##### Table of Contents





UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549





FORM 10-Q





(Mark One)

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

For the quarterly period ended September 30, 2009

OR



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

For the transition period from  to

Commission file number: 000-18188





PAULSON CAPITAL CORP.

(Exact name of registrant as specified in its charter)







|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Oregon                                                         |  | 93-0589534                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



|                                         |  |           
|---------------------------------------- |  | ----------
|811 SW Naito Parkway, Portland, Oregon   |  | 97204     
|(Address of principal executive offices) |  | (Zip Code)

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





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

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

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



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

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

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



|                           |  |                                   
|-------------------------- |  | ----------------------------------
|Common stock, no par value |  | 5,886,785                         
|(Class)                    |  | (Outstanding at November 11, 2009)









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##### Table of Contents

PAULSON CAPITAL CORP. AND SUBSIDIARY

FORM 10-Q

INDEX



|                               |  |                                                                                                             |  |   
|------------------------------ |  | ----------------------------------------------------------------------------------------------------------- |  | --
|                               |  | Page                                                                                                       
|PART I - FINANCIAL INFORMATION |  |                                                                                                            
|                               |  |                                                                                                            
|Item 1.                        |  | Financial Statements                                                                                        |  |   
|                               |  |                                                                                                            
|                               |  | Consolidated Balance Sheets - September 30, 2009 and December 31, 2008 (unaudited)                          |  | 2 
|                               |  |                                                                                                            
|                               |  | Consolidated Statements of Operations - Three and Nine Months Ended September 30, 2009 and 2008 (unaudited) |  | 3 
|                               |  |                                                                                                            
|                               |  | Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2009 and 2008 (unaudited)           |  | 4 
|                               |  |                                                                                                            
|                               |  | Notes to Consolidated Financial Statements (unaudited)                                                      |  | 5 
|                               |  |                                                                                                            
|Item 2.                        |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                       |  | 9 
|                               |  |                                                                                                            
|Item 3.                        |  | Quantitative and Qualitative Disclosures About Market Risk                                                  |  | 16
|                               |  |                                                                                                            
|Item 4T.                       |  | Controls and Procedures                                                                                     |  | 16
|                               | 
|PART II - OTHER INFORMATION    |  |                                                                                                            
|                               |  |                                                                                                            
|Item 6.                        |  | Exhibits                                                                                                    |  | 16
|                               | 
|Signatures                     |  | 17                                                                                                         



1



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##### Table of Contents

PART I - FINANCIAL INFORMATION



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

Paulson Capital Corp. and Subsidiaries

Consolidated Balance Sheets



|                                                                                                                 |  |                   |            |                  |   |           
|---------------------------------------------------------------------------------------------------------------- |  | ----------------- | ---------- | ---------------- | - | ----------
|                                                                                                                 |  | September 30,2009 |            | December 31,2008
|Assets                                                                                                           |  |                   |            |                  |   |           
|Cash                                                                                                             |  | $                 | 219,972    |                  | $ | 318,810   
|Receivable from clearing organization                                                                            |  |                   | 11,379,693 |                  |   | 7,469,811 
|Notes and other receivables                                                                                      |  |                   | 1,330,946  |                  |   | 635,027   
|Income taxes receivable                                                                                          |  |                   | 570,273    |                  |   | 6,480,699 
|Deferred income taxes                                                                                            |  |                   | 568,000    |                  |   | 1,409,000 
|Trading and investment securities, at fair value                                                                 |  |                   | 8,826,837  |                  |   | 6,611,097 
|Underwriter warrants, at fair value                                                                              |  |                   | 2,477,000  |                  |   | 1,675,000 
|Prepaid and deferred expenses                                                                                    |  |                   | 652,395    |                  |   | 885,136   
|Furniture and equipment, at cost, net of accumulated depreciation and amortization of $917,892 and $881,621      |  |                   | 51,755     |                  |   | 94,991    
|                                                                                                                 |  |                   |            |                  |   |           
|Total Assets                                                                                                     |  | $                 | 26,076,871 |                  | $ | 25,579,571
|                                                                                                                 |  |                   |            |                  |   |           
|                                                                                                                 |  |                  
|Liabilities and Shareholders Equity                                                                             |  |                   |            |                  |   |           
|Accounts payable and accrued liabilities                                                                         |  | $                 | 1,135,664  |                  | $ | 675,491   
|Payable to clearing organization                                                                                 |  |                   | 1,347,256  |                  |   | 2,490,075 
|Compensation, employee benefits and payroll taxes                                                                |  |                   | 767,842    |                  |   | 497,791   
|Securities sold, not yet purchased, at fair value                                                                |  |                   | 550        |                  |   |          
|Income taxes payable - long-term                                                                                 |  |                   | 326,000    |                  |   | 315,000   
|Deferred revenue                                                                                                 |  |                   | 300,000    |                  |   | 375,000   
|Underwriter warrants - employee and independent contractor, at fair value                                        |  |                   | 49,000     |                  |   | 124,000   
|                                                                                                                 |  |                   |            |                  |   |           
|Total Liabilities                                                                                                |  |                   | 3,926,312  |                  |   | 4,477,357 
|                                                                                                                 |  |                  
|Commitments and Contingencies                                                                                    |  |                   |           |                  |   |          
|                                                                                                                 |  |                  
|Shareholders Equity                                                                                             |  |                   |            |                  |   |           
|Preferred stock, no par value; 500,000 shares authorized; none issued                                            |  |                   |           |                  |   |          
|Common stock, no par value; 20,000,000 shares authorized; shares issued and outstanding: 5,885,285 and 5,928,285 |  |                   | 2,182,890  |                  |   | 1,947,280 
|Retained earnings                                                                                                |  |                   | 19,967,669 |                  |   | 19,154,934
|                                                                                                                 |  |                   |            |                  |   |           
|Total Shareholders Equity                                                                                       |  |                   | 22,150,559 |                  |   | 21,102,214
|                                                                                                                 |  |                   |            |                  |   |           
|Total Liabilities and Shareholders Equity                                                                       |  | $                 | 26,076,871 |                  | $ | 25,579,571
|                                                                                                                 |  |                   |            |                  |   |           

See accompanying Notes to Consolidated Financial Statements.



2



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Paulson Capital Corp. and Subsidiaries

Consolidated Statements of Operations

(Unaudited)



|                                       |  |                                          |           |   |                                         |   |             |      |  |   |            |   |  |   |             |  
|-------------------------------------- |  | ---------------------------------------- | --------- | - | --------------------------------------- | - | ----------- | ---- |  | - | ---------- | - |  | - | ----------- | -
|                                       |  | For the Three Months Ended September 30, |           |   | For the Nine Months Ended September 30, |  
|                                       |  | 2009                                     |           |   | 2008                                    |   |             | 2009 |  |   | 2008       |  
|Revenues                               |  |                                          |           |   |                                         |   |             |      |  |   |            |   |  |   |             |  
|Commissions                            |  | $                                        | 3,690,445 |   |                                         | $ | 3,239,163   |      |  | $ | 9,906,201  |   |  | $ | 11,251,895  |  
|Corporate finance                      |  |                                          | 38,714    |   |                                         |   |            |      |  |   | 526,224    |   |  |   | 395,389     |  
|Investment income (loss)               |  |                                          | 266,512   |   |                                         |   | (4,262,800  | )    |  |   | 847,669    |   |  |   | (16,337,021 | )
|Trading income (loss)                  |  |                                          | 805,858   |   |                                         |   | (5,273,518  | )    |  |   | 2,713,300  |   |  |   | (2,721,476  | )
|Interest and dividends                 |  |                                          | 55,410    |   |                                         |   | 13,112      |      |  |   | 155,989    |   |  |   | 40,583      |  
|Other                                  |  |                                          | 25,333    |   |                                         |   | 25,771      |      |  |   | 75,659     |   |  |   | 82,667      |  
|                                       |  |                                          |           |   |                                         |   |             |      |  |   |            |   |  |   |             |  
|                                       |  |                                          | 4,882,272 |   |                                         |   | (6,258,272  | )    |  |   | 14,225,042 |   |  |   | (7,287,963  | )
|                                       |  |                                          |           |  
|Expenses                               |  |                                          |           |   |                                         |   |             |      |  |   |            |   |  |   |             |  
|Commissions and salaries               |  |                                          | 3,570,015 |   |                                         |   | 3,022,404   |      |  |   | 9,533,860  |   |  |   | 10,550,804  |  
|Underwriting expenses                  |  |                                          | 31,896    |   |                                         |   | 4,755       |      |  |   | 157,525    |   |  |   | 318,761     |  
|Rent, telephone and quotation services |  |                                          | 290,976   |   |                                         |   | 305,565     |      |  |   | 884,591    |   |  |   | 894,182     |  
|Professional fees                      |  |                                          | 143,978   |   |                                         |   | 154,046     |      |  |   | 559,024    |   |  |   | 627,604     |  
|Travel and entertainment               |  |                                          | 45,640    |   |                                         |   | 55,869      |      |  |   | 96,345     |   |  |   | 257,096     |  
|Advertising and promotion              |  |                                          | 62,700    |   |                                         |   | 50,653      |      |  |   | 140,150    |   |  |   | 165,239     |  
|Settlement expense                     |  |                                          | 342,128   |   |                                         |   | 44,800      |      |  |   | 503,144    |   |  |   | 76,800      |  
|Bad debt expense                       |  |                                          | 223,961   |   |                                         |   | 9,113       |      |  |   | 227,847    |   |  |   | 14,289      |  
|Depreciation and amortization          |  |                                          | 11,090    |   |                                         |   | 27,603      |      |  |   | 45,583     |   |  |   | 84,787      |  
|Other                                  |  |                                          | 250,274   |   |                                         |   | 372,139     |      |  |   | 758,511    |   |  |   | 1,147,316   |  
|                                       |  |                                          |           |   |                                         |   |             |      |  |   |            |   |  |   |             |  
|                                       |  |                                          | 4,972,658 |   |                                         |   | 4,046,947   |      |  |   | 12,906,580 |   |  |   | 14,136,878  |  
|                                       |  |                                          |           |   |                                         |   |             |      |  |   |            |   |  |   |             |  
|                                       |  |                                          |           |  
|Income (loss) before income taxes      |  |                                          | (90,386   | ) |                                         |   | (10,305,219 | )    |  |   | 1,318,462  |   |  |   | (21,424,841 | )
|                                       |  |                                          |           |  
|Income tax expense (benefit):          |  |                                          |           |   |                                         |   |             |      |  |   |            |   |  |   |             |  
|Current                                |  |                                          | (509,363  | ) |                                         |   | (2,344,366  | )    |  |   | (367,433   | ) |  |   | (1,819,568  | )
|Deferred                               |  |                                          | 616,000   |   |                                         |   | (1,612,634  | )    |  |   | 841,000    |   |  |   | (6,298,432  | )
|                                       |  |                                          |           |   |                                         |   |             |      |  |   |            |   |  |   |             |  
|                                       |  |                                          | 106,637   |   |                                         |   | (3,957,000  | )    |  |   | 473,567    |   |  |   | (8,118,000  | )
|                                       |  |                                          |           |   |                                         |   |             |      |  |   |            |   |  |   |             |  
|                                       |  |                                          |           |  
|Net income (loss)                      |  | $                                        | (197,023  | ) |                                         | $ | (6,348,219  | )    |  | $ | 844,895    |   |  | $ | (13,306,841 | )
|                                       |  |                                          |           |   |                                         |   |             |      |  |   |            |   |  |   |             |  
|Basic net income (loss) per share      |  | $                                        | (0.03     | ) |                                         | $ | (1.07       | )    |  | $ | 0.14       |   |  | $ | (2.23       | )
|                                       |  |                                          |           |   |                                         |   |             |      |  |   |            |   |  |   |             |  
|Diluted net income (loss) per share    |  | $                                        | (0.03     | ) |                                         | $ | (1.07       | )    |  | $ | 0.14       |   |  | $ | (2.23       | )
|                                       |  |                                          |           |   |                                         |   |             |      |  |   |            |   |  |   |             |  
|                                       |  |                                          |           |  
|Shares used in per share calculations: |  |                                          |           |   |                                         |   |             |      |  |   |            |   |  |   |             |  
|Basic                                  |  |                                          | 5,921,569 |   |                                         |   | 5,942,150   |      |  |   | 5,910,226  |   |  |   | 5,975,581   |  
|                                       |  |                                          |           |   |                                         |   |             |      |  |   |            |   |  |   |             |  
|Diluted                                |  |                                          | 5,921,569 |   |                                         |   | 5,942,150   |      |  |   | 5,958,503  |   |  |   | 5,975,581   |  
|                                       |  |                                          |           |   |                                         |   |             |      |  |   |            |   |  |   |             |  

See accompanying Notes to Consolidated Financial Statements.



3



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Paulson Capital Corp. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)



|                                                                                                         |  |                                         |            |   |      |   |             |  
|-------------------------------------------------------------------------------------------------------- |  | --------------------------------------- | ---------- | - | ---- | - | ----------- | -
|                                                                                                         |  | For the Nine Months Ended September 30, |           
|                                                                                                         |  | 2009                                    |            |   | 2008 |  
|Cash flows from operating activities:                                                                    |  |                                         |            |   |      |   |             |  
|Net income (loss)                                                                                        |  | $                                       | 844,895    |   |      | $ | (13,306,841 | )
|Adjustments to reconcile net income (loss) to net cash flows provided by (used in) operating activities: |  |                                         |            |   |      |   |             |  
|Receipt of underwriter warrants                                                                          |  |                                         | (217,000   | ) |      |   | (462,320    | )
|Unrealized (appreciation) depreciation/expiration of underwriter warrants                                |  |                                         | (585,000   | ) |      |   | 14,476,320  |  
|Unrealized depreciation of underwriter warrants - employee and independent contractor                    |  |                                         | (75,000    | ) |      |   | (520,000    | )
|Stock-based compensation                                                                                 |  |                                         | 241,000    |   |      |   |            |  
|Depreciation and amortization                                                                            |  |                                         | 45,583     |   |      |   | 84,787      |  
|Deferred income taxes                                                                                    |  |                                         | 841,000    |   |      |   | (6,298,432  | )
|Deferred revenue                                                                                         |  |                                         | (75,000    | ) |      |   | (75,000     | )
|Bad debt expense                                                                                         |  |                                         | 227,847    |   |      |   | 14,289      |  
|Loss on asset disposition                                                                                |  |                                         | 134        |   |      |   |            |  
|Change in assets and liabilities:                                                                        |  |                                         |            |   |      |   |             |  
|Receivables from/payable to clearing organization                                                        |  |                                         | (5,052,701 | ) |      |   | 3,182,620   |  
|Notes and other receivables                                                                              |  |                                         | (923,766   | ) |      |   | 891,197     |  
|Income taxes receivable                                                                                  |  |                                         | 5,910,426  |   |      |   | (2,647,279  | )
|Trading and investment securities                                                                        |  |                                         | (2,215,740 | ) |      |   | 10,104,090  |  
|Prepaid and deferred expenses                                                                            |  |                                         | 232,741    |   |      |   | 293,097     |  
|Accounts payable, accrued liabilities and compensation payables                                          |  |                                         | 730,224    |   |      |   | (3,710,798  | )
|Securities sold, not yet purchased                                                                       |  |                                         | 550        |   |      |   | 5,606       |  
|Income taxes payable - current                                                                           |  |                                         |           |   |      |   | (1,369,710  | )
|Income taxes payable - long-term                                                                         |  |                                         | 11,000     |   |      |   | 14,000      |  
|                                                                                                         |  |                                         |            |   |      |   |             |  
|Net cash provided by (used in) operating activities                                                      |  |                                         | (58,807    | ) |      |   | 675,626     |  
|                                                                                                         |  |                                        
|Cash flows from investing activities:                                                                    |  |                                         |            |   |      |   |             |  
|Additions to furniture and equipment                                                                     |  |                                         | (2,481     | ) |      |   | (5,863      | )
|                                                                                                         |  |                                         |            |   |      |   |             |  
|Net cash used in investing activities                                                                    |  |                                         | (2,481     | ) |      |   | (5,863      | )
|                                                                                                         |  |                                        
|Cash flows from financing activities:                                                                    |  |                                         |            |   |      |   |             |  
|Proceeds from exercise of stock options                                                                  |  |                                         | 5,650      |   |      |   |            |  
|Payments to retire common stock                                                                          |  |                                         | (43,200    | ) |      |   | (482,205    | )
|                                                                                                         |  |                                         |            |   |      |   |             |  
|Net cash used in financing activities                                                                    |  |                                         | (37,550    | ) |      |   | (482,205    | )
|                                                                                                         |  |                                         |            |   |      |   |             |  
|                                                                                                         |  |                                        
|Increase (decrease) in cash and cash equivalents                                                         |  |                                         | (98,838    | ) |      |   | 187,558     |  
|                                                                                                         |  |                                        
|Cash:                                                                                                    |  |                                         |            |   |      |   |             |  
|Beginning of period                                                                                      |  |                                         | 318,810    |   |      |   | 43,619      |  
|                                                                                                         |  |                                         |            |   |      |   |             |  
|End of period                                                                                            |  | $                                       | 219,972    |   |      | $ | 231,177     |  
|                                                                                                         |  |                                         |            |   |      |   |             |  
|                                                                                                         |  |                                        
|Supplemental cash flow information:                                                                      |  |                                         |            |   |      |   |             |  
|Cash (paid) received during the period for income taxes, net                                             |  | $                                       | 6,288,859  |   |      | $ | (2,183,421  | )
|                                                                                                         |  |                                        
|Supplemental non-cash information:                                                                       |  |                                         |            |   |      |   |             |  
|Conversion of corporate finance client note receivable to equity investment                              |  | $                                       | 404,959    |   |      | $ |            |  

See accompanying Notes to Consolidated Financial Statements.



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PAULSON CAPITAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Basis of Presentation

The financial information for Paulson Capital Corp. and its wholly-owned subsidiaries, Paulson Investment Company and Paulson Capital Properties, LLC,
included herein as of September 30, 2009 and December 31, 2008 and for the three and nine-month periods ended September 30, 2009 and 2008 is unaudited; however, such information reflects all adjustments, consisting only of normal
recurring adjustments, which, in the opinion of management, are necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods. The financial information as of December 31, 2008 is
derived from our 2008 Annual Report on Form 10-K. The interim consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in our 2008 Annual Report on Form 10-K. The
results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full year.

Note 2. Earnings Per Share

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



|                                                                                                                    |  |                                 |  |                                |  |           |  |          
|------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- |  | ------------------------------ |  | --------- |  | ---------
|                                                                                                                    |  | Three Months EndedSeptember 30, |  | Nine Months EndedSeptember 30,
|                                                                                                                    |  | 2009                            |  | 2008                           |  | 2009      |  | 2008     
|Shares used for basic net income (loss) per share                                                                   |  | 5,921,569                       |  | 5,942,150                      |  | 5,910,226 |  | 5,975,581
|Effect of dilutive stock options                                                                                    |  |                                |  |                               |  | 48,277    |  |         
|                                                                                                                    |  |                                 |  |                                |  |           |  |          
|Shares used for diluted net income (loss) per share                                                                 |  | 5,921,569                       |  | 5,942,150                      |  | 5,958,503 |  | 5,975,581
|                                                                                                                    |  |                                 |  |                                |  |           |  |          
|Stock options not included in diluted net income (loss) per share because their effect would have been
antidilutive |  | 482,500                         |  | 95,000                         |  |          |  | 95,000   
|                                                                                                                    |  |                                 |  |                                |  |           |  |          

Note 3. Unrecognized Tax Benefits and Deferred Taxes

During the three and nine-month periods ended September 30, 2009, accrued interest on unrecognized tax benefits increased $3,000 and $11,000,
respectively, as a result of tax positions taken in prior periods.

During the three and nine-month periods ended September 30, 2009, our
valuation allowance against our deferred tax assets decreased by $0.1 million and $0.3 million, respectively. At September 30, 2009, our valuation allowance totaled $0.5 million and our net deferred tax assets totaled $0.6 million.

Deferred tax assets relating to unrealized capital losses totaled $0.6 million at September 30, 2009. The realization of these deferred tax assets
is almost entirely dependent on our ability to trigger such losses and obtain refunds from carryback years. Accordingly, if such losses are not triggered by December 31, 2009, then a significant portion of these deferred tax assets may need to
be subjected to a valuation allowance and additional tax expense would be incurred.

Additionally, the corollary tax benefits recorded within
our reserve for uncertain tax positions is dependent upon our ability to obtain refunds from carryback years. If the liabilities associated with the uncertain tax positions are not incurred in the year ended December 31, 2009, and if we
are unable to generate a sufficient amount of taxable income for the year ended December 31, 2009, then the corollary income tax benefits associated with the reserve for uncertain tax positions may require a valuation allowance against such
assets and additional tax expense would be incurred.



5



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Note 4. Fair Value Measurements

We provide information related to the fair value measurements of our assets and liabilities in accordance with the provisions of ASC 820-10, Fair Value Measurements and Disclosures 
Overall, and ASC 320-10, Investments  Debt and Equity Securities  Overall.

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



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



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



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

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

Following are the disclosures related to our financial assets and (liabilities) (in thousands):



|                                                           |  |                    |       |   |             |        
|---------------------------------------------------------- |  | ------------------ | ----- | - | ----------- | -------
|                                                           |  | September 30, 2009
|                                                           |  | Fair Value         |       |   | Input Level
|Trading and investment securities, marketable              |  | $                  | 6,142 |   |             | Level 1
|Trading securities sold, not yet purchased                 |  |                    | (1    | ) |             | Level 1
|Investment securities, not readily marketable              |  |                    | 2,685 |   |             | Level 3
|Underwriter warrants                                       |  |                    | 2,477 |   |             | Level 3
|Underwriter warrants - employee and independent contractor |  |                    | (49   | ) |             | Level 3

Following is a summary of activity related to our Level 3 financial assets and liabilities (in
thousands):



|                                                                                                |  |                     |       |   |                                                        |   |      |                                           |  |   |       |  
|----------------------------------------------------------------------------------------------- |  | ------------------- | ----- | - | ------------------------------------------------------ | - | ---- | ----------------------------------------- |  | - | ----- | -
|                                                                                                |  | UnderwriterWarrants |       |   | UnderwriterWarrants
Employee andIndependentContractor |   |      | Not ReadilyMarketableInvestmentSecurities | 
|Balance, December 31, 2008                                                                      |  | $                   | 1,675 |   |                                                        | $ | (124 | )                                         |  | $ | 2,276 |  
|Fair value of underwriter warrants received included as a component of corporate finance income |  |                     | 217   |   |                                                        |   |     |                                           |  |   |      |  
|Net unrealized gain (loss), included as a component of investment income (loss)                 |  |                     | 592   |   |                                                        |   | 75   |                                           |  |   | (94   | )
|Underwriter warrants exercised or expired included as a component of investment income          |  |                     | (7    | ) |                                                        |   |     |                                           |  |   |      |  
|Conversion of corporate finance client note receivable to equity investment                     |  |                     |      |   |                                                        |   |     |                                           |  |   | 503   |  
|                                                                                                |  |                     |       |   |                                                        |   |      |                                           |  |   |       |  
|Balance, September 30, 2009                                                                     |  | $                   | 2,477 |   |                                                        | $ | (49  | )                                         |  | $ | 2,685 |  
|                                                                                                |  |                     |       |   |                                                        |   |      |                                           |  |   |       |  

Valuation of Trading Securities and Marketable Investment Securities

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

Valuation of Not Readily Marketable Investment Securities

Securities not readily marketable include investment securities (a) for which there is no market on a securities exchange or no independent publicly quoted market, (b) that cannot be publicly
offered or sold unless registration has been effected under the Securities Act of 1933, or (c) that cannot be offered or sold because of other arrangements, restrictions or conditions applicable to the securities or to us. The fair value
of not readily marketable securities is estimated by management using available information including the following: quoted market prices of similar securities (i.e., unrestricted shares of the same



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company); price of recent known trades of the same or similar securities; the cost of the security, if recently purchased, adjusted for changes in the financial condition of the issuer; all other
information available from review of available documents related to the issuer or discussions with management of the issuer.

Valuation
of Underwriter Warrants

We estimate the fair value of our underwriter warrants using the Black-Scholes Option Pricing Model. The
Black-Scholes model requires us to use five inputs including: stock price, risk free rate, exercise price, time remaining on the warrant and price volatility. After stock price, the most influential factor in this model is price volatility, which we
calculate for each companys warrants based on each companys own historical closing stock prices as well as an index of historical prices for comparable companies. When we initially receive a new underwriter warrant from an initial public
offering, its calculated volatility factor is entirely based on the volatility of an index of comparable companies, since there is no price history for a new publicly traded company. As each underwriter warrant approaches its expiration date, its
volatility factor is derived primarily from the historical prices of its underlying common stock. We cannot assure you that we will ultimately be able to exercise any of our warrants in a way that will realize the value that we attribute to them in
our financial statements based on this model.

Note 5. Conversion of Note Receivable to Equity

In February 2009, our $0.4 million note receivable from Shiftwise was converted to 966,598 shares of Series A2 Preferred Stock of Shiftwise with a value of
$0.5 million. When added to our previously existing shares, this resulted in our ownership of a total of 3,466,598 shares of Shiftwise Series A2 Preferred Stock.

Note 6. Stock Option Grants

On July 1, 2009, we granted options exercisable
for a total of 487,500 shares of our common stock with an exercise price of $1.13 per share, which was equal to the closing price of our common stock on that day. The fair value of the stock options was determined using the Black-Scholes valuation
method and totaled $241,000. The options are immediately exercisable and, accordingly, the $241,000 was recognized as a component of commissions and salaries in the third quarter of 2009.

Note 7. Reclassifications

Certain
amounts in the prior period financial statements have been reclassified to conform to the current period presentation.

Note 8. New
Accounting Pronouncements

Codification

Effective July 1, 2009, the Financial Accounting Standards Boards (FASB) Accounting Standards Codification (ASC) became the single official source of authoritative,
nongovernmental generally accepted accounting principles (GAAP) in the United States. The historical GAAP hierarchy was eliminated and the ASC became the only level of authoritative GAAP, other than guidance issued by the Securities
and Exchange Commission. Our accounting policies were not affected by the conversion to ASC. However, references to specific accounting standards in the footnotes to our consolidated financial statements have been changed to refer to the
appropriate section of ASC.

Recently Adopted Accounting Guidance

Amendment to ASC 855

ASC 855, Subsequent Events, was amended and defines
subsequent events as transactions that occur after the balance sheet date but before financial statements are issued or are available to be issued. The amendment defines two types of subsequent events: (i) events or transactions that provide
additional



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evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements (that is, recognized subsequent events);
and (ii) events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date (that is, nonrecognized subsequent events). In addition, the amendment requires an entity to disclose the date
through which subsequent events have been evaluated, as well as whether that date is the date the financial statements were issued or the date the financial statements were available to be issued. The amendment was effective for periods ending after
June 15, 2009. The adoption of the amendment, effective June 30, 2009, did not have any effect on our financial position, results of operations or cash flows.

Amendment to ASC 825

ASC 825, Financial Instruments, was amended to require
disclosures about fair value of financial instruments for interim reporting periods as well as in annual financial statements. This amendment also requires those disclosures in summarized financial information at interim reporting periods. The
adoption of this amendment, effective June 30, 2009, did not have any effect on our financial position, results of operations or cash flows.

Amendment to ASC 820 and ASC 320

ASC 820, Fair Value Measurements and Disclosures, and ASC 320, Investments
 Debt and Equity Securities, were amended to provide additional guidance for estimating fair value and emphasize that, even if there has been a significant decrease in the volume and level of activity for the asset or liability and
regardless of the valuation techniques used, the fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market
participants at the measurement date under current market conditions. The amendments also require disclosure in interim and annual periods regarding the inputs and valuation techniques used to measure fair value and a discussion of changes in
valuation techniques and related inputs, if any, during the period. It also requires that entities define major categories for equity and debt securities. The adoption of these amendments, effective June 30, 2009, did not have any effect on our
financial position, results of operations or cash flows.

Recent Accounting Guidance Not Yet Adopted

ASU 2009-05

Accounting Standards Update
(ASU) 2009-05, Fair Value Measurements and Disclosures (Topic 820)  Measuring Liabilities at Fair Value, amends ASC Topic 820, Fair Value Measurements, to allow companies determining the fair value of
a liability to use the perspective of an investor that holds the related obligation as an asset. The new guidance is effective for interim and annual periods beginning after August 27, 2009, and applies to all fair-value measurements of
liabilities required by GAAP. No new fair-value measurements are required by the update. We do not believe that the adoption of this ASU will have a material effect on our financial position, results of operations or cash flows.

Amendment to ASC 860

ASC 860,
Transfers and Servicing, was amended to improve the relevance, representational faithfulness and comparability of the information that a reporting entity provides in its financial reports about a transfer of financial assets; the effects
of a transfer on its financial position, financial performance, and cash flows; and a transferors continuing involvement in transferred financial assets. The amendments to ASC 860 are effective as of the beginning of an entitys first
annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. Earlier application is prohibited. The amendments must be
applied to transfers occurring on or after the effective date. While we are still analyzing the effects of the adoption of the amendments, we do not believe that the adoption will have a material effect on our financial position, results of
operations or cash flows.



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Note 9. Subsequent Events

We have considered all events that have occurred subsequent to September 30, 2009 and through November 13, 2009, the date the financial statements as of and for the periods ended
September 30, 2009 were available to be issued.



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

FORWARD LOOKING STATEMENTS AND RISK FACTORS

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



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



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



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



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



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



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



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



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

OVERVIEW

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



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



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



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



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



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In addition, our wholly-owned subsidiary Paulson Capital Properties, LLC was established in 2008 for the
purpose of purchasing, improving and remarketing undervalued real estate. Through September 30, 2009, we had not purchased any real estate.

Because we operate in the financial services industry, our revenues and earnings are substantially affected by general conditions in financial markets. Further, past performance is not necessarily indicative of results to be expected in
future periods. In our securities brokerage business, the amount of our revenues depends on levels of market activity requiring the services we provide. Our corporate finance activity, which consists of acting as the managing underwriter of initial
and follow-on public offerings, private investments in public equity (PIPEs) and private placements for smaller companies, is similarly affected by the strength of the market for new equity offerings, which has historically experienced
substantial cyclical fluctuation. The number of initial public offerings (IPOs) in the U.S. has declined as volatility in the U.S. economy continues. According to Renaissance Capital LLC, during the first nine months of 2009, there were
30 U.S. IPOs with gross proceeds totaling $8.9 billion. During 2008, 43 companies completed IPOs in the U.S., with proceeds totaling $28 billion. This compares to 272 IPOs in 2007, with proceeds totaling $59.7 billion. With the VISA IPO excluded
from the 2008 results, the IPOs in 2008 raised $10 billion. 2008 was the slowest year for U.S. IPOs since 1978. The low demand for IPOs in 2008 was also evidenced by the 101 companies that filed with the SEC to withdraw proposed offerings, almost
double the 51 that did so in 2007. Although we attempt to match operating costs with activity levels, many of our expenses are either fixed or difficult to change on short notice. Accordingly, fluctuations in brokerage and corporate finance revenues
tend to result in sharper fluctuations, on a percentage basis, in net income or loss.

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

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

CURRENT EVENTS

As a result of the continuing global economic turmoil and our poor operating results, in February 2009, we terminated 15% of our back
office staff, discontinued the 401(k) matching contribution and implemented 10% pay cuts for all salaried employees effective April 1, 2009. In addition, we suspended the summer 2009 investment banking conference and the November 2009
Westergaard Conference, as well as eliminated other non-essential business expenditures. We anticipate that these actions will result in annualized cost savings of approximately $1.5 million. Costs associated with these actions were primarily for
severance and related costs and were immaterial.

In September 2009, half of the 10% pay cuts for the salaried employees was restored.



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CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES

We reaffirm the critical accounting policies and estimates as reported in our Annual Report on Form 10-K for the year ended December 31, 2008, which was
filed with the Securities and Exchange Commission on March 31, 2009.

RESULTS OF OPERATIONS

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



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



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



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



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

The following tables set forth the changes in our operating results in the three and nine-month periods ended
September 30, 2009 compared to the three and nine-month periods ended September 30, 2008 (dollars in thousands):



|                                       |  |                                 |       |   |                    |   |         |                     |  |   |        |   |  |       |  
|-------------------------------------- |  | ------------------------------- | ----- | - | ------------------ | - | ------- | ------------------- |  | - | ------ | - |  | ----- | -
|                                       |  | Three Months EndedSeptember 30, |       |   | Increase(Decrease) |   |         | %Increase(Decrease) | 
|                                       |  | 2009                            |       |   | 2008               |   |         |                    
|Revenues:                              |  |                                 |       |   |                    |   |         |                     |  |   |        |   |  |       |  
|Commissions                            |  | $                               | 3,690 |   |                    | $ | 3,239   |                     |  | $ | 451    |   |  | 13.9  | %
|Corporate finance                      |  |                                 | 39    |   |                    |   |        |                     |  |   | 39     |   |  | *     |  
|Investment income (loss)               |  |                                 | 267   |   |                    |   | (4,263  | )                   |  |   | 4,530  |   |  | 106.3 |  
|Trading income (loss)                  |  |                                 | 806   |   |                    |   | (5,273  | )                   |  |   | 6,079  |   |  | 115.3 |  
|Interest and dividends                 |  |                                 | 55    |   |                    |   | 13      |                     |  |   | 42     |   |  | 323.1 |  
|Other                                  |  |                                 | 25    |   |                    |   | 26      |                     |  |   | (1     | ) |  | (3.8  | )
|                                       |  |                                 |       |   |                    |   |         |                     |  |   |        |   |  |       |  
|Total revenues (loss)                  |  |                                 | 4,882 |   |                    |   | (6,258  | )                   |  |   | 11,140 |   |  | 178.0 |  
|Expenses:                              |  |                                 |       |   |                    |   |         |                     |  |   |        |   |  |       |  
|Commissions and salaries               |  |                                 | 3,570 |   |                    |   | 3,022   |                     |  |   | 548    |   |  | 18.1  |  
|Underwriting expenses                  |  |                                 | 32    |   |                    |   | 5       |                     |  |   | 27     |   |  | *     |  
|Rent, telephone and quotation services |  |                                 | 291   |   |                    |   | 305     |                     |  |   | (14    | ) |  | (4.6  | )
|Professional fees                      |  |                                 | 144   |   |                    |   | 154     |                     |  |   | (10    | ) |  | (6.5  | )
|Travel and entertainment               |  |                                 | 46    |   |                    |   | 56      |                     |  |   | (10    | ) |  | (17.9 | )
|Advertising and promotion              |  |                                 | 63    |   |                    |   | 51      |                     |  |   | 12     |   |  | 23.5  |  
|Settlement expense                     |  |                                 | 342   |   |                    |   | 45      |                     |  |   | 297    |   |  | *     |  
|Bad debt expense                       |  |                                 | 224   |   |                    |   | 9       |                     |  |   | 215    |   |  | *     |  
|Depreciation and amortization          |  |                                 | 11    |   |                    |   | 28      |                     |  |   | (17    | ) |  | (60.7 | )
|Other                                  |  |                                 | 250   |   |                    |   | 372     |                     |  |   | (122   | ) |  | (32.8 | )
|                                       |  |                                 |       |   |                    |   |         |                     |  |   |        |   |  |       |  
|Total expenses                         |  |                                 | 4,973 |   |                    |   | 4,047   |                     |  |   | 926    |   |  | 22.9  |  
|                                       |  |                                 |       |   |                    |   |         |                     |  |   |        |   |  |       |  
|Loss before income taxes               |  | $                               | (91   | ) |                    | $ | (10,305 | )                   |  | $ | 10,214 |   |  | 99.1  | %
|                                       |  |                                 |       |   |                    |   |         |                     |  |   |        |   |  |       |  



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|                                       |  |                                |        |      |                    |         |   |                     |   |        |   |  |       |   
|-------------------------------------- |  | ------------------------------ | ------ | ---- | ------------------ | ------- | - | ------------------- | - | ------ | - |  | ----- | --
|                                       |  | Nine Months EndedSeptember 30, |        |      | Increase(Decrease) |         |   | %Increase(Decrease) |  
|                                       |  | 2009                           |        | 2008 |                    |         |  
|Revenues:                              |  |                                |        |      |                    |         |   |                     |   |        |   |  |       |   
|Commissions                            |  | $                              | 9,906  |      | $                  | 11,252  |   |                     | $ | (1,346 | ) |  | (12.0 | )%
|Corporate finance                      |  |                                | 526    |      |                    | 395     |   |                     |   | 131    |   |  | 33.2  |   
|Investment income (loss)               |  |                                | 848    |      |                    | (16,337 | ) |                     |   | 17,185 |   |  | 105.2 |   
|Trading income (loss)                  |  |                                | 2,713  |      |                    | (2,722  | ) |                     |   | 5,435  |   |  | 199.7 |   
|Interest and dividends                 |  |                                | 156    |      |                    | 41      |   |                     |   | 115    |   |  | 280.5 |   
|Other                                  |  |                                | 76     |      |                    | 83      |   |                     |   | (7     | ) |  | (8.4  | ) 
|                                       |  |                                |        |      |                    |         |   |                     |   |        |   |  |       |   
|Total revenues                         |  |                                | 14,225 |      |                    | (7,288  | ) |                     |   | 21,513 |   |  | 295.2 |   
|Expenses:                              |  |                                |        |      |                    |         |   |                     |   |        |   |  |       |   
|Commissions and salaries               |  |                                | 9,534  |      |                    | 10,551  |   |                     |   | (1,017 | ) |  | (9.6  | ) 
|Underwriting expenses                  |  |                                | 158    |      |                    | 319     |   |                     |   | (161   | ) |  | (50.5 | ) 
|Rent, telephone and quotation services |  |                                | 885    |      |                    | 894     |   |                     |   | (9     | ) |  | (1.0  | ) 
|Professional fees                      |  |                                | 559    |      |                    | 628     |   |                     |   | (69    | ) |  | (11.0 | ) 
|Travel and entertainment               |  |                                | 96     |      |                    | 257     |   |                     |   | (161   | ) |  | (62.6 | ) 
|Advertising and promotion              |  |                                | 140    |      |                    | 165     |   |                     |   | (25    | ) |  | (15.2 | ) 
|Settlement expense                     |  |                                | 503    |      |                    | 77      |   |                     |   | 426    |   |  | *     |   
|Bad debt expense                       |  |                                | 228    |      |                    | 14      |   |                     |   | 214    |   |  | *     |   
|Depreciation and amortization          |  |                                | 46     |      |                    | 85      |   |                     |   | (39    | ) |  | 45.9  |   
|Other                                  |  |                                | 758    |      |                    | 1,147   |   |                     |   | (389   | ) |  | (33.9 | ) 
|                                       |  |                                |        |      |                    |         |   |                     |   |        |   |  |       |   
|Total expenses                         |  |                                | 12,907 |      |                    | 14,137  |   |                     |   | (1,230 | ) |  | (8.7  | ) 
|                                       |  |                                |        |      |                    |         |   |                     |   |        |   |  |       |   
|Income (loss) before income taxes      |  | $                              | 1,318  |      | $                  | (21,425 | ) |                     | $ | 22,743 |   |  | 106.2 | % 
|                                       |  |                                |        |      |                    |         |   |                     |   |        |   |  |       |   



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

Revenues

The global economic turmoil that started in the fall of 2008 eased during the second and third quarters of 2009. For the period from
December 31, 2008 to September 30, 2009, the Dow Jones Industrial average increased 10.7% and the NASDAQ composite increased 34.6%. In the third quarter of 2009, the Dow Jones Industrial average increased 15.0% and the NASDAQ composite
increased 15.7%.

Commissions increased 13.9% and decreased 12.0%, respectively, in the three and nine-month periods ended September 30,
2009 compared to the same periods of 2008, primarily as a result of market uncertainty beginning in the third quarter of 2008, with improvement in the third quarter of 2009. We had 92 registered representatives at September 30, 2009 compared to
96 at December 31, 2008.

Corporate finance revenue in the third quarter of 2009 included underwriting discounts earned from a bridge
offering in which we raised $450,000. Corporate finance revenue in the nine-month period ended September 30, 2009 also included revenue related to a follow-on public offering in which we raised $3.4 million for ICOP Digital, Inc., as well as
the Black-Scholes value of the underwriter warrants received in connection with that offering, and revenue related to our participation in closed-end mutual funds.

We did not have any corporate finance revenue during the third quarter of 2008. The nine-month period ended September 30, 2008 included underwriting discounts earned from an initial public offering
in which we raised $5.1 million for Healthy Fast Foods, Inc., as well as the Black-Scholes value of the underwriter warrants received in connection with that offering.



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



|                                                                                                                                                                                 |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------- | -
|                                                                                                                                                                                 |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                                                                                                                                                                 |  | 2009                            |        |   | 2008                           |   |        | 2009 |  |   | 2008   |  
|Net unrealized appreciation (depreciation) related to underwriter warrants                                                                                                       |  | $                               | 198    |   |                                | $ | (2,869 | )    |  | $ | 585    |   |  | $ | (14,476 | )
|Net unrealized (appreciation) depreciation of underwriter warrants - employee and independent contractor                                                                         |  |                                 | (26    | ) |                                |   | 77     |      |  |   | 75     |   |  |   | 520     |  
|Net unrealized appreciation (depreciation) of securities held based on quoted market prices or, for securities that are not
readily marketable, our estimate of their fair value |  |                                 | 1,616  |   |                                |   | (1,420 | )    |  |   | 1,959  |   |  |   | (2,956  | )
|Net realized gains (losses) on the sale of securities with quoted market prices, securities that are not readily marketable and
gains from the exercise of underwriter warrants  |  |                                 | (1,521 | ) |                                |   | (51    | )    |  |   | (1,771 | ) |  |   | 575     |  
|                                                                                                                                                                                 |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|                                                                                                                                                                                 |  | $                               | 267    |   |                                | $ | (4,263 | )    |  | $ | 848    |   |  | $ | (16,337 | )
|                                                                                                                                                                                 |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  

We did not exercise any underwriter warrants during the three or nine-month periods ended
September 30, 2009 or the three-month period ended September 30, 2008. We exercised two warrants during the nine-month period ended September 30, 2008. Generally, when we exercise a warrant to obtain the underlying common stock, the
common stock is subsequently sold in the near term and the related gain is reflected as a component of investment income. In order to successfully complete a follow-on offering in the second quarter of 2009, we returned 75,750 ICOP Digital, Inc.
(units) underwriter warrants and 17,875 ICOP Digital, Inc. (common and warrant) underwriter warrants to ICOP Digital, Inc.

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

Trading income increased $6.1 million and $5.4 million, respectively, in the three and
nine-month periods ended September 30, 2009 compared to the same periods of 2008. In the three and nine-month periods ended September 30, 2009, trading income was positively affected by favorable results for certain securities that we were
holding in our trading inventories. In the three and nine-month periods ended September 30, 2008, trading income was negatively affected by difficult conditions in the market, especially the significant downturn in the third quarter of 2008.
Our focus is on very small capitalization issues, especially those tied to our corporate finance clients. Trading income (loss) can be volatile from period to period because it is driven by the market value of the securities in which we make a
market.

Expenses

Total expenses increased $0.9 million and decreased $1.2 million, respectively, in the three and nine-month periods ended September 30, 2009 compared to the same periods of 2008, as described in more detail below.

Commissions and salaries increased $0.5 million and decreased $1.0 million, respectively, in the three and nine-month periods ended September 30, 2009
compared to the same periods of 2008. The increase in the three-month period was primarily due to increased commission expense on higher commission revenue, as well as $0.2 million of non-cash, stock-based compensation related to stock option grants
in the third quarter of 2009. The decrease in the nine-month period was primarily due to lower commissions earned on lower commission revenue, partially offset by $0.2 of non-cash, stock-based compensation. The 2009 periods were also positively
affected by our staff reductions and salary decreases as discussed above. Retail commissions as a percentage of retail sales was comparable period over period.

Travel and entertainment expenses decreased $10,000 and $161,000, respectively, in the three and nine-month periods ended September 30, 2009 compared to the same periods of 2008 primarily as a result
of an investment banking conference in June 2008 with no comparable conference in 2009.



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Bad debt expense is recorded when amounts are determined to be uncollectible. Bad debt expense totaled
$224,000 and $228,000, respectively, in the three and nine-month periods ended September 30, 2009 and was related to the write-off of a note receivable from a corporate finance client. Bad debt expense was $9,000 and $14,000 in the three and
nine-month periods ended September 30, 2008, respectively.

Settlement expense of $342,000 and $503,000, respectively, in the three and
nine-month periods ended September 30, 2009 was primarily related to a failed corporate finance transaction, partially offset by insurance recoveries.

LIQUIDITY AND CAPITAL RESOURCES

Our primary sources of liquidity include our cash and
receivables from our clearing organization, offset by payables to our clearing organization. In addition, during the fourth quarter of 2008, we sold certain securities at a loss. The sale of these securities increased our income taxes receivable as
we are able to carry back the losses to prior years. We received $0.7 million of the income tax receivable during the first quarter of 2009 and $5.6 million in the second quarter of 2009.

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

We believe our cash and receivables from our clearing organization at September 30, 2009 are sufficient to meet our cash and regulatory net capital needs for at least the next twelve-month period
from September 30, 2009, which allows us to hold our investment securities for the long-term. Our liquidity could be negatively affected by protracted unfavorable market conditions. The major market indices declined significantly during 2008
and this decline continued in the first quarter of 2009, with improvements in the second and third quarters of 2009.

As a securities
broker-dealer, we are required by SEC regulations to meet certain liquidity and capital standards. We believe we were in compliance with these standards at September 30, 2009.

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

At September 30, 2009, we owned 10 underwriter warrants from 8 issuers, all but one of which was exercisable. One of the warrants had an exercise price below the September 30, 2009 market price of the securities receivable upon
exercise. There is little or no direct relationship between the intrinsic value of our underwriter warrants at the end of any given period and the fair value calculated using the Black-Scholes option pricing model. The prices of the securities
underlying the underwriter warrants are very volatile, and substantial fluctuations in their fair value can be expected in the future.



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Cash used in operating activities totaled $0.1 million in the first nine months of 2009, primarily due to
our net income of $0.8 million being offset by net non-cash income items of $0.4 million and changes in our operating assets and liabilities as discussed in more detail below.

Our net receivable from our clearing organization increased $5.0 million to $10.0 million at September 30, 2009 from $5.0 million at December 31, 2008, primarily due to the results of the
activity in our trading and investment accounts and income tax refunds, as well as the timing of general corporate expenditures and cash flow requirements.

Notes and other receivables increased $0.7 million to $1.3 million at September 30, 2009 from $0.6 million at December 31, 2008, primarily due to additional amounts loaned to corporate finance
clients, offset by the conversion of a $0.4 million corporate finance client note receivable to an equity investment and a $0.2 million write-off of a note receivable from one of our corporate finance clients.

Income taxes receivable, current decreased $5.9 million to $0.6 million at September 30, 2009 from $6.5 million at December 31, 2008, primarily
due to refunds received.

Deferred tax assets decreased $0.8 million to $0.6 million at September 30, 2009 from $1.4 million at
December 31, 2008, primarily due to sales of securities that were in a loss position.

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

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



|                                         |  |   |       |  
|---------------------------------------- |  | - | ----- | -
|Balance, December 31, 2008               |  | $ | 1,675 |  
|Receipt of underwriter warrants          |  |   | 217   |  
|Net unrealized gain on value of warrants |  |   | 592   |  
|Warrants exercised or expired            |  |   | (7    | )
|                                         |  |   |       |  
|Balance, September 30, 2009              |  | $ | 2,477 |  
|                                         |  |   |       |  

Deferred revenue of $0.3 million at September 30, 2009 related to amounts received from our
clearing firm based on the execution of a five-year agreement and a one-year extension of the agreement, and is being amortized at the rate of $8,333 per month through September 2012.

Underwriter warrants  employee and independent contractor of $49,000 at September 30, 2009 represented the fair value of underwriter warrants held for which the gain from the sale of the
related stock upon exercise is due to certain employees.

In September 2001, our Board of Directors approved a stock repurchase program
pursuant to which we are authorized to repurchase up to 600,000 shares of our common stock. In addition, in June 2008, our Board of Directors approved the repurchase of up to a total of an additional 200,000 shares of our common stock. We
repurchased 48,000 shares during the first nine months of 2009 and, at September 30, 2009, 195,011 shares remained available for repurchase. These repurchase programs do not have an expiration date.

OFF-BALANCE SHEET ARRANGEMENTS

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

NEW ACCOUNTING PRONOUNCEMENTS

See Note 8 of Notes to Consolidated Financial Statements.



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

Not required for Smaller Reporting Companies.



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

Disclosure Controls and Procedures

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

Changes in Internal Control Over Financial Reporting

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

PART II - OTHER INFORMATION



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

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



|     |  |                                                                                                                                                             
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.1 |  | Form of Incentive Stock Option Agreement for July 2009 stock option grants pursuant to the Paulson Capital Corporation 1999 Stock Option Plan.              
|     | 
|10.2 |  | Form of Non-Qualified Stock Option Agreement for July 2009 stock option grants pursuant to the Paulson Capital Corporation 1999 Stock Option Plan.          
|     | 
|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 Principal 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 Principal Financial Officer pursuant to Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.



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SIGNATURES

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



|                        |  |  |  |                       |  |                                      
|----------------------- |  |  |  | --------------------- |  | -------------------------------------
|Date: November 13, 2009 |  |  |  | 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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