, including two PIPEs.

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Investment income(loss) included the following (in thousands):
| ** **                                                                                                                                                                                 | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                                                                                                                 | ** ** | **2007**                                            | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net unrealized  gain (loss) related to underwriter warrants                                                                                                                                |       | $                                                   | 1,158      |                                              | $          | (314 | ) | $ | 5,234 |   | $ | (1,939 | ) |
| 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 market value |       | (2,184                                              | )          | 1                                                 |       | (3,320 | ) | (9,599 | ) |
| Net realized  gains on the sale of securities with quoted market prices and securities that  are not readily marketable                                                                    |       | 397                                                 |       | 389                                               |       | 642 |   | 6,449 |   |
|                                                                                                                                                                                       |       | $                                                   | (629       | )                                                 | $          | 76 |   | $ | 2,556 |   | $ | (5,089 | ) |

 

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

Trading incomeincreased $0.6 million and $1.9 million, respectively, in the three andsix-month periods ended June 30, 2007 compared to the same periods of 2006. Theincome in the three and six-month periods ended June 30, 2007 was due to highlyfavorable results for certain securities that we were holding in our tradinginventories. The 2006 results reflected lower volume and lower prices forseveral of the securities we held in our trading inventories. Our focus is onvery small capitalization issues, especially those tied to our corporatefinance clients. Trading income (loss) can be volatile from period to periodbecause it is driven by the market value of the securities in which we make amarket.

***Expenses***

Total expensesincreased $0.3 million and $0.8 million, respectively, in the three andsix-month periods ended June 30, 2007 compared to the same periods of 2006,primarily due to increases in commissions and salaries, underwriting expenses,bad debt expense and settlement expense.

Commissions andsalaries increased $0.1 million and $0.3 million, respectively, in the threeand six-month periods ended June 30, 2007 compared to the same periods of 2006,primarily due to higher commissions earned on higher commission and corporatefinance revenue. Retail commissions as a percentage of retail sales wascomparable between the current year and prior year periods.

Underwritingexpense increased $18,000 and $142,000, respectively, in the three andsix-month periods ended June 30, 2007 compared to the same periods of 2006,primarily due to the completion of two initial public offerings in the firstsix months of 2007 compared to one in the first six months of 2006.

Bad debt expenseis recorded for specific amounts when they are determined by management to beuncollectible. Bad debt expense in the second quarter of 2007 included a$104,000 write-off of a loan to a potential corporate finance client.

Settlement expense of $230,000 in thethree-month period ended June 30, 2007 primarily related to an accrual for$220,000 in connection with a legal claim that settled July 16, 2007. We do notexpect insurance recovery on this claim. In addition, the $310,000 in thesix-month period ended June 30, 2007 included a net $63,000 adjustment for openclaims.

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**Liquidityand Capital Resources**

Our primarysources of liquidity include our cash and cash equivalents and receivables fromour clearing organization, offset by payables to our clearing organization.

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

We believe ourliquidity is sufficient to meet our needs for both the short and long-termhorizon. Our liquidity could be negatively affected by protracted unfavorablemarket conditions.

As a securitiesbroker-dealer, we are required by SEC regulations to meet certain liquidity andcapital standards. We believe we were in compliance with these standards atJune 30, 2007.

Following thelapse of restrictions upon issuance, capital available from the sale of theunderlying securities of underwriter warrants exercised can fluctuatesignificantly from period to period as the value of the underlying securitiesfluctuates with overall market and individual company financial condition orperformance. There is no public market for the underwriter warrants. Thesecurities receivable upon exercise of the underwriter warrants cannot beresold unless the issuer has registered these securities with the SEC and withthe states in which the securities will be sold unless exemptions areavailable. Any delay or other problem in the registration of these securitieswould have an adverse impact upon our ability to obtain funds from the exerciseof the underwriter warrants and the resale of the underlying securities.

At June 30, 2007,we owned 17 underwriter warrants from 16 issuers, all but four of which wereexercisable. Five of the warrants had an exercise price below the June 30, 2007market price of the securities receivable upon exercise. The intrinsic value ofthese warrants was $1.7 million at June 30, 2007. There is little or no directrelationship between the intrinsic value of our underwriter warrants at the endof any given period and the fair value calculated using the Black-Scholesoption pricing model. The prices of the securities underlying the underwriterwarrants are very volatile, and substantial fluctuations in our estimate oftheir value can be expected in the future.

Cash provided byoperating activities in the first six months of 2007 totaled $449,000,primarily due to our net income of $3.8 million being offset by net non-cashincome items of $5.4 million and changes in our operating assets andliabilities as discussed in more detail below.

Our net receivablefrom our clearing organization increased $2.5 million to $10.2 million at June30, 2007 from $7.7 million at December 31, 2006, primarily due to the resultsof the activity in our trading and investment accounts, as well as the timingof general corporate expenditures.

Changes in ourtrading and investment securities are dependent on the purchase and sale ofsecurities during the period, as well as changes in their fair market valuesduring the period.

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Underwriterwarrants increased $6.9 million to $12.6 million at June 30, 2007 compared to$5.7 million at December 31, 2006.  Aroll-forward of the value of the warrants was as follows (in thousands):
| **Balance, December 31, 2006**                                 |   | $      | 5,650  |   |
|----------------------------------------------------------------|--------|--------|--------|--------|
| Fair value of  warrants received, net of employee compensation |   | 1,761  |   |
| Net unrealized  gain on value of warrants                      |   | 5,234  |   |
| Value of  warrants exercised and expired                       |   | — |   |
| **Balance, June 30, 2007**                                     |   | $      | 12,645 |   |

 

Compensation,employee benefits and payroll taxes payable increased $0.2 million to $1.2million at June 30, 2007 from $1.0 million at December 31, 2006, primarily dueto strong retail and corporate finance results in the last month of the secondquarter of 2007 compared to the last month of the fourth quarter of 2006.

Income taxesreceivable decreased $0.8 million to a payable of $0.5 million at June 30, 2007from a receivable of $0.3 million at December 31, 2006, primarily due toreceipt of refunds, adjustments made for the adoption of Interpretation No. 48during the first quarter of 2007 and taxable income in the first six months of2007. See also Note 6 of Notes to Consolidated Financial Statements.

Deferred revenueof $425,000 at June 30, 2007 related to amounts received from our clearing firmbased on the execution of a five-year agreement, and is being amortized at therate of $8,333 per month through September 2011.

Deferred incometaxes payable increased $1.6 million to $3.3 million at June 30, 2007 from $1.7million at December 31, 2006, primarily due to a $4.3 million net unrealizedgain on securities and underwriter warrants during the first six months of2007.

In September 2001,our Board of Directors approved a stock repurchase program pursuant to which weare authorized to repurchase up to 600,000 shares of our common stock. Duringthe first six months of 2007, we repurchased a total of 111,565 shares for$591,000 and, at June 30, 2007, 204,172 shares remained available forrepurchase. This repurchase program does not have an expiration date.

**Off-BalanceSheet Arrangements**

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

**NewAccounting Pronouncements**

There has been nochange in new accounting pronouncements since the filing of our Form 10-K forthe year ended December 31, 2006, which was filed with the Securities andExchange Commission on April 2, 2007.

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**Item 3.  Quantitative and Qualitative DisclosuresAbout Market Risk**

There have been no material changes inour reported market risks or risk management policies since the filing of ourForm 10-K for the year ended December 31, 2006, which was filed with theSecurities and Exchange Commission on April 2, 2007.

**Item 4.  Controls and Procedures**

***DisclosureControls and Procedures***

Our management hasevaluated, under the supervision and with the participation of our Presidentand our Chief Financial Officer, the effectiveness of our disclosure controlsand procedures as of the end of the period covered by this report as defined inRule 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 our ChiefFinancial Officer have concluded that, as of the end of the period covered bythis report, our disclosure controls and procedures are effective in ensuringthat 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 ourChief Financial Officer, as appropriate, to allow timely decisions regardingrequired disclosure.

***Changesin Internal Control Over Financial Reporting***

There has been nochange in our internal control over financial reporting that occurred duringour last fiscal quarter that has materially affected, or is reasonably likelyto materially affect, our internal control over financial reporting.

**PART II - OTHER INFORMATION**

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

See Note 2 ofNotes to Consolidated Financial Statements in Part I, Item 1.

**Item 1A.  Risk Factors**

Our Annual Report on Form10-K for the year ended December 31, 2006 includes a detailed discussion of ourrisk factors. There have been no material changes from the risk factorspreviously disclosed in our Annual Report on Form 10-K. Accordingly, theinformation in this Form 10-Q should be read in conjunction with the riskfactors and information disclosed in our Annual Report on Form 10-K for theyear ended December 31, 2006, which was filed with the Securities and ExchangeCommission on April 2, 2007. See also Part I, Item 2 “Management’s Discussion and Analysis of Financial Condition andResults of Operations” in this report under the heading “Forward Looking Statements and Risk Factors.”

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**Item 2.  Unregistered Sales of Equity Securitiesand Use of Proceeds**

We repurchased thefollowing shares of our common stock during the second quarter of 2007:
|                      | ** ** | **Total number   of shares   purchased** | ** ** | **Average   price paid   per share** | ** ** | **Total number of   shares purchased   as part of publicly   announced plan** | ** ** | **Maximum number   of shares that may   yet be purchased   under the plan** | ** ** |
|----------------------|------------|--------------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------|------------|
| April 1 to April  30 |       | 10,000                                                       |       | $                                                        | 5.00       |                                                                                                                            | 331,763    |                                                                                                                               | 268,237    |   |
| May 1 to May 31      |       | —                                                       |       | —                                                   |       | —                                                                                                                          |       | —                                                                                                                             |       |
| June 1 to June  30   |       | 64,065                                                       |       | 5.38                                                     |       | 395,828                                                                                                                         |       | 204,172                                                                                                                            |       |
| Total                |       | 74,065                                                       |       | 5.30                                                     |       | 395,828                                                                                                                         |       | 204,172                                                                                                                            |       |
|                      |            |                                                              |            |                                                          |            |                                                                                                                                 |            |                                                                                                                                    |            |  |

 

The plan torepurchase up to a total of 600,000 shares of our common stock was approved byour Board of Directors in September 2001 and does not have an expirationdate.  

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

Our annual meeting of the shareholderswas held on June 14, 2007.  The followingaction was approved:

1.             To elect the followingpersons to serve as directors of Paulson Capital Corp. until the next annualmeeting of shareholders and until their successors are duly elected andqualified:
| Name                   | ** ** | **Number of Shares   Voting For** | ** ** | **Number of Shares  Withheld Voting** | ** ** |
|------------------------|------------|-------------------------------------------------------|------------|------------------------------------------------------|------------|
| Chester L. F.  Paulson |       | 5,801,154                                             |       | 186,532                                              |       |
| Jacqueline M.  Paulson |       | 5,801,154                                             |       | 186,532                                              |       |
| Steve Kleemann         |       | 5,801,154                                             |       | 186,532                                              |       |
| Shannon P. Pratt       |       | 5,801,154                                             |       | 186,532                                              |       |
| Paul Shoen             |       | 5,801,154                                             |       | 186,532                                              |       |

 

**Item 6.  Exhibits**

The followingexhibits are filed herewith and this list is intended to constitute the exhibitindex:
| 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 therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
| Date:      August 10, 2007 |   | PAULSON CAPITAL CORP.                  |
|------------------------------------------------|--------|----------------------------------------|
|                                           |   |                                   |
|                                           |   |                                   |
|                                           |   | By                                     |  /s/  CHESTER L. F. PAULSON |   |
|                                           |   | Chester L. F.  Paulson                 |
|                                           |   | President and  Chief Executive Officer |
|                                           |   | Principal  Executive Officer           |
|                                           |   |                                   |
|                                           |   |                                   |
|                                           |   | By                                     | /s/ KAREN L.  JOHANNES |   |
|                                           |   | Karen L.  Johannes                     |
|                                           |   | Chief Financial  Officer               |
|                                           |   | Principal  Financial Officer           |
|                                                |        |                                        |  |  |  |  |

 

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