**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON D.C.20549**

 

----

 

**FORM 10-QSB**

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

** **

**For thequarterly period ended September 30, 2002**

 
| **o****TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|----------------------------------------------------------------------------------------------|

** **

**For thetransition periodfrom         to         **

 

**Commission filenumber: 0-18188**

 

**PAULSON CAPITAL CORP.**

(Exact name of small businessissuer 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 ofeach of the issuer’s classes of common stock, as of the latest practicabledate:

 

Common stock, no parvalue—3,125,811 shares as of November  4, 2002

 

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

 

 

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**PART I —FINANCIAL INFORMATION**

 

ITEM1.  FINANCIAL STATEMENTS

 

PAULSON CAPITAL CORP. ANDSUBSIDIARY

CONSOLIDATED BALANCESHEETS

** **
|                                           |   | **9/30/02**     |       | **12/31/01** |   |
|------------------------------------------------|--------|-----------------|------------|--------------|--------|
|                                           |   | **(unaudited)** |       |         |   |
| **ASSETS**                                     |   |            |       |         |   |
|                                           |   |            |       |         |   |
| **Current Assets**                             |   |            |       |         |   |
| Cash and cash  equivalents                     |   | $               | 44,894     |         | $      | 42,938 |   |
| Receivable from  clearing organization         |   | 4,728,612       |       | 8,433,039    |   |
| Notes and other  receivables                   |   | 474,033         |       | 407,716      |   |
| Trading  securities, at market value           |   | 1,352,973       |       | 1,559,960    |   |
| Investment  securities, at market value        |   | 14,608,566      |       | 18,632,580   |   |
| Underwriter  warrants, at estimated fair value |   | 1,706,700       |       | 6,165,000    |   |
| Prepaid and  deferred expenses                 |   | 913,208         |       | 989,750      |   |
| Income taxes  receivable                       |   | 1,845,378       |       | 1,846,100    |   |
| Deferred income taxes                          |   | 994,800         |       | —       |   |
|                                           |   |            |       |         |   |
| **Total Current Assets**                       |   | 26,669,164      |       | 38,077,083   |   |
|                                           |   |            |       |         |   |
| FURNITURE AND  EQUIPMENT, net                  |   | 294,696         |       | 344,349      |   |
|                                           |   |            |       |         |   |
| INVESTMENT IN  REAL ESTATE                     |   | 169,900         |       | 169,900      |   |
|                                           |   |            |       |         |   |
| **Total Assets**                               |   | $               | 27,133,760 |         | $      | 38,591,332 |   |

 

The accompanyingnotes are an integral part of these statements.

 

2

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|                                                                                                                                |   | **9/30/02**     |       | **12/31/01** |   |
|-------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------|------------|--------------|--------|
|                                                                                                                                |   | **(unaudited)** |       |         |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                      |   |            |       |         |   |
|                                                                                                                                |   |            |       |         |   |
| **Current Liabilities**                                                                                                             |   |            |       |         |   |
| Accounts payable  and accrued liabilities                                                                                           |   | $               | 140,690    |         | $      | 369,977 |   |
| Payable to  clearing organization                                                                                                   |   | 1,375,991       |       | 1,418,779    |   |
| Compensation,  employee benefits and  payroll taxes                                                                            |   | 360,345         |       | 1,335,471    |   |
| Securities sold,  not yet purchased, at market value                                                                                |   | 12,007          |       | 12,846       |   |
| Deferred income  taxes                                                                                                              |   | —          |       | 2,305,200    |   |
|                                                                                                                                |   |            |       |         |   |
| **Total Current Liabilities**                                                                                                       |   | 1,889,033       |       | 5,442,273    |   |
|                                                                                                                                |   |            |       |         |   |
| Deferred income  taxes                                                                                                              |   | 18,100          |       | 18,100       |   |
|                                                                                                                                |   |            |       |         |   |
| **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, 3,130,811  at 9/30/02 and 3,163,062 at 12/31/01 |   | 1,087,990       |       | 1,062,428    |   |
| Retained  earnings                                                                                                                  |   | 24,138,637      |       | 32,068,531   |   |
|                                                                                                                                |   |            |       |         |   |
| **Total Shareholders’ Equity**                                                                                                 |   | 25,226,627      |       | 33,130,959   |   |
|                                                                                                                                |   |            |       |         |   |
| **Total Liabilities and Shareholders’  Equity**                                                                                |   | $               | 27,133,760 |         | $      | 38,591,332 |   |

 

The accompanyingnotes are an integral part of these statements.

 

3

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PAULSON CAPITAL CORP. ANDSUBSIDIARY

CONSOLIDATED STATEMENTS OFOPERATIONS

(unaudited)

** **
|                                                    |   | **Three  months ended** |       | **Nine months  ended** |   |
|---------------------------------------------------------|--------|-------------------------|------------|------------------------|--------|
|                                                    |   | **9/30/02**             |       | **9/30/01**            |   | **9/30/02** |   | **9/30/01** |   |
|                                                    |   |                    |       |                   |   |   |   |   |   |
| **Revenues**                                            |   |                    |       |                   |   |   |   |   |   |
| Commissions                                             |   | $                       | 1,649,922  |                   | $      | 1,761,495 |   | $ | 4,975,376 |   | $ | 5,717,312 |   |
| Corporate  finance                                      |   | 32,016                  |       | 827,164                |   | 117,671 |   | 3,872,222 |   |
| Investment  income                                      |   | (286,417                | )          | (3,749,934             | )      | (8,720,809 | ) | 4,402,471 |   |
| Trading income                                          |   | (261,261                | )          | (381,605               | )      | (689,615 | ) | 467,550 |   |
| Interest and  dividends                                 |   | 12,542                  |       | 11,926                 |   | 52,215 |   | 30,419 |   |
| Other                                                   |   | 446                     |       | 196                    |   | 1,180 |   | 1,221 |   |
|                                                    |   |                    |       |                   |   |   |   |   |   |
|                                                    |   | 1,147,248               |       | (1,530,758             | )      | (4,263,982 | ) | 14,491,195 |   |
| **Expenses**                                            |   |                    |       |                   |   |   |   |   |   |
| Commissions and  salaries                               |   | 1,871,466               |       | 1,776,680              |   | 5,678,656 |   | 6,923,572 |   |
| Underwriting  expenses                                  |   | —                  |       | 108,399                |   | — |   | 487,070 |   |
| Rent, telephone  and quotation services                 |   | 236,794                 |       | 222,546                |   | 701,489 |   | 732,512 |   |
| Interest expense                                        |   | 780                     |       | 486                    |   | 7,910 |   | 41,285 |   |
| Professional  fees                                      |   | 103,065                 |       | 180,055                |   | 410,079 |   | 301,589 |   |
| Bad debt expense                                        |   | 30,000                  |       | 30,000                 |   | 90,000 |   | 90,000 |   |
| Travel and  entertainment                               |   | 61,692                  |       | 36,895                 |   | 224,806 |   | 181,803 |   |
| Settlements                                             |   | —                  |       | 26,000                 |   | 85,000 |   | 33,000 |   |
| Other                                                   |   | 286,499                 |       | 404,264                |   | 990,763 |   | 1,465,904 |   |
|                                                    |   |                    |       |                   |   |   |   |   |   |
|                                                    |   | 2,590,296               |       | 2,785,325              |   | 8,188,703 |   | 10,256,735 |   |
|                                                    |   |                    |       |                   |   |   |   |   |   |
| Earnings (loss)  before income taxes                    |   | (1,443,048              | )          | (4,316,083             | )      | (12,452,685 | ) | 4,234,460 |   |
|                                                    |   |                    |       |                   |   |   |   |   |   |
| Income tax  expense (benefit)                           |   |                    |       |                   |   |   |   |   |   |
| Current                                                 |   | (580,000                | )          | (1,381,000             | )      | (1,500,000 | ) | (1,581,000 | ) |
| Deferred                                                |   | 180,000                 |       | (301,000               | )      | (3,300,000 | ) | 3,275,000 |   |
|                                                    |   |                    |       |                   |   |   |   |   |   |
| **Net  Earnings (Loss)**                                |   | $                       | (1,043,048 | )                      | $      | (2,634,083 | ) | $ | (7,652,685 | ) | $ | 2,540,460 |   |
|                                                    |   |                    |       |                   |   |   |   |   |   |
| Earnings (loss)  per share, basic and diluted           |   | $                       | (0.33      | )                      | $      | (0.82 | ) | $ | (2.43 | ) | $ | 0.78 |   |
|                                                    |   |                    |       |                   |   |   |   |   |   |
| Weighted average  number of shares outstanding, basic   |   | 3,136,240               |       | 3,202,080              |   | 3,146,237 |   | 3,257,945 |   |
|                                                    |   |                    |       |                   |   |   |   |   |   |
| Weighted average  number of shares outstanding, diluted |   | 3,136,240               |       | 3,202,080              |   | 3,146,237 |   | 3,260,395 |   |
|                                                         |        |                         |            |                        |        |  |  |  |  |  |  |  |  |  |  |  |  |

 

The accompanying notes are an integral part of thesestatements

 

4

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PAULSON CAPITAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENT OFSHAREHOLDERS’ EQUITY

For the two year periodended December 31, 2001

and the nine month periodended September 30, 2002

 
|                                       |   | **Common  Stock** |   | **Retained  Earnings** |      |
|--------------------------------------------|--------|-------------------|--------|------------------------|-----------|
|                                       |   | **Shares**        |   | **Amount**             |      |   |
| Balance at  December 31, 1999              |   | 3,541,235         |   | $                      | 732,343   |   | $ | 30,388,263 |   |
|                                       |   |              |   |                   |      |   |   |
| Stock option  grants                       |   | —            |   | 317,750                |      | — |   |
|                                       |   |              |   |                   |      |   |   |
| Stock options  exercised                   |   | 16,000            |   | 71,000                 |      | — |   |
|                                       |   |              |   |                   |      |   |   |
| Redemption of  common stock                |   | (189,869          | )      | (41,082                | )         | (1,235,230 | ) |
|                                       |   |              |   |                   |      |   |   |
| Net loss for the  year                     |   | —            |   | —                 |      | (3,048,214 | ) |
|                                       |   |              |   |                   |      |   |   |
| 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 (unaudited)       |   | 8,000             |   | 35,500                 |      | — |   |
|                                       |   |              |   |                   |      |   |   |
| Redemption of  common stock (unaudited)    |   | (40,251           | )      | (9,938                 | )         | (277,209 | ) |
|                                       |   |              |   |                   |      |   |   |
| Net loss for  year to date (unaudited)     |   | —            |   | —                 |      | (7,652,685 | ) |
|                                       |   |              |   |                   |      |   |   |
| Balance at  September 30, 2002 (unaudited) |   | 3,130,811         |   | $                      | 1,087,990 |   | $ | 24,138,637 |   |

 

The accompanying notes are an integral part of thesestatements

 

5

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PAULSON CAPITAL CORP. ANDSUBSIDIARY

CONSOLIDATED STATEMENTSOF CASH FLOWS

(unaudited)

 
|                                                                                                   |   | **Nine months ended September 30,** |       |
|--------------------------------------------------------------------------------------------------------|--------|-------------------------------------|------------|
|                                                                                                   |   | **2002**                            |       | **2001** |   |
| Increase  (Decrease) in Cash and Cash Equivalents                                                      |   |                                |       |   |   |
|                                                                                                   |   |                                |       |   |   |
| Cash flows from  operating activities                                                                  |   |                                |       |   |   |
| Net earnings  (loss)                                                                                   |   | $                                   | (7,652,685 | ) | $ | 2,540,460 |   |
| Adjustments to  reconcile net earnings (loss) to net cash provided by (used in) operating  activities: |   |                                |       |   |   |
| Receipt of  underwriter warrants                                                                       |   | (68,391                             | )          | — |   |
| Unrealized  (appreciation) depreciation on investment securities                                       |   | 8,570,534                           |       | (8,175,742 | ) |
| Realized (gain)  loss on investment securities                                                         |   | 150,275                             |       | 1,250,081 |   |
| Depreciation and  amortization                                                                         |   | 138,567                             |       | 149,219 |   |
| Deferred income  taxes                                                                                 |   | (3,300,000                          | )          | 3,275,000 |   |
| Change in assets  and liabilities                                                                      |   |                                |       |   |   |
| Receivables                                                                                            |   | 3,638,110                           |       | 3,906,838 |   |
| Trading  securities                                                                                    |   | 206,987                             |       | (425,039 | ) |
| Prepaid and  deferred expenses                                                                         |   | 76,542                              |       | 604,228 |   |
| Accounts payable  and accrued liabilities                                                              |   | (1,247,201                          | )          | 1,366,085 |   |
| Securities sold,  not yet purchased                                                                    |   | (839                                | )          | 116,091 |   |
| Income taxes  payable/receivable                                                                       |   | 722                                 |       | (4,995,254 | ) |
|                                                                                                   |   |                                |       |   |   |
| Net cash  provided by (used in) operating activities                                                   |   | 512,621                             |       | (388,033 | ) |
|                                                                                                   |   |                                |       |   |   |
| Cash flows from  investing activities                                                                  |   |                                |       |   |   |
| Purchases of  investment securities                                                                    |   | (11,769,845                         | )          | (26,755,958 | ) |
| Proceeds from  sale of investment securities                                                           |   | 11,599,742                          |       | 28,174,338 |   |
| Additions to  furniture and equipment                                                                  |   | (88,915                             | )          | (21,592 | ) |
|                                                                                                   |   |                                |       |   |   |
| Net cash  provided by (used in) investing activities                                                   |   | (259,018                            | )          | 1,396,788 |   |
|                                                                                                   |   |                                |       |   |   |
| Cash flows from  financing activities                                                                  |   |                                |       |   |   |
| Proceeds from  exercise of stock options                                                               |   | 35,500                              |       | 31,063 |   |
| Payments to  retire common stock                                                                       |   | (287,147                            | )          | (1,096,546 | ) |
|                                                                                                   |   |                                |       |   |   |
| Net cash  provided by (used in) financing activities                                                   |   | (251,647                            | )          | (1,065,483 | ) |
|                                                                                                   |   |                                |       |   |   |
| NET INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS                                                  |   | 1,956                               |       | (56,728 | ) |
|                                                                                                   |   |                                |       |   |   |
| Cash and cash  equivalents at beginning of period                                                      |   | 42,938                              |       | 104,309 |   |
|                                                                                                   |   |                                |       |   |   |
| Cash and cash  equivalents at end of period                                                            |   | $                                   | 44,894     |   | $ | 47,581 |   |
|                                                                                                   |   |                                |       |   |   |
| Cash paid during the three months for                                                                  |   |                                |       |   |   |
|                                                                                                   |   |                                |       |   |   |
| Interest                                                                                               |   | $                                   | 780        |   | $ | 41,285 |   |
| Income taxes                                                                                           |   | $                                   | 2,009      |   | $ | 7,816 |   |
|                                                                                                        |        |                                     |            |  |  |  |  |  |  |

 

The accompanyingnotes are an integral part of these statements

 

6

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**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

(unaudited)

1. Basis of Presentation

 

The accompanyingunaudited consolidated financial statements have been prepared in accordancewith the instructions for interim financial statements in Item 310(b) ofRegulation S-B and, therefore, do not include all information and footnotesrequired by generally accepted accounting principles for complete financialstatements.  In the opinion of management,the interim financial statements include all adjustments (consisting only ofnormal recurring adjustments) necessary to state fairly the information showntherein.  The nature of the Company’sbusiness is such that the results of any interim period are not necessarilyindicative of results for a full fiscal year.

 

2. Securities Owned

 

Gains and losses from the disposition of securities are reflected astrading revenues in the income statement for the period.

 

3.Commitments and Contingencies

 

InJanuary 2001, V.J.E. Enterprises, Inc. and Vincent and Diana Nartker,former customers of Paulson Investment Company, Inc. ("PIC"), theCompany's wholly owned operating subsidiary, filed a customer complaint withPIC regarding the handling of their account by PIC and one of its registeredrepresentatives. They have asserted that their account was mismanaged and thatPIC failed to supervise its registered representative. They have requested thatPIC pay them $275,100. PIC is investigating this claim, but believes it hasmeritorious defenses and intends to defend this matter vigorously if anarbitration is filed.

 

InMay 2001, PIC received notice that Eugene V. Doty, a former PIC customer, hadmade a customer complaint about the handling of his account at PIC.  Mr. Doty alleges that his account was tradedexcessively but has not identified what amount, if any, he seeks from PIC orits former broker.  PIC is investigatingthis claim, but believes it has meritorious defenses and intends to defend thismatter vigorously if an arbitration is filed.

 

OnNovember 7, 2001, the Company and PIC were named as defendants in a lawsuitfiled by Spirit Partners, L.P. and Tech-Trade Capital LLC.  The lawsuit was filed in the Supreme Courtof the State of New York for the County of New York.  The lawsuit alleges that PIC committed fraud and was unjustlyenriched in connection with the redemption of warrants issued in the initialpublic offering of audiohighway.com, for which PIC served as underwriter.  According to plaintiffs, the warrantagreement and prospectus contain different provisions governing the redemptionof the warrants.  This allegedlyoccurred because the redemption provisions were changed during the registrationprocess, and the warrant agreement was not amended to reflect the change inprovisions.  audiohighway.com’sredemption was proper under the terms of the prospectus, which contains theupdated redemption provisions and allowed the issuer to redeem when the closingbid price of the common stock was at least $13.50 for 10 calendar days.  Plaintiffs allege that the redemption wasimproper under the terms of the warrant agreement, which they allege containsthe original redemption provisions and allows the issuer to redeem when theclosing bid price of the common stock exceeded $13.50 for 20 consecutivetrading days.  Plaintiffs also allegethat counsel for audiohighway.com and PIC fraudulently concealed the allegeddiscrepancy between the prospectus and warrant agreement by amending thewarrant agreement to be consistent with the prospectus.

 

7

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Plaintiffsclaim unspecified monetary damages and seek $3 million in punitive damages. Thelawsuit has been stayed, pending mandatory arbitration before the NASD.  The arbitration is in a very early stage andPIC has not yet conducted discovery. However, PCC and PIC believe that they have meritorious defenses tothese claims and intend to defend the case vigorously.

 

InJanuary 2002, PIC was served in an arbitration brought by one of its formercustomers, Patricia Weber, against PIC and its registered representative MelvinVukcevich.  The arbitration claimalleges unsuitable securities recommendations, misrepresentation, breach offiduciary duty and negligence.  Theclaimant is seeking damages of $255,000, interest, an additional return on herportfolio, punitive damages and attorney fees. PIC has filed its answer.  PICbelieves it has meritorious defenses and intends to defend these mattersvigorously.

 

InMarch 2002, PIC and one of its registered representatives, Marvin Cox, werenamed as defendants in lawsuits filed by Louis Barinaga and Stuart Mackenzie,former PIC customers.  The claims ofBarinaga and Mackenzie relate to purchases of convertible notes of E.com, whichwere purchased directly from E.com. Barinaga and Mackenzie allege that PIC and Mr. Cox participated in andmaterially aided the sale of the notes and, therefore, are liable under statesecurities law.  Barinaga and Mackenzieallege damages of $717,000 and $165,000, respectively, plus interest andattorney fees. PIC asserted that the claims are subject to arbitration.Plaintiffs have abated their lawsuit and refiled their claims before theNASD.  PIC has not had an opportunity tofully investigate these claims, but believes it has meritorious defenses andintends to defend this matter vigorously.

 

In March 2002, PIC andone of its registered representatives, Melvin Vukcevich, were named asrespondents in arbitration claims filed by former customers Paul and MaryHerold.  The Herolds claim they weremisled into purchasing unsuitable securities and allege damages of $70,000 plusunspecified punitive damages.  This caseis in the early stages of discovery, but PIC believes it has meritoriousdefenses and intends 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 New Jersey.  It asserts various federal securities lawclaims and common law fraud and negligence against numerous defendants,including PIC, arising out of two secondary offerings of Suprema Specialties,Inc.  PIC participated in one of the twoofferings, the August 25, 2000 secondary offering of Suprema Specialities, Inc.as a member of the underwriting syndicate, underwriting 75,000 shares intotal.  The plaintiffs seek damages forthe purchase of 399,151 shares of Suprema Specialities, Inc. stock betweenAugust 25, 2000 and November 14, 2001. PIC has not had an opportunity to investigate this claim but believes ithas meritorious defenses.  PIC intendsto defend this matter vigorously.

 

Inaddition to the matters described above, PIC has information that certainformer customers may file claims against it; however, no such claims have beenasserted at this time.  PIC has noinformation regarding what amounts, if any, may be sought from PIC but believesthe amounts may be material.  PIC hasnot had an opportunity to fully investigate these claims, but believes it hasmeritorious defenses and intends to defend these matters vigorously if anyclaims are filed.

 

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.

 

8

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ITEM 2.  MANAGEMENT’S DISCUSSIONAND ANALYSIS OR PLAN OF OPERATION

 

**General**

 

FORWARD-LOOKING STATEMENTS

 

This report, including, without limitation, “Item 2: Management’sDiscussion and Analysis or Plan of Operation,” contains or incorporates bothhistorical and “forward-looking” statements within the meaning of Section 27Aof the Securities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended.  Wordssuch 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 securities we have underwritten or otherwise  sold to our customers may affect our reputation with other potential syndicate  and selling group members and institutional and other retail accounts and may  also affect the amount of money in 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 condition and results of operations, may be  significantly and adversely affected by changes in the value of the companies  themselves or of comparable companies whose stock values we use in estimating  the value of our portfolio securities. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| • |   | We  are subject to a very high degree of regulation and are responsible for  compliance with applicable regulations by all of our personnel.  A significant regulatory infraction by us  or any of our registered representatives could result in significant  penalties, including the loss of our license to conduct securities business  in one or more jurisdictions.                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| • |   | Alternatives  available to our customers to transact securities trades could affect our  ability to continue to execute our brokerage customers’ transactions.                                                                                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| • |   | The  loss of our Chairman, Chester Paulson, could have a material adverse impact  on our business.                                                                                                                                                                                                                                                                                                                                               |

 

9

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**Overview**

 

Substantially all of our business consists of the securities brokerageand investment banking activities of our wholly owned subsidiary, PaulsonInvestment Company, Inc., or PIC. PIC has operations in four principalcategories, all of them in the financial services industry. These categoriesare:

 
| • |   | securities  brokerage activities for which PIC earns commission revenues;                                                                                                     |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                          |
| • |   | securities  trading from which PIC records profit or loss, depending on trading results;                                                                                      |
|   |   |                                                                                                                                                                          |
| • |   | corporate  finance revenues consisting principally of underwriting discounts,  underwriter warrants received, and other compensation from investment banking  activities; and |
|   |   |                                                                                                                                                                          |
| • |   | investment  income resulting from profits from, and increases or decreases in the value  of, PIC’s investment portfolio.                                                 |

 

Because we operate in the financial services industry, our revenues andearnings are substantially affected by conditions in financial marketsgenerally. In our securities brokerage and corporate finance businesses, theamount of our revenues depends substantially on levels of market activityrequiring the services we provide. For example, our investment bankingactivity, which consists primarily of acting as managing or participating underwriterof initial 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.

 

Our investment income or loss and, to a lesser extent, our tradingincome or loss are affected by changes in market valuation of securitiesgenerally and, in particular, by changes in valuation of the equity securitiesof microcap companies in which our investments and trading activities tend tobe concentrated. 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.

 

A substantial portion of our investment banking business consists ofacting as managing underwriter of initial and follow-on public offerings formicrocap companies. As a part of our underwriter compensation for thisactivity, we typically receive warrants exercisable to purchase securitiesidentical to those that we offer and sell to the public. The underwriterwarrants are not exercisable for the first year after the offering in whichthey are earned and are thereafter generally exercisable for four years, afterwhich they expire. The exercise price is typically 120% of the price at whichwe initially sold the securities to the public. Accordingly, unless there is atleast a 20% increase in the price of these securities at some time more thanone and less than five years after the offering, the warrants will remain“under water” and will ultimately expire unexercised.

 

10

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**Critical Accounting Policies**

 

The following discussion and analysis of our financial condition andresults of operations is based upon our consolidated financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States.  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 critical accounting policiesare limited to 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 Underwriter Warrants, at estimated fair value on that balancesheet. When a new warrant is earned as a result of our investment bankingactivity, its estimated value is included in Corporate Finance revenue for theperiod in which it is earned. In subsequent periods, any change in estimatedvalue is recorded as Investment Income for the period. If, and when, anunderwriter warrant is exercised, the book value is adjusted to reflect thevalue of the securities purchased, net of the exercise price, and theadjustment amount is recorded as investment income or loss for the relevantperiod. If the warrant expires unexercised, the book value is adjusted to zeroand the decrease is recorded as a loss in the relevant period.

 

We estimate the value of our underwriter warrants using the Black-ScholesOption Pricing Model.  The Black-Scholesmodel requires 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 receivenew underwriter warrants, from an initial public offering, their calculatedvolatility factor is entirely based on the volatility of an index of comparablecompanies, since there is no price history. As each underwriter warrantapproaches its expiration date, its volatility factor is derived primarily fromthe historical prices of that company’s common stock. We cannot assure you thatwe will ultimately be able to exercise any of our warrants in a way that willrealize the value that we attribute to them in our financial statements based on this model.  As of September 30, 2002, our underwriter warrants, based on theBlack-Scholes Option Pricing Model, were valued at approximately $1.7 million.

 

In addition to ourunderwriters warrants, we hold other securities, some of which have verylimited liquidity and some of which do not have a readily ascertainable marketvalue.  According to GAAP, we arerequired to carry these securities at estimated fair value, with no discountfor restricted or illiquid securities.

 

As a result of the factors described above, our revenues and earningsare subject to substantial fluctuation from period to period based oncircumstances that often are beyond our control. An increase in financialmarket activity generally, and/or an increase in equity valuations generally,will normally result in increases in revenue, earnings and net worth as ouractivity levels and the value of our investment portfolio increase. Conversely,a general market retrenchment will typically lead to decreased revenue,earnings and net worth as a result of both decreased activity and the need toadjust high investment portfolio values to lower levels. Accordingly, resultsfor any historical period are not necessarily indicative of similar results forany future period.

 

**Results ofOperations**

 

PIC's revenues and operating results are influenced by fluctuations inthe equity underwriting markets as well as general economic and marketconditions, particularly conditions in the over-the-counter market, where PIC’sinvestment account, trading inventory positions and underwriter warrants areheavily concentrated.  Significantfluctuations can occur in PIC’s revenues and operating results from one periodto another.  PIC’s financial resultsdepend upon many factors, such as the number of companies that are seekingpublic financing, the quality and financial condition of those companies,market conditions in general, the performance of previous PIC underwritings andinterest in certain industries by investors. As a result, revenues and income derived from these activities may varysignificantly from period to period.  Inthe table below, “Trading Income” is the net gain or loss from tradingpositions before commissions paid to the representatives in the tradingdepartment.

 

11

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**Summary of Changes in Major Categories**

**of Revenues and Expenses**

increase/(decrease)

 
|                                    |   | **Quarters  Ended September 30  2002 vs. 2001** |      | **Nine  Months Ended September 30  2002 vs. 2001** |    |
|-----------------------------------------|--------|-------------------------------------------------|-----------|----------------------------------------------------|---------|
| **Revenues:**                           |   |                                            |      |                                               |    |   |   |   |   |
| Commissions                             |   | $                                               | (111,573  | )                                                  | (6.3    | )% | $ | (741,936 | ) | (13.0 | )% |
| Corporate  finance                      |   | (795,148                                        | )         | (96.1                                              | )%      | (3,754,551 | ) | (97.0 | )% |
| Investment  income                      |   | 3,463,517                                       |      | 92.4                                               |  % | (13,123,280 | ) | N/A |   |
| Trading income                          |   | 120,344                                         |      | 31.5                                               |  % | (1,157,165 | ) | N/A |   |
| Other                                   |   | 866                                             |      | 7.1                                                | %       | 21,755 |   | 68.8 | % |
|                                    |   |                                            |      |                                               |    |   |   |   |   |
| Total                                   |   | $                                               | 2,678,006 |                                               | N/A     |   | $ | (18,755,177 | ) | N/A |   |
|                                    |   |                                            |      |                                               |    |   |   |   |   |
| **Expenses:**                           |   |                                            |      |                                               |    |   |   |   |   |
| Commissions and  salaries               |   | $                                               | 94,786    |                                               | 5.3     | % | $ | (1,244,916 | ) | (18.0 | )% |
| Underwriting  expenses                  |   | (108,399                                        | )         | (100.0                                             | )%      | (487,070 | ) | (100.0 | )% |
| Rent, telephone  and quotation services |   | 14,248                                          |      | 6.4                                                | %       | (31,023 | ) | (4.2 | )% |
| Other                                   |   | (195,664                                        | )         | (28.9                                              | )%      | (305,023 | ) | (14.4 | )% |
|                                    |   |                                            |      |                                               |    |   |   |   |   |
| Total                                   |   | $                                               | (195,029  | )                                                  | (7.0    | )% | $ | (2,068,032 | ) | (20.2 | )% |
|                                    |   |                                            |      |                                               |    |   |   |   |   |
| Earnings before  income taxes           |   | $                                               | 2,873,035 |                                               | 66.6    |  % | $ | (16,687,145 | ) | N/A |   |
|                                         |        |                                                 |           |                                                    |         |  |  |  |  |  |  |  |  |

 

**ThreeMonths Ended September 30, 2002 vs. Three Months Ended September 30, 2001**

 

Revenues for the third quarter of 2002 increased $2,678,006, to total revenues of $1,147,248, from negative revenues of $1,530,758 for the third quarter of 2001.  As shown in the table above, commissionsfell $111,573, or 6.3 percent, from $1,761,495 in the third quarter of 2001 to$1,649,922 in the comparable 2002 period. This decrease resulted from less favorable price movements and tradinglevels in the very small capitalization issues (the primary focus of PIC’sinvestment banking and trading businesses) in the 2002 quarter compared to thesame period in 2001.  In addition,continuing weak market conditions related to the lingering effects of therecession and terrorist attacks and a serious lack of investor confidence in thesecurities markets in general, due particularly to the financial accountingproblems reported by various major corporations during the last nine months,have resulted in significantly decreased securities prices across almost allsectors. The Nasdaq composite fell 19.9 percent in the third quarter of 2002compared to a decrease of 30.1 percent in the third quarter of 2001.  Corporate finance revenues fell $795,148 inthe third quarter of 2002, to $32,016, significantly down from corporatefinance revenues of $827,164 for the third quarter of 2001.  One corporate finance transaction generatinggross proceeds of $11 million was completed in the third quarter of 2001, whileno transactions were completed in the comparable 2002 quarter.  Corporate finance revenue is directlyrelated to the amount of money raised in completed transactions.  Investment income improved from a loss of$3,749,934 in the third quarter of 2001 to a loss of $286,417 in the thirdquarter of 2002.  Investment income inthe 2001 period consisted of significant, unrealized net losses in investmentsecurities unrelated to underwriter warrants and a decrease in the estimatedfair value of underwriter warrants.  Inthe 2002 quarter, there was a significant decrease in the fair value of underwriterwarrants offset by an unrealized gain in the value of investment securities.

 

12

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No underwriter warrants were exercised in either the2001 or 2002 quarters. Trading losses were reduced by $120,344, to a loss of$261,261 in the third quarter of 2002, from a loss of $381,605 in thecomparable 2001 period.  This increasewas primarily due to slightly improved market conditions.  Other income increased $866, from $12,122 inthe third quarter of 2001 to $12,988 in the 2002 quarter, due primarily to anincrease in interest and dividend income.

 

Total expenses decreased$195,029 in the third quarter of 2002 from the comparable 2001 period, adecrease of 7 percent, from $2,785,325 to $ 2,590,296.  Commissions and salaries increased $94,786,or 5.3 percent, from $1,776,680 in the 2001 period to $1,871,466 in 2002.  This increase was primarily due to highercommissions paid to new independent contractor branches. Underwrit­ing expensesfell $108,399, or 100 percent, from $108,399 in the 2001 quarter to $0 in thethird quarter of 2002.  One corporatefinance transaction generating total gross proceeds of $11 million wascompleted in the 2001 period, while no corporate finance transactions werecompleted in third quarter of 2002. Rent, telephone and quote expenses increased from $222,546 in the 2001period to $236,794 in 2002, an increase of 6.4 percent, primarily due to theaddition of a new employee branch in Manhattan.  The aggregate of all other expenses fell 28.9 percent, from$677,700 in the third quarter of 2001 to $482,036 in the third quarter of 2002,primarily due to the elimination of expenses related to an annual summerconference and a decrease in professional fees.

 

The Company had a pretax loss of$1,443,048 in the third quarter of 2002 compared to a pretax loss of $4,316,083in the comparable 2001 period.  Thesmaller pre-tax loss was primarily due to a reduction in the loss in investmentand trading income partially offset by reduced corporate finance revenues inthe 2002 period.  Independent ofinvestment income, the Company would have had a pretax loss of $1,156,631 forthe third quarter of 2002 compared to a pretax loss of $566,149 in thirdquarter of 2001. Significant fluctuations can occur in PIC’s revenues andoperating results from one period to another, particularly in very volatilemarket environments such as the market to date in 2002.

 

The Company had $400,000 inestimated tax benefits for the third quarter of 2002, compared to estimated taxbenefits in the third quarter of 2001 of $1,682,000.

 

**Nine MonthsEnded September 30, 2002 vs. Nine Months Ended September 30, 2001**

 

Totalrevenues for the first nine months of 2002 decreased $18,755,177, to a lossof  $4,263,982 from total revenues of$14,491,195 for the first nine months of 2001. As shown in the table above, sales commissions decreased $741,936, or 13percent, from $5,717,312 for the first nine months of 2001 to $4,975,376 forthe first nine months of 2002.  Thisdecrease resulted from lower transaction volume and reduced price levels,particularly in the very small capitalization sector, which is the primaryfocus of the Company’s business, during the first nine months of 2002 comparedto the same period in 2001.  As notedabove, weak market conditions due to the recession, fears of further terroristattacks and reports of significant accounting irregularities by several largepublic companies contributed to a serious loss of confidence by investors inthe securities markets during the first nine months of 2002.  The Nasdaq composite fell 39.9 percent fromJanuary 1, 2002 through September 30, 2002, following a similar decrease of39.3 percent during the first nine months of 2001.  Corporate finance revenues fell $3,754,551, or 97 %, for thefirst nine months of 2002, from $3,872,222 for the first three quarters of 2001to $117,671 for the first three quarters of 2002.  No corporate finance transactions were completed during the firstnine months of 2002; in the same period in 2001, three corporate financetransactions generating total gross proceeds of $30.4 million were completed.

 

13

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Corporate finance revenues are directlyrelated to the amount of money raised in completed transactions.  Investment income decreased by $13,123,280 toa loss of $8,720,809 for the first nine months of 2002 compared to a gain of$4,402,471 for the first nine months of 2001. During the first nine months of2002, the market value of investment securities and the fair value ofunderwriter warrants decreased significantly compared to the same period in2001 when both investment securities and the fair value of underwriter warrantsshowed increases.   No underwriterwarrants were exercised in either period. Trading income decreased $1,157,165 to a loss of $689,615 for the firstnine months of 2002 compared to a profit of $467,550 during the first ninemonths of 2001.  This decrease was theresult of lower trading volume and reduced price levels for many securitiesduring the 2002 period.  Other income,including interest and dividends, for the first nine months of 2002 increasedto $53,395 compared to $31,640 for the first nine months of 2001, primarily dueto increases in dividend and interest income.

 

Totalexpenses for the first nine months of 2002 decreased $2,068,032, or 20.2percent, to $8,188,703 for the first nine months of 2002 from $10,256,735 forthe first nine months of 2001. Commissions and salaries decreased 18 percent, or $1,244,916, to$5,678,656 for the first nine months of 2002 compared to $6,923,572 for thefirst nine months of 2001.  Thisdecrease was primarily due to lower commissions paid on reduced revenues duringthe first nine months of 2002.  Underwriting expenses decreased 100 percent during the first nine monthsof 2002 since no corporate finance transactions were closed during the period,from $487,070 for the first nine months of 2001, in which three transactionswere completed.  Rent, telephone andquote expenses were down $31,023, or 4.2 percent, for the first nine months of2002 to $701,489 from $732,512 for the first nine months of 2001.  The 2001 period included expenses related toimprovements to quotation systems.  Theaggregate of all other expenses decreased $305,023, or 14.4 percent, for thefirst nine months of 2002, to $1,808,558 from $2,113,581 for the first ninemonths of 2001.  The decrease for thefirst nine months of 2002 was due primarily to a decrease in accrual for profitsharing contribution and elimination of expenses associated with an annualsummer conference, partially offset by an increase in professional fees.

 

TheCompany had a pretax loss of $12,452,685 for the first nine months of 2002compared to a pretax profit of $4,234,460 for the first nine months of 2001,primarily due to significant decreases in corporate finance revenues andinvestment and trading income during the first nine months of 2002.  Independent of investment income, theCompany would have had a pretax loss of $3,731,876 for the first nine months of2002 compared to a pre-tax loss of $168,011 for the first nine months of2001.  Significant fluctuations canoccur in PIC’s revenues and operating results from one period to another,particularly in highly volatile markets such as the first nine months of 2002.

 

TheCompany also accrued $4,800,000 in estimated tax benefits for the first ninemonths of 2002, compared to income taxes of $1,694,000 for the first ninemonths of 2001.

 

**Liquidity and Capital Resources**

 

The majority of PIC’s assets arecash and assets readily convertible to cash. PIC’s securities inventory is stated at market value.  The liquidity of the market for many ofPIC’s securities holdings, however, varies with trends in the stockmarket.  Since many of the securitiesheld by PIC are thinly traded, and PIC is in many cases a primary market makerin the issues held, any significant sales of PIC’s positions could adverselyaffect the liquidity of the issues held. In general, falling prices in OTC securities (which make up most ofPIC’s trading positions) lead to decreased liquidity in the market for theseissues, while rising prices in OTC issues tend to increase the liquidity of themarket for these securities. The overall increase in prices for the OTCsecurities traded by PIC in early 2001 was combined with a general increase inthe liquidity of the markets for these securities.  The significant decline in prices for the OTC securities tradedby PIC to date in 2002 was combined with a general decrease in the liquidity ofthe markets for these securities.  PIC’sinvestment account and trading inventory accounts are stated at fair marketvalue, which is at or below quoted market price.

 

14

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PIC borrows money from its clearing firm in the ordinary course of itsbusiness, pursuant to an understanding under which the clearing firm agrees tofinance PIC’s trading accounts.  As ofSeptember 30, 2002, 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.

 

Another source of capital to PIC and the Company has been theunderwriter warrants issued to PIC in connection with its corporate financeactivities and the sale of the underlying securities.  These underwriter warrants are not exercisable for the first yearafter the offerings in which they are earned and are thereafter generallyexercisable for four years, after which they expire.  The exercise price is typically 120% of the price at which weinitially sold the securities to the public. Accordingly, unless there is at least a 20% increase in the price ofthese securities at some time more than one and less than five years after theoffering, the warrants will remain “under water” and will ultimately expireunexercised.  There is no public marketfor the underwriter warrants. The securities receivable upon exercise of theunderwriter warrants cannot be resold unless the issuer has registered thesesecurities with the SEC and the states in which the securities will be sold orexemptions are available.  Any delay orother problem in the registration of these securities would have an adverseimpact upon PIC’s ability to obtain funds from the exercise of the underwriterwarrants and the resale of the underlying securities.  At September 30, 2002, PIC owned 26underwriter warrants (from 21 issuers), of which 25 were currently exercisable;one had an exercise price below the current market price of the securitiesreceivable upon exercise.   If we hadexercised that warrant and sold the securities on September 30, 2002, we wouldhave received  $5,313.  There is little or no direct relationshipbetween the intrinsic value of PIC’s underwriter warrants at the end of anygiven period and the fair value calculated using the Black-Scholes pricingmodel, as described more fully in Overview above. The prices of thesesecurities are influenced by general movements in the prices of OTC securitiesas well as the success of the issuers of the underwriter warrants.  The prices of the securities underlying theunderwriter warrants are very volatile, and substantial fluctuations in theCompany’s estimate of their value can be expected in the future.

 

In the nine months ended September 30, 2002, $512,621 of net cash wasprovided by operating activities of the Company.  The major adjustments to reconcile this result to the Company’snet loss of $7,652,685 include unrealized depreciation on investment securitiesof $8,570,534, a decrease in accounts receivable of $3,638,110, offset by achange in deferred income taxes of $3,300,000 and a decrease in accountspayable of $1,247,201.  In the mostrecent period, $259,018 of net cash was used by the Company’s investingactivities, the result of $11,599,742 in proceeds from the sale of investmentsecurities being more than offset by the purchase of $11,769,845 of investmentsecurities and $88,915 of additions to furniture and equipment.  $251,647 in cash was used in financingactivities by the Company during the nine month period, the result of paymentsto retire common stock of $287,147, partially offset by $35,500 in proceedsfrom the exercise of stock options.

 

15

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As a securities broker-dealer, the Company’s wholly owned subsidiary,PIC, is required by SEC regulations to meet certain liquidity and capitalstandards.  We believe we are incompliance with these standards.

 

At September 30, 2002, the Company had no material commitments forcapital expenditures.

 

In general, the primary ongoing sources of PIC’s, and therefore theCompany’s, liquidity, including PIC’s trading positions, borrowings on thosepositions and profits recognized from underwriter warrants, all depend in largepart on the trend in the general markets for OTC securities.  Rising OTC price levels will tend toincrease the value and liquidity of PIC’s trading positions, the amount thatcan be borrowed from its clearing firm based upon those positions, and thevalue of PIC’s underwriter warrants. The Company believes its liquidity is sufficient to meet its needs forthe foreseeable future.

 

**Inflation**

 

Because PIC’s assets are primarily liquid, they are not significantlyaffected by inflation.  The rate ofinflation affects PIC’s expenses, such as employee compensation, office leasingand communications costs.  These costsmay not readily be recoverable in the price of services offered by theCompany.  To the extent inflationresults in rising interest rates and has other adverse effects in thesecurities markets and the value of securities held in inventory or PIC’sinvestment account, it may adversely affect the Company’s financial positionand results of operations.

 

ITEM 3.  CONTROLS AND PROCEDURES

 

(a)           Under thesupervision and with the participation of our management, including our principalexecutive officer and principal financial officer, we conducted an evaluationof our disclosure controls and procedures, as such term is defined under Rule13a-14(c) promulgated under the Securities Exchange Act of 1934, as amended,within 90 days of the filing date of this report.  Based on their evaluation, our principal executive officer andprincipal accounting officer concluded that our disclosure controls andprocedures are effective.

 

(b)           There have been nosignificant changes (including corrective actions with regard to significantdeficiencies or material weaknesses) in our internal controls or in otherfactors that could significantly affect these controls subsequent to the dateof the evaluation referenced in paragraph (a) above.

 

16

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**PART II**

**OTHER INFORMATION**

 
| Item  1. Legal Proceedings.                                                     |
|---------------------------------------------------------------------------------|
|                                                                            |   |
|                                                                            | See  Note 3 of Notes to Condensed Consolidated Financial Statements in Part 1. |
|                                                                            |   |
| Item  2. Changes in Securities.                                                 |
|                                                                            | None |
|                                                                            |   |   |
| Item  3. Defaults upon Senior Securities.                                       |
|                                                                            | None |
|                                                                            |   |   |
| Item  4. Submission of Matters to a Vote of Security Holders.                   |
|                                                                            | None |
|                                                                            |   |   |
| Item  5. Other Information.                                                     |
|                                                                            | None |
|                                                                            |   |   |
| Item  6. Exhibits and Reports on Form 8-K                                       |
|                                                                            |
| Exhibits  -                                                                     | 99.1 | Certification Pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant to Section 906 of the   Sarbanes-Oxley Act of 2002 |
|                                                                            | 99.2 | Certification Pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant to Section 906 of the   Sarbanes-Oxley Act of 2002 |
|                                                                            |
| No  Reports on Form 8-K were filed during the quarter ended September 30, 2002. |
|                                                                                 |  |  |  |  |

 

17

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**SIGNATURES**

 

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

 
|                                 | PAULSON  CAPITAL CORP. |
|--------------------------------------|------------------------|
|                                 |                   |   |
|                                 |                   |   |
| Date:   November 12, 2002  | By:                    | /s/  CHESTER L.F. PAULSON |   |
|                                 |                   | Chester L.F. Paulson |
|                                 |                   | President |
|                                 |                   | Principal Executive  Officer |
|                                 |                   |   |
| Date:   November  12, 2002 | By:                    | /s/  CAROL RICE |   |
|                                 |                   | Carol  Rice |
|                                 |                   | Chief  Financial Officer |

 

18

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**CERTIFICATIONS**

 

I, Chester L.F. Paulson,certify that:

 

1. I have reviewed thisquarterly report on Form 10-Q of Paulson Capital Corp.

 

2. Based on my knowledge,this quarterly report does not contain any untrue statement of a material factor omit to state a material fact necessary to make the statements made, inlight of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3. Based on my knowledge,the financial statements, and other financial information included in thisquarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, and for,the periods presented in this quarterly report;

 

4. The registrant’s othercertifying officers and I are responsible for establishing and maintainingdisclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and15d-14) for the registrant and we have:

 

a) designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly report is being prepared:

 

b) evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c) presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluations as of the Evaluation Date:

 

5. The registrant’s othercertifying officers and I have disclosed, based on our most recent evaluation,to the registrant’s auditors and the audit committee of registrant’s board ofdirectors (or persons performing the equivalent function):

 

a) all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b) any fraud, whether ornot material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6. The registrant’s othercertifying officers and I have indicated in this quarterly report whether ornot there were significant changes in internal controls or in other factorsthat could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 

Date: November 12, 2002

 
|   | /s/ Chester L.  F. Paulson |   |
|--------|----------------------------|--------|
|   | Chester L. F.  Paulson     |   |
|   | Chief Executive  Officer   |   |
|        |                            |        |  |  |

 

19

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I, Carol Rice, certifythat:

 

1. I have reviewed thisquarterly report on Form 10-Q of Paulson Capital Corp.;

 

2. Based on my knowledge,this quarterly report does not contain any untrue statement of a material factor omit to state a material fact necessary to make the statements made, inlight of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3. Based on my knowledge,the financial statements, and other financial information included in thisquarterly report, fairly present in all material respects the financialcondition, results or operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4. The registrant’s othercertifying officers and I are responsible for establishing and maintainingdisclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and15d-14) for the registrant and we have:

 

a) designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly report is being prepared;

 

b) evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c) presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5. The registrant’s othercertifying officers and I have disclosed, based on our most recent evaluation,to the registrant’s auditors and the audit committee of registrant’s board ofdirectors (or persons performing the equivalent function):

 

a) all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors and theaudit committee of registrant’s board of directors (or persons performing the equivalentfunction):

 

b) any fraud, whether ornot material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6. The registrant’s othercertifying officers and I have indicated in this quarterly report whether ornot there were significant changes in internal controls or in other factorsthat could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

Date: November 12, 2002

 
|   | /s/ Carol Rice           |   |
|--------|--------------------------|--------|
|   | Carol Rice               |   |
|   | Chief Financial  Officer |   |
|        |                          |        |  |  |

 

20

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**EXHIBIT INDEX**

 
| 99.1   |   | Certification  Pursuant to U.S.C. Section 1350, as AdoptedPursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
|--------|--------|---------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                |
| 99.2   |   | Certification  Pursuant to U.S.C. Section 1350, as AdoptedPursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |

 

21

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