**UNITED
        STATES SECURITIES AND EXCHANGE COMMISSION**
 **Washington,
        D.C. 20549**
 
 **FORM
        10-Q**
 
 **QUARTERLY
        REPORT PURSUANT TO SECTION 13 OR 15(d) OF**
 **THE
        SECURITIES EXCHANGE ACT OF 1934**
 
 **For
        the quarterly period ended**  **September
        30, 2008**
  **1-32146**
 
 Commission
        file number
 
 
 
 **DOCUMENT
                  SECURITY SYSTEMS, INC.**(Exact name of registrant as specified in its charter)
 
 **New
                  York**
              
              **16-1229730**(State
                  of incorporation)
              
              (IRS Employer Identification Number)
 
 **28
                  Main Street East, Suite 1525****Rochester,****NY****14614**(Address
                  of principal executive office)
 
 **(585)
                  325-3610**(Registrant's
                  telephone number)
 
 **Indicate
        by check mark whether the registrant:**
 (1)
        filed
        all reports required to be filed by Section 13 or 15(d) of the Exchange Act
        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 is a large accelerated filer, an
        accelerated filer, a non-accelerated filer, or a smaller reporting company.
        See
        definition of “large accelerated filer”, “accelerated filer” and “smaller
        reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
 Large
        accelerated filer  ̈ Accelerated
        filer x Non-accelerated
        filer  ̈ Smaller
        reporting company  ̈
 
 Indicate
        by check mark whether the registrant is a shell company (as defined in Rule
        12b-2 of the Exchange Act)
 **Yes** ** ̈** **No** **x**
  **Applicable
        only to corporate issuers**
 As
        of
        November 7, 2008 (the most recent practicable date), there were 14,472,994
        shares of the issuer's Common Stock, $0.02 par value per share,
        outstanding.
  
 **DOCUMENT
          SECURITY SYSTEMS, INC.**
 **FORM
          10-Q**
 **TABLE
          OF CONTENTS**
 
 **PART
                    I**
                
                **FINANCIAL
                    INFORMATION**Item
                    1
                
                Financial
                    StatementsConsolidated
                    Balance Sheets
                
                3Consolidated
                    Statements of Operations
                
                4Consolidated
                    Statements of Cash Flows
                
                5Notes
                    to Interim Consolidated Financial Statements
                
                6Item
                    2
                
                Management's
                    Discussion and Analysis of Financial Condition and Results of
                    Operations
                
                16Item
                    3
                
                Quantitative
                    and Qualitative Disclosures about Market Risk
                
                23Item
                    4
                
                Controls
                    and Procedures
                
                23**PART
                    II**
                
                **OTHER
                    INFORMATION**Item
                    1
                
                Legal
                    Proceedings
                
                23Item
                    1a
                
                Risk
                    Factors
                
                25Item
                    2
                
                Unregistered Sales
                    of Equity Securities and Use of Proceeds
                
                30Item
                    3
                
                Defaults
                    upon Senior Securities
                
                30Item
                    4
                
                Submission
                    of Matters to a Vote of Security Holders
                
                30Item
                    5
                
                Other
                    Information
                
                30Item
                    6
                
                Exhibits
                
                31**SIGNATURES**
 2
  **PART
        I**
  **FINANCIAL
        INFORMATION**
 ITEM
        1 -
        FINANCIAL STATEMENTS
 
 **DOCUMENT
        SECURITY SYSTEMS, INC.  AND SUBSIDIARIES**
 **Consolidated
        Balance Sheets**
 **As
        of**
 **September 30,**
                
                **December 31,****2008**
                
                **2007****(unaudited)**
                
                **(audited)****ASSETS****Current
                    assets:**Cash
                    and cash equivalents
                
                $
                442,803
                
                $
                742,468Restricted
                    cash
                
                
                157,500
                
                
                -Accounts
                    receivable, net of allowance of $65,000 ($82,000 as of December
                    31,
                    2007)
                
                
                784,668
                
                
                617,320Inventory
                
                
                230,272
                
                
                259,442Loans
                    to employees
                
                
                67,781
                
                
                120,732Prepaid
                    expenses and other current assets
                
                
                87,906
                
                
                487,715Total
                    current assets
                
                
                1,770,930
                
                
                2,227,677**Restricted
                    cash**
                
                
                -
                
                
                177,345**Fixed
                    assets, net**
                
                
                1,349,230
                
                
                1,494,540**Other
                    assets**
                
                
                258,085
                
                
                147,958**Goodwill**
                
                
                1,396,734
                
                
                1,396,734**Other
                    intangible assets, net**
                
                
                3,580,285
                
                
                6,149,530**Total
                    assets**
                
                $
                8,355,264
                
                $
                11,593,784**LIABILITIES
                    AND STOCKHOLDERS' EQUITY****Current
                    liabilities:**Accounts
                    payable
                
                $
                1,353,926
                
                $
                1,795,085Accrued
                    expenses & other current liabilities
                
                
                1,112,404
                
                
                818,606Deferred
                    revenue & customer deposits
                
                
                56,580
                
                
                732,355Current
                    portion of capital lease obligations
                
                
                84,129
                
                
                79,948Total
                    current liabilities
                
                
                2,607,039
                
                
                3,425,994**Revolving
                    notes from related parties**
                
                
                1,858,000
                
                
                300,000**Capital
                    lease obligations**
                
                
                215,229
                
                
                294,821**Deferred
                    revenue**
                
                
                -
                
                
                15,938**Deferred
                    tax liability**
                
                
                203,397
                
                
                200,000**Commitments
                    and contingencies (see Note 10)****Stockholders'
                    equity**Common
                    stock, $.02 par value; 200,000,000 shares authorized, 14,359,756
                    shares
                    issued and outstanding (13,654,364 in 2007) (325,000 subscribed
                    in
                    2008)
                
                
                287,195
                
                
                273,087Additional
                    paid-in capital
                
                
                34,881,064
                
                
                31,298,571Subscriptions
                    receivable
                
                
                (1,300,000
                )
                
                -Accumulated
                    deficit
                
                
                (30,396,660
                )
                
                (24,214,627
                )Total
                    stockholders' equity
                
                
                3,471,599
                
                
                7,357,031**Total
                    liabilities and stockholders' equity**
                
                $
                8,355,264
                
                $
                11,593,784
 
 See
        accompanying notes
  3
  **DOCUMENT
          SECURITY SYSTEMS, INC. AND SUBSIDIARIES**
 **Consolidated
          Statements of Operations**
 (unaudited)
 
 **Three Months Ended September 30,**
                
                **Nine Months Ended September 30,****2008**
                
                **2007**
                
                **2008**
                
                **2007**RevenueSecurity
                    printing and products
                
                $
                1,334,184
                
                $
                945,941
                
                $
                3,421,437
                
                $
                2,764,323Royalties
                
                
                181,047
                
                
                278,290
                
                
                1,401,522
                
                
                871,243Digital
                    solutions
                
                
                8,220
                
                
                9,469
                
                
                24,660
                
                
                184,240Legal
                    products
                
                
                150,129
                
                
                175,725
                
                
                482,561
                
                
                513,070Total
                    Revenue
                
                
                1,673,580
                
                
                1,409,425
                
                
                5,330,180
                
                
                4,332,876Costs
                    of revenueSecurity
                    printing and products
                
                
                635,934
                
                
                635,935
                
                
                2,027,636
                
                
                1,691,473Digital
                    solutions
                
                
                3,507
                
                
                3,507
                
                
                10,521
                
                
                40,521Legal
                    products
                
                
                86,120
                
                
                82,575
                
                
                257,536
                
                
                276,342Total
                    costs of revenue
                
                
                725,561
                
                
                722,017
                
                
                2,295,693
                
                
                2,008,336**Gross
                    profit**
                
                
                948,019
                
                
                687,408
                
                
                3,034,487
                
                
                2,324,540**Operating
                    expenses:**Selling,
                    general and administrative
                
                
                1,789,790
                
                
                1,979,171
                
                
                5,828,136
                
                
                5,587,903Research
                    and development
                
                
                72,876
                
                
                110,833
                
                
                322,106
                
                
                314,130Impairment
                    of patent defense costs
                
                
                -
                
                
                -
                
                
                291,581
                
                
                -Amortization
                    of intangibles
                
                
                540,934
                
                
                480,256
                
                
                1,605,104
                
                
                1,258,985Operating
                    expenses
                
                
                2,403,600
                
                
                2,570,260
                
                
                8,046,927
                
                
                7,161,018**Operating
                    loss**
                
                
                (1,455,581
                )
                
                (1,882,852
                )
                
                (5,012,440
                )
                
                (4,836,478
                )**Other
                    income (expense):**Interest
                    income
                
                
                484
                
                
                14,829
                
                
                569
                
                
                89,816Gain
                    (loss) on foreign currency transactions
                
                
                7,534
                
                
                (6,378
                )
                
                (16,652
                )
                
                (10,669
                )Interest
                    expense
                
                
                (41,208
                )
                
                (1,362
                )
                
                (95,098
                )
                
                (3,811
                )Loss
                    on sale of patent assets
                
                
                (1,169,947
                )
                
                -
                
                
                (1,169,947
                )
                
                -Other
                    Income
                
                
                -
                
                
                -
                
                
                125,795
                
                
                -**Loss
                    from continuing operations before income taxes**
                
                
                (2,658,718
                )
                
                (1,875,763
                )
                
                (6,167,773
                )
                
                (4,761,142
                )Income
                    tax expense
                
                
                4,738
                
                
                4,738
                
                
                14,260
                
                
                14,214**Loss
                    from continuing operations**
                
                
                (2,663,456
                )
                
                (1,880,501
                )
                
                (6,182,033
                )
                
                (4,775,356
                )**Loss
                    from discontinued operations (Note 8)**Gain
                    on sale of discontinued assets
                
                
                
                
                
                42,905
                
                
                
                
                
                42,905Loss
                    from discontinued operations
                
                
                -
                
                
                (43,807
                )
                
                -
                
                
                (59,233
                )Loss
                    on discontinued operations
                
                
                -
                
                
                (902
                )
                
                -
                
                
                (16,328
                )**Net
                    loss**
                
                $
                (2,663,456
                )
                $
                (1,881,403
                )
                $
                (6,182,033
                )
                $
                (4,791,684
                )**Net
                    loss per share -basic and diluted:**Continuing
                    operations
                
                $
                (0.19
                )
                $
                (0.14
                )
                $
                (0.45
                )
                $
                (0.35
                )Discontinued
                    operations
                
                
                (0.00
                )
                
                0.00
                
                
                (0.00
                )
                
                0.00Net
                    Loss
                
                $
                (0.19
                )
                $
                (0.14
                )
                $
                (0.45
                )
                $
                (0.35
                )**Weighted
                    average common shares outstanding, basic and diluted**
                
                
                14,286,192
                
                
                13,676,030
                
                
                13,879,891
                
                
                13,629,241
  See
          accompanying notes
  4
 
 **DOCUMENT
        SECURITY SYSTEMS, INC. AND SUBSIDIARIES**
 **Consolidated
        Statements of Cash Flows**
 **For
        the Nine Months Ended September 30,**
 (unaudited)
  **2008**
              
              **2007****Cash
                  flows from operating activities:**Net
                  loss
              
              $
              (6,182,033
              )
              $
              (4,791,684
              )Adjustments
                  to reconcile net loss to net cash used by operating
                  activities:Depreciation
                  and amortization
              
              
              1,841,975
              
              
              1,396,262Stock
                  based compensation
              
              
              1,536,403
              
              
              970,829Impairment
                  of patent defense costs
              
              
              291,581
              
              
              -Net
                  gain on disposal of discontinued operations
              
              
              -
              
              
              (42,905
              )Loss
                  on sale of patent assets
              
              
              1,169,947
              
              
              -Decrease
                  in restricted cash
              
              
              19,845
              
              
              -(Increase)
                  decrease in assets:Accounts
                  receivable
              
              
              (167,348
              )
              
              (112,870
              )Inventory
              
              
              29,170
              
              
              4,762Prepaid
                  expenses and other assets
              
              
              (43,049
              )
              
              (171,526
              )Increase
                  (decrease) in liabilities:Accounts
                  payable
              
              
              (65,053
              )
              
              445,334Accrued
                  expenses and other liabilities
              
              
              143,914
              
              
              (25,635
              )Deferred
                  revenue
              
              
              (691,713
              )
              
              (234,464
              )Net
                  cash used by operating activities
              
              
              (2,116,361
              )
              
              (2,561,897
              )**Cash
                  flows from investing activities:**Purchase
                  of fixed assets
              
              
              (226,716
              )
              
              (423,918
              )Proceeds
                  from the sale of discontinued operations
              
              
              -
              
              
              80,000Proceeds
                  from the sale of patent assets
              
              
              500,000
              
              
              -Purchase
                  of other intangible assets
              
              
              (1,144,351
              )
              
              (1,150,977
              )Net
                  cash used by investing activities
              
              
              (871,067
              )
              
              (1,494,895
              )**Cash
                  flows from financing activities:**Borrowing
                  on short-term credit facility
              
              
              500,000
              
              
              -Repayment
                  on short-term credit facility
              
              
              (500,000
              )
              
              -Borrowing
                  on revolving note- related parties
              
              
              1,558,000
              
              
              -Repayments
                  of capital lease obligations
              
              
              (75,411
              )
              
              (27,140
              )Increase
                  in restricted cash
              
              
              -
              
              
              (177,345
              )Payment
                  of stock issuance costs
              
              
              -
              
              
              (519,619
              )Issuance
                  of common stock
              
              
              1,205,174
              
              
              355,225Net
                  cash provided (used) by financing activities
              
              
              2,687,763
              
              
              (368,879
              )**Net
                  increase (decrease) in cash and cash equivalents**
              
              
              (299,665
              )
              
              (4,425,671
              )**Cash
                  and cash equivalents beginning of period**
              
              
              742,468
              
              
              5,802,615**Cash
                  and cash equivalents end of period**
              
              $
              442,803
              
              $
              1,376,944
 
 See
        accompanying notes.
  5
  **DOCUMENT
        SECURITY SYSTEMS, INC.**
 **NOTES
        TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS**
 **September
        30, 2008**
 **(Unaudited)**
  **1.    
        Basis of Presentation and Significant Accounting Policies**
  The
        accompanying unaudited condensed consolidated financial statements have been
        prepared in accordance with U.S. generally accepted accounting principles
        for
        interim financial information and with the instructions to Form 10-Q and
        Article
        10 of Regulation S-X. Accordingly, these statements do not include all of
        the
        information and footnotes required by U.S. generally accepted accounting
        principles for complete financial statements. In the opinion of management,
        the
        accompanying balance sheets and related interim statements of operations
        and
        cash flows include all adjustments, consisting only of normal recurring items
        necessary for their fair presentation in accordance with U.S. generally accepted
        accounting principles. All significant intercompany transactions have been
        eliminated.
 
 Interim
        results are not necessarily indicative of results expected for a full year.
        For
        further information regarding Document Security Systems, Inc (the “Company”)
        accounting policies, refer to the audited consolidated financial statements
        and
        footnotes thereto included in the Company's Form 10-K for the fiscal year
        ended
        December 31, 2007.
 
 The
        preparation of financial statements in conformity with accounting principles
        generally accepted in the United States requires management to make estimates
        and assumptions that affect the reported amounts of assets and liabilities
        and
        disclosure of contingent assets and liabilities at the date of the financial
        statements and the reported amounts of revenues and expenses during the
        reporting period. Actual results could differ materially from those estimates
        and assumptions.
 
 ***Other
        Intangible Assets*** – Other
        intangible assets consists of costs associated with the application, acquisition
        and defense of the Company’s patents, contractual rights to patents and trade
        secrets associated with the Company’s technologies, a non-exclusive licensing
        agreement, and customer lists obtained as a result of acquisitions. The
        Company’s patents and trade secrets are for document anti-counterfeiting and
        anti-scanning technologies and processes that form the basis of the Company’s
        document security business. External legal costs incurred to defend the
        Company’s patents are capitalized to the extent of an evident increase in the
        value of the patents and an expected successful outcome. Legal costs are
        expensed at the point when it is determined that the outcome is expected
        to be
        unsuccessful. The Company capitalizes the cost of an appeal until it is
        determined that the appeal will be unsuccessful. The Company’s capitalized
        patent defense costs expenses are analyzed for impairment based on the expected
        eventual outcome of the legal action and recoverability of proceeds or added
        economic value of the patent in excess of the costs. Legal actions related
        to
        the same patent defense case are unified into one asset group for the purposes
        on the impairment analysis. The Company amortizes its other intangible assets
        over their estimated useful lives. Patents are amortized over the remaining
        legal life, up to 20 years. Intangible asset amortization expense is classified
        as an operating expense.
 
 ***Recent
        Accounting Pronouncements*** In
        September 2006, the FASB issued SFAS No.157 *,
        Fair Value Measurements* .
        SFAS
        No. 157, as amended, defines fair value, establishes a framework for measuring
        fair value in accordance with accounting principles generally accepted in
        the
        United States of America, and expands disclosures about fair value measurements.
        With respect to financial assets and liabilities, SFAS No. 157 is effective
        for
        financial statements issued for fiscal years beginning after November 15,
        2007. However, in February 2008, the FASB determined that an entity need
        not apply this standard to nonfinancial assets and liabilities that are
        recognized or disclosed at fair value in the financial statements on a
        nonrecurring basis until 2009. Accordingly, the Company’s adoption of this
        standard on January 1, 2008, is limited to financial assets and
        liabilities and did not have a material effect on the Company’s financial
        condition or results of operations. The Company’s still in the process of
        evaluating the impact of this standard with respect to its effect on
        nonfinancial assets and liabilities and has not yet determined the impact
        that
        it will have on the consolidated financial statements upon full adoption.
 
 In
        February 2007, the FASB issued SFAS No. 159, *The
        Fair Value Option for Financial Assets and Financial
        Liabilities* ,
        which
        permits entities to choose to measure certain financial assets and liabilities
        at fair value. SFAS No. 159 is effective for years beginning after
        November 15, 2007. The Company has not adopted the fair value option
        method permitted by SFAS No. 159.
  6
  In
        December 2007, the Financial Accounting Standards Board issued Statement of
        Financial Accounting Standards No. 141 (revised 2007), “ *Business
        Combinations* ”
(“SFAS
        141R”), which replaces SFAS 141. SFAS 141R establishes principles and
        requirements for how an acquirer in a business combination recognizes and
        measures in its financial statements the identifiable assets acquired, the
        liabilities assumed, and any controlling interest; recognizes and measures
        the
        goodwill acquired in the business combination or a gain from a bargain purchase;
        and determines what information to disclose to enable users of the financial
        statements to evaluate the nature and financial effects of the business
        combination. SFAS 141R is to be applied prospectively to business combinations
        for which the acquisition date is on or after an entity’s fiscal year that
        begins after December 15, 2008. We are currently evaluating the potential
        impact of the adoption of SFAS 141R on our consolidated financial position,
        results of operations and cash flows.
 
 In
        December 2007, the FASB issued SFAS No. 160, *Noncontrolling
        Interests in Consolidated Financial Statements-on Amendment of ARB No.
        51* .
        SFAS
        No. 160 establishes accounting and reporting standards for the noncontrolling
        interest in a subsidiary. SFAS No. 160 is effective for financial statements
        issued for fiscal years beginning after December 15, 2008, and interim
        statements within those fiscal years. Among other things, SFAS No. 160 requires
        noncontrolling interest to be included as a component of shareholders’ equity.
        The Company does not currently have any noncontrolling interests.
 
 On
        December 21, 2007, the SEC issued Staff Accounting Bulletin No. 110,
“Share-Based Payment”. SAB No. 110 addresses the use of a “simplified”
method in developing an estimate of expected term of “plain vanilla” share
        options in accordance SFAS No. 123(R), “Share-Based Payment”. SAB
        No. 110 allows the use of the “simplified” method of estimating expected
        term where a company may not have sufficient historical exercise data. SAB
        No. 110 is effective January 1, 2008 and the Company plans to
        continue to use the simplified method to estimate the expected term of its
        plain
        vanilla employee options.
  On
        December 12, 2007, the Financial Accounting Standards Board (FASB) ratified
        the
        Emerging Issues Task Force (“EITF”) opinion related to EITF Issue 07-1,
“Accounting for Collaborative Arrangements.” The Task Force reached a consensus
        that a collaborative arrangement is a contractual arrangement that involves
        two
        or more parties, all of which are both (a) involved as active participants
        in a
        joint operating activity that is not conducted primarily through a separate
        legal entity and (b) exposed to significant risks and rewards that depend
        on the
        commercial success of the joint operating activity. This Issue also addresses
        (i) the income statement classification by participants in a collaborative
        arrangement for transactions with third parties and transactions between
        the
        participants and (ii) financial statement disclosures. The consensus on EITF
        Issue 07-1 is effective for fiscal years beginning after December 15, 2008,
        and
        for interim periods within those fiscal years. Entities should apply the
        consensus retrospectively to all periods presented for only those collaborative
        arrangements existing as of the effective date, unless it is impractical
        to do
        so. The Company will adopt this new accounting pronouncement effective January
        1, 2009, and does not anticipate any material impact on its financial condition
        or results of operations.
 
 In
        April 2008, the FASB issued FSP FAS 142-3, “Determination of Useful Life of
        Intangible Assets” (“FSP FAS 142-3”). FSP FAS 142-3 amends the factors that
        should be considered in developing the renewal or extension assumptions used
        to
        determine the useful life of a recognized intangible asset under FAS 142,
        “Goodwill and Other Intangible Assets.” FSP FAS 142-3 also requires expanded
        disclosure related to the determination of intangible asset useful lives.
        FSP
        FAS 142-3 is effective for fiscal years beginning after December 15, 2008.
        The Company is currently evaluating the potential impact the adoption of
        FAS FSP
        142-3 will have on its financial statements.
  In
        May 2008, the FASB issued FASB Staff Position (“FSP”) APB 14-1, “Accounting
        for Convertible Debt Instruments That May Be Settled in Cash upon Conversion
        (Including Partial Cash Settlement)” (“FSP APB 14-1”), which clarifies the
        accounting for convertible debt instruments that may be settled in cash upon
        conversion, including partial cash settlement. FSP APB 14-1 specifies that
        an
        issuer of such instruments should separately account for the liability and
        equity components of the instruments in a manner that reflect the issuer’s
        non-convertible debt borrowing rate when interest costs are recognized in
        subsequent periods. FSP APB 14-1 is effective for fiscal years beginning
        after
        December 15, 2008, and retrospective application is required for all
        periods presented. The Company is currently evaluating the potential impact
        of
        the adoption of FSP APB 14-1 on its financial statements.
  In
        May
        2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted
        Accounting Principles. The purpose of this statement is to improve financial
        reporting by providing a consistent framework for determining applicable
        accounting principles to be used in the preparation of financial statements
        presented in conformity with accounting principles generally accepted in
        the
        United States of America. SFAS No. 162 will become effective 60 days after
        the
        SEC’s approval. The Company believes that the adoption of this standard on its
        effective date will not have a material effect on the consolidated financial
        statements
  7
  In
        June
        2008, the FASB issued FSP EITF 03-6-1 to address whether instruments granted
        in
        share-based payment transactions are participating securities prior to their
        vesting and therefore need to be included in the earnings per share calculation
        under the two-class method described in SFAS No. 128, “Earnings per Share.” This
        FSP requires companies to treat unvested share-based payment awards that
        have
        non-forfeitable rights to dividends or dividend equivalents as participating
        securities and thus, include them in calculation of basic earnings per share.
        FSP EITF 03-6-1 is effective for fiscal years beginning after December 15,
        2008.
        The Company does not anticipate a material impact on its financial statements
        or
        its computation of basic earnings per share upon adoption.
  During
        the quarter ended June 30 2008, the Company adopted FSP 00-19-2, Accounting
        for Registration Payment Arrangements. This FSP specifies that the contingent
        obligation to make future payments or otherwise transfer consideration under
        a
        registration payment arrangement, whether issued as a separate agreement
        or
        included as a provision of a financial instrument or other agreement, should
        be
        separately recognized and measured in accordance with FASB Statement No.
        5,
        Accounting for Contingencies. The Company has determined it to be remote,
        that
        it will be required to remit payments to the investors for failing to obtain
        an
        effective registration statement  on
        or
        before the required time frame.
  **2.    
        Restricted Cash**
  In
        July
        2007, the Company established a restricted cash balance of 87,500 British
        pounds, or approximately $157,500 (as of September 30, 2008), as collateral
        for
        a deed of guarantee that was required by the English Court of Appeals in
        order
        for the Company to pursue an appeal in that court. On March 19, 2008, the
        Company was notified that its appeal was denied and that the Company owed
        the
        European Central Bank, the successful party in the appeal, the 87,500 British
        pounds. On May 14, 2008, the Company made a payment of 87,500 British pounds
        to
        the European Central Bank as an interim payment of the appeal costs pending
        final assessment by the Court which is expected in the fourth quarter of
        2008.
        The Company was not able to apply the funds in its restricted account to
        this
        payment. The Company will use the restricted funds to pay additional fees
        due
        upon final assessment of the costs by the Court, if any. Accordingly, the
        Company classified the restricted cash as current as of September 30, 2008.
        (See
        Note 10 *Commitments
        and Contingencies)*
  **3.**  **Inventory**
  Inventory
        consisted of the following:
  **September 30**
              
              **December 31,****2008**
              
              **2007****(unaudited)**
              
              **(audited)**Finished
                  Goods
              
              $
              143,606
              
              $
              161,978Raw
                  Materials
              
              
              86,666
              
              
              97,464$
              230,272
              
              $
              259,442
  8
  **4.    
        Other Intangible Assets**
  Other
        intangible assets are comprised of the following:
 
 **September 30, 2008**
              
              **December 31, 2007****Useful**
                **Life**
              
              **Gross Carrying**
                **Amount**
              
              **Accumulated**
                **Amortizaton**
              
              **Net Carrying**
                **Amount**
              
              **Gross Carrying**
                **Amount**
              
              **Accumulated**
                **Amortizaton**
              
              **Net Carrying**
                **Amount**Royalty
                  rights
              
              
              5 years
              
              $
              90,000
              
              $
              85,500
              
              $
              4,500
              
              $
              90,000
              
              $
              72,000
              
              $
              18,000Other
                  intangibles
              
              
              5
                  years
              
              
              1,187,595
              
              
              508,374
              
              $
              679,221
              
              
              1,187,595
              
              
              335,304
              
              
              852,291Patent
                  and contractual rights
              
              
              Varied
              (1)
              
              5,427,570
              
              
              2,531,006
              
              $
              2,896,564
              
              
              8,205,340
              
              
              2,926,101
              
              
              5,279,239**$**
              **6,705,165**
              
              **$**
              **3,124,880**
              
              **$**
              **3,580,285**
              
              **$**
              **9,482,935**
              
              **$**
              **3,333,405**
              
              **$**
              **6,149,530**
  (1)-
        patent rights are amortized over their expected useful life which is generally
        the legal life of the patent. As of September 30, 2008 the weighted average
        remaining useful life of these assets in service was 3.0 years.
  On
        March
        19, 2008, the Company received notification that its appeal of the invalidation
        of its European Patent 455750B1 in the UK was not successful. As result of
        the
        adverse court decision, the Company recognized an impairment loss of
        approximately $292,000 associated with the U.K appeal as of March 31, 2008.
        The
        impairment loss includes a judgment for reimbursement of estimated counterpart
        legal fees. The Company may owe additional counter party legal fees associated
        with the decision, which the Company will expense as soon as the amount,
        if any,
        is estimatable.
  On
        August
        20, 2008, the Company entered into an agreement with Trebuchet Capital Partners,
        LLC (“Trebuchet”) under which Trebuchet has agreed to pay substantially all of
        the litigation costs associated with pending validity proceedings initiated
        by
        the European Central Bank (“ECB”) in eight European countries relating to the
        Company’s European Patent 0 455 750B1 that the Company has claimed the ECB
        infringed in printing of the Euro currency (the “Patent”). Trebuchet also agreed
        to pay substantially all of the litigation costs associated with future validity
        challenges filed by the ECB or other parties, provided that Trebuchet elects
        to
        assume the defense of any such challenges, in its sole discretion, and patent
        infringement suits filed against the ECB and certain other alleged infringers
        of
        the Patent, all of which suits may be brought at the sole discretion of
        Trebuchet and may be in the name of the Company, Trebuchet or both. The Company
        provided Trebuchet with the sole and exclusive right to manage infringement
        litigation relating to the Patent in Europe, including the right to initiate
        litigation in the name of the Company, Trebuchet or both and to choose whom
        and
        where to sue, subject to certain limitations set forth in the agreement.
        Under
        the terms of the Agreement, the Company and Trebuchet have agreed to equally
        share all proceeds generated from litigation relating to the Patent, including
        judgments and licenses or other arrangements entered into in settlement of
        any
        such litigation. Trebuchet is also entitled to recoup any litigation expenses
        specifically awarded to the Company in such actions.
 
 Under
        the
        terms of the Agreement, and in consideration for Trebuchet’s funding agreement,
        the Company assigned and transferred a 49% interest of all of the Company’s
        right, title and interest in the Patent to Trebuchet which allows Trebuchet
        to
        have a separate and exclusive interest including a separate and distinct
        right
        to exploit the Patent. Pursuant to this transaction, the Company recognized
        a
        loss on the sale of patent assets for its assignment and transfer of 49%
        of its
        ownership rights in the patent, which had a net book value of approximately
        $1,670,000, for proceeds of $500,000. As a result, the Company recognized
        a loss
        on sale of patent assets of approximately $1,170,000. The Company considered
        this a triggering event and reviewed its remaining capitalized patent costs
        for
        impairment as of September 30, 2008. With the assistance of Trebuchet, the
        Company determined that the expected eventual outcome of the legal action
        and
        recoverability of proceeds or added economic value of the patent was still
        in
        excess of the current carrying amount.
  9
  **5.    
        Revolving Notes**
  On
        January 4, 2008, the Company entered into a Credit Facility Agreement with
        Fagenson and Co., Inc., as agent, a related party to Robert B. Fagenson,
        the
        Chairman of the Company's Board of Directors. Under the Fagenson Credit
        Agreement, the Company can borrow up to a maximum of $3,000,000 from time
        to
        time up to and until January 4, 2010. The advances are generally limited
        to
        $400,000 unless otherwise mutually agreed upon by both parties per fiscal
        quarter, with the exception of $600,000 that can be advanced at any time
        for
        patent litigation related bills. Any amount borrowed by the Company pursuant
        to
        the Fagenson Credit Agreement will have an annual interest rate of 2% above
        LIBOR and will be secured by the Common Stock of Plastic Printing Professionals,
        Inc., (“P3”) the Company's wholly owned subsidiary. Interest is payable
        quarterly in arrears and the principal is payable in full at the end of the
        term
        under the Fagenson Credit Agreement. In addition, on January 4, 2008, the
        Company also entered into a Credit Facility Agreement with Patrick White,
        the
        Company's Chief Executive Officer and a member of the Board of Directors.
        Under
        the White Credit Agreement, the Company can borrow up to $600,000 from time
        to
        time up to and until January 4, 2010. Any amount borrowed by the Company
        pursuant to the White Credit Agreement will have an annual interest rate
        of 2%
        above LIBOR and will be secured by the accounts receivable of the Company,
        excluding the accounts receivable of P3. Interest is payable quarterly in
        arrears and the principal is payable in full at the end of the Term under
        the
        White Credit Agreement. Mr. White can accept common stock as repayment of
        the
        loan upon a default. Under the terms of the agreement the Company is required
        to
        comply with various covenants. During the year ended December 31, 2007, Patrick
        White advanced the Company $300,000 while the terms of the credit facility
        were
        being finalized. As of September 30, 2008, the Company was in technical default
        of both agreements due to a failure to pay interest when due. Both Fagenson
        and
        Co., Inc. and Patrick White have agreed to waive the defaults through January
        1,
        2010.
  As
        of
        September 30, 2008, the Company had outstanding $450,000 under the White
        Credit
        Agreement, $1,408,000 under the Fagenson Credit Agreement. Interest expense
        amounted to $63,000 for the nine month period ending September 30, 2008 and
        is
        included in accrued expenses as of September 30, 2008.
  On
        May 7,
        2008 the Company entered into a $500,000 unsecured credit facility with Taiko
        III Corp to fund the Company’s ongoing patent infringement and related lawsuits
        against the European Central Bank. Interest shall accrue on the unpaid principal
        amount at a 6% annual rate. The outstanding principal amount may be prepaid
        by
        the Company, in whole but not in part and including the full interest through
        the maturity of the loan, at its option so long as the Company provides Taiko
        III with prior written notice of such prepayment. The term of the line of
        credit
        is 364 days. In addition, the loan can be repaid by the Company, at the
        discretion of Taiko III if the Company had defaulted under the credit facility,
        by using the Company’s common stock at a discount to the market value at the
        time of the repayment at 33% to market at the time of payment at no less
        than
        $2.00 per share and no more than $5.00 per share. On August 20, 2008, the
        Company entered into an agreement with Trebuchet Capital Partners, which,
        among
        other things, called for Trebuchet to pay the Company $500,000, which the
        Company used to pay in full the Company’s existing obligation owed to Taiko III
        Corp. See Note 4.
  **6.    
        Shareholders’ Equity**
  ***Stock
        Issued for Patent Defense Costs*** ****** - ****** On
        November 14, 2006, the Company entered into an stock payment agreement with
        McDermott Will & Emery LLP (“MWE”), its lead counsel on its European Central
        Bank (“ECB Litigation”) patent infringement and related cases. The agreement
        with MWE allows the Company to use its common stock to eliminate the Company’s
        cash requirements for MWE’s legal fees related to the ECB validity litigation,
        not to exceed $1.2 million in stock. During the nine months ended September
        30,
        2007, 60,866 restricted common shares were issued to MWE to pay for
        approximately $746,000 of legal fees incurred through September 30, 2007.
 
 ***Stock
        Issued in Private Placement*** -
        On June
        25, 2008 the Company entered into two Share Purchase Agreements pursuant
        to
        which the Company agreed to sell a total of 500,000 shares of the Company’s
        common stock for an aggregate purchase price of $2,000,000. Pursuant to the
        terms of the first Agreement, the Company sold 150,000 shares of Common Stock
        to
        the Purchaser for $600,000 payable on June 25, 2008. Pursuant to the terms
        of
        the second Agreement, the Company sold 350,000 shares of Common Stock for
        $1,400,000, with $100,000 payable on June 25, 2008 and the remaining $1,300,000
        payable in six-month installments over a two-year period. Pursuant to the
        terms
        of the first Agreement, the Purchaser may not sell the 150,000 shares of
        Common
        Stock purchased thereunder earlier than June 25, 2009. Pursuant to the terms
        of
        the second Agreement, the Purchaser may not sell the 350,000 shares of Common
        Stock purchased thereunder until the earlier of (i) one year after the Purchase
        Price being paid in full to the Company, or (ii) the one-year anniversary
        of a
        Payment Failure Termination Event (as defined in the second Agreement). (See
        Note 10 -Commitments)
 
 On
        January 22, 2007, the Company sold 6 units at a price of $50,000 per unit
        for
        gross proceeds of $300,000 consisting of 35,280 unregistered shares of the
        Company’s common stock and five-year warrants to purchase up to an aggregate of
        17,640 shares of the Company’s common stock at an exercise price of $11.75 per
        share. The fair market value of these warrants was determined using the Black
        Scholes option pricing model at $107,000.
 
 On
        August
        20, 2008, the Company entered into an agreement with Trebuchet Capital Partners,
        LLC who agreed to pay substantially all of the litigation costs associated
        with
        pending validity proceedings initiated by the ECB in eight European countries
        relating to the Company’s European Patent 0 455 750B1 that the Company has
        claimed the ECB infringed in printing of the Euro currency. Trebuchet has
        also
        purchased 100,000 shares of the Company’s common stock, for an aggregate
        purchase price of $400,000, the proceeds of which were used by the Company
        to
        pay existing litigation cost.
  10
  ***Restricted
        Stock –*** As
        of
        September 30, 2008, there are 42,793 unvested restricted shares granted to
        employees and consultants that vest through June 2009. In addition, there
        are
        195,000 restricted shares that will vest only upon the occurrence of certain
        events over the next 4 years, which include, among other things a change
        of
        control of the Company or other merger or acquisition of the Company, the
        achievement of certain financial goals, including among other things a
        successful result of the Company’s patent infringement lawsuit against the
        European Central Bank. These 195,000 shares, if vested, would result in the
        recording of stock based compensation expense of approximately $2,438,000,
        the
        grant date fair value, over the period beginning when any of the contingent
        vesting events is deemed to be probable over the expected requisite service
        period. As of September 30, 2008, vesting is not considered probable and
        no
        compensation expense has been recognized related to the performance grants.
        On
        May 10, 2008, the Company accelerated the vesting of 33,333 restricted shares
        and retired 250,000 of unvested restricted stock as the result of a separation
        agreement with the Company’s former President. The 33,333 shares of restricted
        stock, formerly set to vest pro-ratably through June 2009, were accelerated
        to
        vest pro-ratably on a monthly basis over a ten-month vesting period ending
        in
        March 2009. As a result of the acceleration of the 33,333 shares of restricted
        stock, the Company recognized approximately $194,000 of stock based compensation
        during the second quarter of 2008. (See Note 10 -Commitments)
  ***Stock
        Options*** –
During
        the nine months ended September 30, 2008, the Company issued options to purchase
        37,000 of its common shares at an exercise price of $6.31 per share to
        non-employee directors pursuant to the 2004 Non-Employee Officer Director
        Stock
        Option Plan that vest at the end of one of year of service on the Company’s
        Board of Directors. The Company also issued options to purchase 50,000 of
        its
        common shares at an exercise price of $5.68 per share to employees pursuant
        to
        the 2004 Employee Stock Option Plan that will vest over three years. The
        aggregate fair value of these options amounted to approximately $220,000
        determined by utilizing the Black Scholes option pricing model. The Company
        records stock-based payment expense related to these options based on the
        grant
        date fair value in accordance with FASB 123R.
  ***Stock
        Warrants*** –
During
        the nine months ended September 30, 2008, the Company received $100,000 in
        proceeds from the exercise of warrants to purchase 50,000 shares of our common
        stock. During the nine months ended September 30, 2007, the Company received
        approximately $55,000 in proceeds from the exercise of warrants to purchase
        12,125 shares of our common stock.
 
 ***Stock-Based
        Compensation*** **-** Stock-based
        compensation includes expense charges for all stock-based awards to employees,
        directors and consultants. Such awards include option grants, warrant grants,
        and restricted stock awards. During the nine months ended September 30, 2008,
        the Company recognized approximately $1,536,000 ($971,000- 2007) in stock-based
        compensation. Approximately $194,000 of the expense was the result of the
        acceleration of vesting of restricted shares to the Company’s former President
        as the result of his separation from the Company in May 2008.
 
 As
        of
        September 30, 2008, there was approximately $816,000 of total unrecognized
        compensation costs related to non-vested options and restricted stock granted
        under the Company’s stock option plans which the Company expects to vest over a
        period of not to exceed five years.
 
 On
        August
        13, 2008, the Company cancelled 330,500 employee stock options with exercise
        prices ranging from $6.24 to $12.50, and replaced the cancelled options with
        330,500 employee stock options with an exercise price of $6.00. No other
        terms
        of the options were modified. On the date of grant, the fair market value
        of the
        Company’s Common Stock was $5.15. The repricing was treated as a modification
        under FAS123R, and resulted in an additional aggregate fair value expense
        determined using the Black- Scholes option pricing model of approximately
        $225,000, of which approximately $170,000 was expensed as of the grant date
        for
        fully vested options. The remaining fair value of the modified options will
        be
        expensed proratably during the expected vesting period of the options thru
        2010.
 
 **7.** **Other
            Income**
 On
        May
        31, 2008, the Company was awarded a judgment of approximately $126,000 pursuant
        to a positive judgement for the Company in its counterclaim the matter “Frank
        LaLoggia v. Document Security Systems, Inc”, which the Company won in June 2006.
        The Company expects to collect the full amount of the judgment.
  11
  **8.    
        Discontinued Operations**
 
 On
        September 25, 2007, the Company sold certain assets and the operations of
        its
        retail copying and quickprinting operations to an unrelated third party for
        $80,000 and the assumption of ongoing operating leases. The sale included
        fixed
        assets with a net book value of approximately $37,000. The Company recognized
        a
        gain on the sale of approximately $43,000. In accordance with SFAS 144, the
        disposal of assets constitutes a component of the entity and has been accounted
        for as discontinued operations. The operating results relating to these assets
        are segregated and reported as discontinued operations in the accompanying
        2007
        consolidated statement of operations. The results of operations directly
        attributed to the division’s operations that have been reclassified from
        continuing operations are as follows:
 
 **Three Months Ended**
              
              **Nine Months Ended****September 30, 2007**
              
              **September 30, 2007**Revenues
              
              $
              72,791
              
              
              292,282Cost
                  of sales
              
              
              48,720
              
              
              150,525Operating
                  expenses
              
              
              67,878
              
              
              200,990Income
                  from discontinued operations
              
              $
              (43,807
              )
              
              (59,233
              )
  **9.    
        Earnings Per Share**
 
 Basic
        earnings per share is computed by dividing net income by the weighted-average
        number of common shares outstanding for the period. Diluted earnings per
        share
        is computed by including the number of additional shares that would have
        been
        outstanding if dilutive potential shares had been issued. In periods of losses,
        diluted loss per share is computed on the same basis as basic loss per share
        as
        the inclusion of any other potential shares outstanding would be
        anti-dilutive.  If the Company had generated earnings during the nine month
        period ended September 30, 2008, 426,980 (767,887- 2007) common equivalent
        shares would have been added to the weighted average shares outstanding to
        compute the diluted weighted average shares outstanding.
 
 **10.    
        Commitments and Contingencies**
  *Legal
        Matters*
  On
        August
        1, 2005, the Company commenced a suit against the European Central Bank (“ECB”)
        alleging patent infringement by the ECB and claimed unspecified damages.
        The
        suit was brought in European Court of First Instance in Luxembourg. The Company
        alleged that all Euro banknotes in circulation infringe the Company European
        Patent 0 455 750B1 (the “Patent”), which covers a method of incorporating an
        anti-counterfeiting feature into banknotes or similar security documents
        to
        protect against forgeries by digital scanning and copying devices. The Court
        of
        First Instance ruled on September 5, 2007 that it does not have jurisdiction
        to
        rule on the patent infringement claim, and also ruled that the Company will
        be
        required to pay attorneys and court fees of the ECB. The ECB formally requested
        the Company to pay attorneys and court fees in the amount of Euro 93,752
        ($144,000), which, unless the amount is agreed will be subject to an assessment
        procedure that will not likely be concluded until approximately the end of
        2008,
        which the Company will accrue as soon as the assessed amount, if any, is
        estimatable.
 
 On
        March
        24, 2006, the Company received notice that the ECB has filed a separate claim
        in
        the United Kingdom and Luxembourg courts seeking the invalidation of the
        Patent. Proceedings were commenced before the national courts seeking revocation
        and declarations of ****** invalidity  of
        the
        Patent in each of the Netherlands, Belgium, Italy, France, Spain, Germany
        and
        Austria. On March 26, 2007, the High Court of Justice, Chancery Division,
        Patents Court in London, England (the “English Court”) ruled that the Patent was
        deemed invalid in the United Kingdom, and on March 19, 2008 this decision
        was
        upheld on appeal. The English Court rejected the ECB’s allegations of invalidity
        based on lack of novelty, lack of inventive step and insufficiency, but held
        that the patent was invalid for added subject matter. The English Court’s
        decision does not affect the validity of the Patent in other European countries.
        On March 30, 2007, the English Court awarded the ECB 30%
        of
        their costs (including legal fees) of the initial trial ,
        of
        which the Company paid 90,000 British pounds ($182,000) on April 19, 2007.
        We
        expect that an additional 90,000 pounds ($162,000 at September 30, 2008)
        will
        become payable by the Company for the costs of the initial trial, which is
        included in accrued expenses as of September 30, 2008. In July 2007, the
        Company
        posted a bond of 87,500 British pounds ($157,500 at September 30, 2008),
        as
        collateral for the appeal costs which is recorded as restricted cash at
        September 30, 2008. On June 19, 2008, the Company paid 87,500 British pounds
        ($177,000 based on the applicable exchange rate on that date) towards
        the **** ECB’s
        costs of the English appeal. The Company may also owe additional legal fees
        associated with the Court of Appeal decisions, which, unless otherwise agreed
        by
        the parties, will be subject to an assessment procedure that will not likely
        be
        concluded earlier than the first quarter of 2009. The Company will record
        the
        assessed amount, if any, as soon as it is estimatable.
  12
  On
        March
        27, 2007 the Bundespatentgericht of the Federal Republic of Germany ruled
        that
        the German part of the Patent was valid, having considered the English Court’s
        decision. As a result of this ruling, the Company expects to be awarded
        reimbursements for its costs associated with the German validity case, which
        is
        Euro 44,692 ($64,000 at September 30, 2008), which the Company will record
        when
        the amount, if any, is received. The ECB has filed an appeal against that
        decision, which is not expected to be decided before 2010. On January 9,
        2008
        the French Court held that the Patent was invalid in France for the same
        reasons
        given by the English Court. The Company is required to pay de minimus attorneys’
fees of the ECB as a result of the French decision. The Company filed an
        appeal
        against the French decision on May 7, 2008. On March 12, 2008 the Dutch Court,
        having considered the English, German and French decisions, ruled that the
        Patent is valid in the Netherlands. The ECB filed an appeal against the Dutch
        decision on March 27, 2008. A trial was also held in Madrid, Spain on June
        3 and
        5, 2008 and oral and written closing submissions were made on July 19, 2008.
        A
        judgment is expected in the fourth quarter of 2008.
  The
        Patent has thus been confirmed to be valid and enforceable in two jurisdictions
        (Germany and the Netherlands) that use the Euro as its national currency.
        Additional trials on the validity of the Patent are expected in other European
        jurisdictions in 2008 and 2009.
 
 On
        August
        20, 2008, the Company entered into an agreement with Trebuchet Capital Partners,
        LLC (“Trebuchet”) under which Trebuchet has agreed to pay substantially all of
        the litigation costs associated with pending validity proceedings initiated
        by
        the European Central Bank (“ECB”) in eight European countries relating to the
        Company’s European Patent 0 455 750B1 that the Company has claimed the ECB
        infringed in printing of the Euro currency (the “Patent”). Trebuchet also agreed
        to pay substantially all of the litigation costs associated with future validity
        challenges filed by the ECB or other parties, provided that Trebuchet elects
        to
        assume the defense of any such challenges, in its sole discretion, and patent
        infringement suits filed against the ECB and certain other alleged infringers
        of
        the Patent, all of which suits may be brought at the sole discretion of
        Trebuchet and may be in the name of the Company, Trebuchet or both. The Company
        provided Trebuchet with the sole and exclusive right to manage infringement
        litigation relating to the Patent in Europe, including the right to initiate
        litigation in the name of the Company, Trebuchet or both and to choose whom
        and
        where to sue, subject to certain limitations set forth in the agreement.
        Under
        the terms of the Agreement, the Company and Trebuchet have agreed to equally
        share all proceeds generated from litigation relating to the Patent, including
        judgments and licenses or other arrangements entered into in settlement of
        any
        such litigation. Trebuchet is also entitled to recoup any litigation expenses
        specifically awarded to the Company in such actions.
  On
        January 31, 2003, the Company commenced an action, unrelated to the above
        ECB
        litigation, entitled New Sky Communications, Inc., As Successor-In-Interest
        To
        Thomas M. Wicker, Thomas M.Wicker Enterprises, Inc. and Document Security
        Consultants V. Adler Technologies, Inc. N/K/A Adlertech International, Inc.
        and
        Andrew McTaggert (United States District Court, Western District Of New York
        Case No.03-Cv-6044t(F)) regarding certain intellectual property in which
        the
        Company has an interest. The Company commenced this action alleging various
        causes of action against Adler Technologies, Inc. and Andrew McTaggert for
        breach of contract, breach of the duty of good faith and fair dealing, various
        business torts, including unfair competition and declaratory relief. Adler
        distributes and supplies anti-counterfeit document products and Mr. McTaggert
        is
        a principal of Adler. Adler had entered into several purported agreements
        with
        Thomas M. Wicker Enterprises and Document Security Consultants, both of which
        the Company acquired in 2002. These alleged agreements, generally, would
        have
        authorized Adler to manufacture in Canada the Company’s “Checkmate®” patented
        system for verifying the authenticity of currency and documents. Other purported
        agreements were signed between these parties and Thomas Wicker regarding
        other
        technology claimed to have been owned by Wicker and assigned to the Company.
        Among other things, the Company contends that certain of the purported
        agreements are not binding and/or enforceable. To the extent any of them
        are
        binding and enforceable, the Company claims that Adler has breached these
        purported agreements, failed to make an appropriate accounting and payments
        under them, and may have exceeded the scope of its license. Adler has denied
        the
        material allegations of the complaint and has counterclaimed against the
        Company, claiming Adler owns or co-owns or has a license to use certain of
        the
        Company’s technologies. In May 2005, the Company filed a first amended and
        supplemental complaint adding Blanks/USA and Raymond Maxon as additional
        defendants. In February 2007, the Company filed a second amended and
        supplemental complaint adding Judith Wu (McTaggert’s wife) and Arcis Digital
        Security, Inc. (a company in which Ms. Wu is involved) as additional defendants.
        Maxon has asserted a counterclaim against the Company contending that the
        Company’s purported acquisition of a certain patent from Thomas Wicker in 2002
        gave rise to an alleged right on the part of Maxon to receive a portion of
        Thomas Wicker’s proceeds from such acquisition. The Company has denied the
        material allegations of all of the counterclaims. If Adler or Maxon is
        successful, it may materially affect the Company, the Company’s financial
        condition, and the Company’s ability to market and sell certain of the Company
        technology and related products. This case is in discovery phase, and it
        is too
        soon to determine how the various issues raised by the lawsuit will be
        determined.
  13
  In
        addition to the foregoing, the Company is subject to other legal proceedings
        that have arisen in the ordinary course of business and have not been finally
        adjudicated. Although there can be no assurance in this regard, in the opinion
        of management, none of these legal proceedings to which the Company is a
        party
        to will have a material adverse effect on the Company results of operations,
        cash flows or the Company’s financial condition.
  *Commitments*
  In
        May
        2008, the Company entered into a Separation Agreement with its former President
        that, among other things, accelerated the vesting of 33,333 shares of restricted
        common stock of the Company that were previously awarded to the former President
        pursuant to the Company’s 2004 Employee Stock Option Plan so that such shares
        vested in equal monthly installments during the immediately following ten
        months. The Separation Agreement further provided that if the former President
        did not realize at least $212,000 in gross proceeds from the sale of such
        33,333
        shares of restricted stock upon their vesting, then the Company would pay
        the
        former President the amount that such proceeds is less than $212,000 in cash
        or
        additional shares of common stock of the Company. As of September 30, 2008,
        13,333 of such 33,333 shares had vested generating gross proceeds of
        approximately $48,000.
  In
        June
        2008, the Company entered into two Stock Purchase Agreements in which it
        sold
        500,000 shares of its common stock to Walton Invesco Inc. for an aggregate
        purchase price of $2.0 million. Pursuant to the terms of such Stock Purchase
        Agreements, Walton Invesco Inc. may demand registration of such 500,000 shares
        with the Securities and Exchange Commission on Form S-3 with such registration
        statement to take effect no later than (i) 120 days after payment in full
        for
        such shares under the applicable agreement or, (ii) with respect to 350,000
        shares, 270 days after a Payment Failure Termination Event (as defined in
        the
        applicable Stock Purchase Agreement).
  Pursuant
        to an agreement made in December 2004, the Company is required to share the
        economic benefit derived from settlements, licenses or subsequent business
        arrangements that the Company obtains from any infringer of patents formerly
        owned by the Wicker Family. For infringement matters involving certain U.S.
        patents, the Company will be required to disburse 30% of the settlement
        proceeds. For infringement matters involving certain foreign patents, including
        the lawsuit against the European Central Bank described in Part II Item 1
–
Legal Proceedings, the Company will be required to disburse 14% of the
        settlement proceeds. These payments do not apply to licenses or royalties
        to
        patents that the Company has developed or obtained from persons other than
        the
        Wicker Family. As of September 30, 2008, there have been no settlement amounts
        related to these agreements.
  In
        May
        2005, the Company made an agreement with its legal counsel in charge of the
        Company’s patent infringement litigation in the Court of First Instance with the
        European Central Bank which capped its fees for all matters associated with
        that
        infringement litigation at $500,000 plus expenses, and a $150,000 contingent
        payment upon a successful ruling or settlement on the Company’s behalf in that
        litigation. The Company will record the $150,000 in the period in which the
        Company has determined that a successful ruling or settlement is probable.
  **11 
         Supplemental Cash Flow Information**
  During
        the nine months ended September 30, 2008, the Company issued 19,260 shares
        for
        the payment of approximately $94,000 of marketing expenses. During the nine
        months ended September 30, 2007, the Company issued 60,866 shares of Common
        Stock valued at approximately $746,000 in conjunction with the payment of
        legal
        expenses which were capitalized as other intangible assets. In addition,
        the
        Company extended the term of previously issued warrants to a warrant holder
        in
        exchange for a license valued at approximately $521,000. In addition, during
        2007, the Company issued fully vested, nonforfeitable warrants to consultants
        of
        approximately $525,000 that were recorded as a prepaid expense that was
        recognized as stock based compensation. As of September 30, 2008, all of
        this
        amount had been recognized as expense.
  14
  **12.    
        Segment Information**
  The
        Company's businesses are organized, managed and internally reported as three
        operating segments. Two of these operating segments, Document Security Systems
        and Plastic Printing Professionals, are engaged in various aspects of developing
        and applying printing technologies and procedures to produce, or allow others
        to
        produce, documents with a wide range of features, including the Company’s
        patented technologies and trade secrets. For the purposes of providing segment
        information, these two operating segments have been aggregated into one
        reportable segment in accordance with Financial Accounting Standards Board
        (“FASB”) Statement No. 131- *“Disclosures
        about Segments of an Enterprise and Related Information”* .
        A
        summary of the Company’s two segments is as follows:
  **Document
                  Security and Production**
              
              License,
                  manufacture and sale of document security technologies, including
                  digital
                  security print solutions and secure printed products at Document
                  Security
                  Systems and Plastic Printing Professionals divisions. In September
                  2007,
                  the Company sold substantially all of the assets of its retail
                  printing
                  and copying division, a former component of the Document Security
                  and
                  Production segment, to an unrelated third party as this operation
                  was not
                  critical to the Company’s core operations. The results of the retail and
                  copying division are reported as discontinued operations and are
                  not a
                  component of these segment results (See Note 8).**Legal
                  Supplies**
              
              Sale
                  of specialty legal supplies, primarily to lawyers and law firms
                  located
                  throughout the United States via the website
                  Legalstore.com.
 
 Approximate information concerning the operations by reportable segment for
        the
        three and nine months ended September 30, 2008 and 2007 is as follows. The
        Company relies on intersegment cooperation and management does not represent
        that these segments, if operated independently, would report the results
        contained herein:
  ****
                  
                  **Document**
                  
                  ******Security
                      &****Legal
                      Supplies**
                  
                  **Production**
                  
                  **Corporate**
                  
                  **Total****3
                    months
                    ended September 30, 2008:**Revenues
                      from external customers
                  
                  $
                  151,000
                  
                  $
                  1,523,000
                  
                  $
                  -
                  
                  $
                  1,674,000Depreciation
                      and amortization
                  
                  
                  4,000
                  
                  
                  615,000
                  
                  
                  1,000
                  
                  
                  620,000Segment
                      profit (loss) from continuing operations
                  
                  
                  (6,000
                  )
                  
                  (2,046,000
                  )
                  
                  (611,000
                  )
                  
                  (2,663,000
                  )Identifiable
                      assets
                  
                  
                  328,000
                  
                  
                  7,479,000
                  
                  
                  548,000
                  
                  
                  8,355,000**3
                    months ended September 30, 2007:**Revenues
                      from external customers
                  
                  $
                  176,000
                  
                  $
                  1,233,000
                  
                  $
                  -
                  
                  $
                  1,409,000Depreciation
                      and amortization
                  
                  
                  4,000
                  
                  
                  521,000
                  
                  
                  1,000
                  
                  
                  526,000Segment
                      profit (loss) from continuing operations
                  
                  
                  (13,000
                  )
                  
                  (799,000
                  )
                  
                  (1,069,000
                  )
                  
                  (1,881,000
                  )Identifiable
                      assets
                  
                  
                  255,000
                  
                  
                  10,564,000
                  
                  
                  1,562,000
                  
                  
                  12,381,000
  ****
                  
                  **Document**
                  
                  ******Security
                      &****Legal
                      Supplies**
                  
                  **Production**
                  
                  **Corporate**
                  
                  **Total****9
                    months ended September 30, 2008:**Revenues
                      from external customers
                  
                  $
                  483,000
                  
                  $
                  4,847,000
                  
                  $
                  -
                  
                  $
                  5,330,000Depreciation
                      and amortization
                  
                  
                  12,000
                  
                  
                  1,827,000
                  
                  
                  3,000
                  
                  
                  1,842,000Segment
                      profit (loss) from continuing operations
                  
                  
                  29,000
                  
                  
                  (4,293,000
                  )
                  
                  (1,918,000
                  )
                  
                  (6,182,000
                  )Identifiable
                      assets
                  
                  
                  328,000
                  
                  
                  7,479,000
                  
                  
                  548,000
                  
                  
                  8,355,000**9
                    months ended September 30, 2007:**Revenues
                      from external customers
                  
                  $
                  513,000
                  
                  $
                  3,820,000
                  
                  $
                  -
                  
                  $
                  4,333,000Depreciation
                      and amortization
                  
                  
                  10,000
                  
                  
                  1,356,000
                  
                  
                  30,000
                  
                  
                  1,396,000Segment
                      profit (loss) from continuing operations
                  
                  
                  (11,000
                  )
                  
                  (2,217,000
                  )
                  
                  (2,547,000
                  )
                  
                  (4,775,000
                  )Identifiable
                      assets
                  
                  
                  255,000
                  
                  
                  10,564,000
                  
                  
                  1,562,000
                  
                  
                  12,381,000
 **13.    
        Subsequent Events**
  On
        November 6, 2008 the Company entered into an asset purchase agreement to
        acquire
        the assets of DPI of Rochester, LLC (“DPI”), which agreement is subject to court
        approval in DPI’s pending Chapter 11 bankruptcy case. DPI is a full service
        digital and commercial offset printer located in Rochester, NY with
        approximately $7.6 Million in annual sales in 2007. The
        estimated purchase price is $1,000,000 plus the assumption of certain equipment
        leases, and the Company
        may provide debtor-in-possession financing, subject to United States Bankruptcy
        Court approval, to DPI during its Chapter 11 reorganization process to prevent
        any disruption of service to DPI’s customers. The purchase of assets is expected
        to be completed in the quarter ended December 31, 2008 and is subject to
        the
        United States Bankruptcy Court approval and an opportunity for other parties
        to
        overbid for DPI’s assets. The obligations under the agreement are conditioned
        upon the negotiation of real and personal property leases, the approval of
        the
        bankruptcy court and other matters. There can be no assurance that the
        transaction contemplated by the purchase agreement will be approved by the
        bankruptcy court or that the conditions to closing will be met. Upon court
        approval of the transaction, the purchase price, once known, will be allocated
        to the assets acquired based on their respective fair values.
  15


**ITEM
      2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
      OF
      OPERATIONS**




***FORWARD-LOOKING
      STATEMENTS***




Certain
      statements contained herein constitute “forward-looking statements” within the
      meaning of the Private Securities Litigation Reform Act of 1995 (the “1995
      Reform Act”). Document Security Systems, Inc. desires to avail itself of certain
“safe harbor” provisions of the 1995 Reform Act and is therefore including this
      special note to enable us to do so. Except for the historical information
      contained herein, this report contains forward-looking statements (identified
      by
      the words "estimate," "project," "anticipate," "plan," "expect," "intend,"
      "believe," "hope," "strategy" and similar expressions), which are based on
      our
      current expectations and speak only as of the date made. These forward-looking
      statements are subject to various risks, uncertainties and factors, including,
      without limitation, those contained in our Form 10-K for the year ended December
      31, 2007 and those described herein that could cause actual results to differ
      materially from the results anticipated in the forward-looking
      statements.




**Overview**




Document
      Security Systems, Inc. (referred to in this report as “Document Security,” “we,”
“us,” “our” or “Company”) markets and sells products designed to protect
      valuable information from unauthorized scanning, copying, and digital imaging.
      We develop sophisticated security technologies that are applied during the
      normal printing process and by virtually all printing methods including
      traditional offset, gravure, flexo, digital or via the Internet on paper,
      plastic, or packaging. We believe we are a leader of customized document
      protection solutions for companies and governments worldwide. We hold eight
      patents that protect our technology and have over a dozen patents in process
      or
      pending. Our technologies and products are used by federal, state and local
      governments, law enforcement agencies and are also applied by a broad variety
      of
      industries,, including financial institutions, high technology and consumer
      goods, entertainment and gaming, healthcare/pharmaceutical, defense and genuine
      parts industries. **** Our
      customers use our technologies where there is a need for enhanced security
      for
      protecting and verification of critical financial instruments and vital records,
      or where there are concerns of counterfeiting, fraud, identity theft, brand
      protection and liability.





Our
      core
      business is counterfeit prevention, brand protection and validation of authentic
      print media, including government-issued documents, currency, private corporate
      record and, securities. We believe we are a world leader in the research and
      development of optical deterrent technologies and have commercialized these
      technologies with a broad suite of products that offer our customers a wide
      array of document security solutions to satisfy their specific
      anti-counterfeiting requirements. Our technology can be used in securing
      sensitive and critical documents such as currency, automobile titles, spare
      parts forms for the aerospace industry, gift certificates, permits, checks,
      licenses, receipts, prescription and medical forms, engineering schematics,
      ID
      cards, labels, original music, coupons, homeland security manuals, consumer
      product and pharmaceutical packaging, tickets, and school transcripts. In
      addition, we have developed a digital product to implement our technologies
      in
      Internet-based environments utilizing standard desktop printers. We believe
      that
      our digital technology greatly expands the reach and potential market for our
      technologies and solutions.





*Technologies*





We
      have
      developed or acquired over 30 technologies that provide to our customers a
      wide
      spectrum of solutions. Our primary anti-counterfeiting products and technologies
      are marketed under the AuthentiGuard trade names.





*Products
      and Services*





**Document
      Security Solutions and Production** :
      Our
      technology portfolio allows us to create unique custom secure paper, plastic,
      packaging and Internet-based solutions. We market to end-users that require
      anti-counterfeiting and authentication features in a wide range of printed
      materials like documents, vital records, driver’s licenses, birth certificates,
      receipts, manuals, identification materials, entertainment tickets, coupons,
      parts tracking forms, as well as product packaging including pharmaceutical
      and
      a wide range of consumer goods. We manufacture plastic ID cards at our wholly
      owned subsidiary called Plastic Printing Professionals, in San Francisco, CA,
      and we produce our custom security paper products either internally at our
      small
      printing facility in Rochester, NY, or outsourced at our various licensees.
      Through our strategic licensee program, we can offer our customers a wide range
      of production capabilities to meet the customized requirements.


16





**Security
      Paper** :
      Our
      primary product for the retail end-user market is AuthentiGuard Security Paper.
      AuthentiGuard Security Paper uses our Pantograph 4000 technology, and is a
      paper
      that reveals hidden warning words, logos or images using The Authenticator
      - our
      proprietary viewing lens – or when the paper is faxed, copied, scanned or
      re-imaged. The hidden warning words appear on the duplicate or the computer
      digital file and essentially prevents important documents from being
      counterfeited. We market and sell our Security Paper primarily through two
      major
      paper distributors: Boise Cascade and PaperlinX Limited.





**Technology
      Licensing:** We
      license our anti-counterfeiting technology and trade secrets through licensing
      arrangements with security printers. We seek licensees that have a broad
      customer base that can benefit from our technologies or have unique and
      strategic capabilities that expand the capabilities that we can offer our
      potential customers. Revenue from licensing can take several forms. Licenses
      can
      be for a single technology or for a package of technologies.





**Digital
      Solutions:**  We
      also
      offer our technologies in digital forms that are deliverable via internet and
      intranet environments. In October 2008, we launched our first branded digital
      solution called AuthentiGuard® DX. AuthentiGuard® DX is a networked appliance
      that allows the author of any Microsoft Office document (Outlook, Word, Excel,
      or PowerPoint) to secure nearly any of its alphanumeric content when it is
      printed or digitally stored. AuthentiGuard® DX prints selected content using our
      patented technology so that it cannot be read by the naked eye. Reading the
      hidden content or authenticating the document is performed with a proprietary
      viewing device or software.





Additionally,
      we sell custom hosted or server-based digital solutions for our customers.
      Depending on our customer’s specific requirements, we host a secure server that
      accepts user inputs and delivers custom, variable secure documents for output
      at
      the user location, or offer a bundled server solution that allows for the
      production of custom, variable secure documents within the user’s network
      environment.





**Legal
      Products** :
      We also
      own and operate Legalstore.com, an Internet company which sells legal supplies
      and documents, including security paper and products for the users of legal
      documents and supplies in the legal, medical and educational fields. While
      not a
      component of our core business strategy, we continuously seek to maximize the
      revenue and profitability of this operation.




***Results
      of Operations for the Three and Nine Months Ended***  ***September
      30, 2008***




The
      following discussion and analysis provides information that our management
      believes is relevant to an assessment and understanding of our results of
      operations and financial condition. The discussion should be read in conjunction
      with the financial statements and footnotes in this quarterly report and in
      our
      annual report on Form 10-K for the year ended December 31, 2007. On September
      25, 2007, the Company sold its copying and quick-printing business to an
      unrelated third party. In accordance with FASB 144, the Company accounts for
      the
      revenue and expenses of this operation, which was a component of its security
      printing segment, as a discontinued operation. All amounts have been adjusted
      to
      reflect the Company’s results after the effect of discontinued
      operations.




**Revenue**




**Three Months**
              **Ended September**
              **30, 2008**
            
            **Three Months**
              **Ended September**
              **30, 2007**
            
            **% change vs.**
              **2007**
            
            **Nine Months**
              **Ended September**
              **30, 2008**
            
            **Nine Months**
              **Ended September**
              **30, 2007**
            
            **% change vs.**
              **2007***Revenue*Security
                printing & products
            
            $
            1,334,000
            
            $
            946,000
            
            
            41
            %
            $
            3,421,000
            
            $
            2,765,000
            
            
            24
            %Royalties
            
            
            181,000
            
            
            278,000
            
            
            -35
            %
            
            1,402,000
            
            
            871,000
            
            
            61
            %Digital
                solutions
            
            
            8,000
            
            
            9,000
            
            
            -11
            %
            
            25,000
            
            
            184,000
            
            
            -86
            %Legal
                products
            
            
            150,000
            
            
            176,000
            
            
            -15
            %
            
            483,000
            
            
            513,000
            
            
            -6
            %*Total
                Revenue*
            
            
            1,673,000
            
            
            1,409,000
            
            
            19
            %
            
            5,331,000
            
            
            4,333,000
            
            
            23
            %




For
      the
      three months ended September 30, 2008, revenue increased 19% from the same
      period in 2007. The increase in revenue was primarily the result of strong
      growth in sales of our security products. The Company has sought to become
      a
      full-service provider of printing and production for its customers. During
      the
      quarter, the Company saw 20% sales growth at its Plastic Printing division
      as
      that division began to see the benefit of recent capital investments that
      increased its production capacity and expanded its production capabilities.
      Sales for paper based security products grew 30% from the same quarter of 2007,
      as the Company benefited from increased sales of its safety paper for
      prescriptions, and custom projects, including voter registration paper used
      for
      a foreign election, and coupons for a Fortune 500 customer.


17




Royalty
      revenue decreased primarily due to the absence of royalty revenue as a result
      of
      the new agreement with the Ergonomics Group in the second quarter of 2008,
      as
      described below, which previously had contributed approximately $60,000 per
      quarter of royalty revenue. Otherwise, royalty revenue reflected reductions
      in
      technology usage reported by its remaining licensing customers.




Legalstore.com
      saw an approximately 15% decline in orders from the 2007 quarter, which we
      believe was due to slowing conditions in the general economy along with the
      effects of an issue with its adword placements on one of the major search engine
      sites. The Company addressed its adword issue at the end of the quarter, and
      expects legal products to return to historical levels in the fourth quarter
      of
      2008.




For
      the
      first nine months of 2008, revenue increased 23% compared to the first nine
      months of 2007 primarily as a the result of the significant impact of royalty
      revenue recognized in the second quarter of 2008 along with a 24% growth in
      the
      company’s sales of its security printing and products. During the second quarter
      of 2008, the Company recognized approximately $542,000 of previously deferred
      royalty revenue as the result of a new agreement with the Ergonomic Group in
      April 2008. Under a previous agreement with the Ergonomic Group, the Company
      received $1,000,000 in non-refundable license and royalty fees, of which
      $500,000 was recognized as royalty revenue pro-ratably over a two year license
      period and the remaining $500,000 was considered a prepaid royalty, to be
      recognized as revenue when sales of products using the licensed technology
      were
      made. This agreement was cancelled and a new agreement with the Ergonomic Group
      that covers the Company’s newest digital technologies was established. As a
      result, the non refundable license and royalty payment no longer met the
      criteria for deferral and was recognized in the second quarter of
      2008.




These
      growth areas were partially offset by a significant decline in digital solutions
      sales during the first nine months of 2008 as compared to the first nine months
      of 2007 due to the absence of any digital solutions implementations during
      2008.




**Cost
      of Sales and Gross Profit**




**Three Months**
              **Ended September**
              **30, 2008**
            
            **Three Months**
              **Ended September**
              **30, 2007**
            
            **% change vs.**
              **2007**
            
            **Nine Months**
              **Ended September**
              **30, 2008**
            
            **Nine Months**
              **Ended September**
              **30, 2007**
            
            **% change vs.**
              **2007***Costs
                of revenue*Security
                printing & products
            
            $
            636,000
            
            $
            636,000
            
            
            0
            %
            $
            2,028,000
            
            $
            1,691,000
            
            
            20
            %Digital
                solutions
            
            
            4,000
            
            
            3,000
            
            
            33
            %
            
            11,000
            
            
            41,000
            
            
            -73
            %Legal
                products
            
            
            86,000
            
            
            83,000
            
            
            4
            %
            
            258,000
            
            
            276,000
            
            
            -7
            %*Total
                cost of revenue*
            
            
            726,000
            
            
            722,000
            
            
            1
            %
            
            2,297,000
            
            
            2,008,000
            
            
            14
            %*Gross
                profit*Security
                printing & products
            
            
            698,000
            
            
            310,000
            
            
            125
            %
            
            1,393,000
            
            
            1,074,000
            
            
            30
            %Royalties
            
            
            181,000
            
            
            278,000
            
            
            -35
            %
            
            1,402,000
            
            
            871,000
            
            
            61
            %Digital
                solutions
            
            
            4,000
            
            
            6,000
            
            
            -33
            %
            
            14,000
            
            
            143,000
            
            
            -90
            %Legal
                products
            
            
            64,000
            
            
            93,000
            
            
            -31
            %
            
            225,000
            
            
            237,000
            
            
            -5
            %*Total
                gross profit*
            
            
            947,000
            
            
            687,000
            
            
            38
            %
            
            3,034,000
            
            
            2,325,000
            
            
            30
            %




**Three Months**
              **Ended September**
              **30, 2008**
            
            **Three Months**
              **Ended September**
              **30, 2007**
            
            **% change vs.**
              **2007**
            
            **Nine Months**
              **Ended September**
              **30, 2008**
            
            **Nine Months**
              **Ended September**
              **30, 2007**
            
            **% change vs.**
              **2007***Gross
                profit percentage:*Gross
                profit percentage:
            
            
            57
            %
            
            49
            %
            
            16
            %
            
            57
            %
            
            54
            %
            
            6
            %




Gross
      profit increased 38% to $947,000 in the thrid quarter of 2008 as compared to
      the
      $687,000 of gross profit realized in the third quarter of 2007, primarily the
      result of stong sales of the company’s security printing and products and the
      ability of the Company to increase its margins through operating efficiencies
      and material cost savings that the Company was able to generate at its plastics
      division’s new facility. The increase in gross profits of this group was
      partially offset by decreases in royalty, digital solution and legal products
      profits, respectively, for reasons discussed above. For the nine months ended
      September 30, 2008, the Company’s gross profit increased at a slightly higher
      rate as the Company’s gross profit percentage increased 6 percentage points as
      compared to the 2007 period.




18




**Operating
      Expenses**




**Three Months**
              **Ended September**
              **30, 2008**
            
            **Three Months**
              **Ended September**
              **30, 2007**
            
            **% change vs.**
              **2007**
            
            **Nine Months**
              **Ended September**
              **30, 2008**
            
            **Nine Months**
              **Ended September**
              **30, 2007**
            
            **% change vs.**
              **2007***Selling,
                general and administrative*General
                and administrative compensation
            
            $
            539,000
            
            $
            514,000
            
            
            5
            %
            $
            1,622,000
            
            $
            1,310,000
            
            
            24
            %Professional
                Fees
            
            
            206,000
            
            
            352,000
            
            
            -41
            %
            
            780,000
            
            
            1,036,000
            
            
            -25
            %Sales
                and marketing
            
            
            204,000
            
            
            466,000
            
            
            -56
            %
            
            892,000
            
            
            1,525,000
            
            
            -42
            %Depreciation
                and amortization
            
            
            42,000
            
            
            20,000
            
            
            110
            %
            
            126,000
            
            
            61,000
            
            
            107
            %Other
            
            
            319,000
            
            
            289,000
            
            
            10
            %
            
            902,000
            
            
            685,000
            
            
            32
            %Research
                and development
            
            
            73,000
            
            
            111,000
            
            
            -34
            %
            
            322,000
            
            
            314,000
            
            
            3
            %Stock
                based payments
            
            
            480,000
            
            
            338,000
            
            
            42
            %
            
            1,506,000
            
            
            971,000
            
            
            55
            %Impairment
                of patent defense costs
            
            
            -
            
            
            -
            
            
            
            
            
            292,000
            
            
            -Amortization
                of intangibles
            
            
            541,000
            
            
            480,000
            
            
            13
            %
            
            1,605,000
            
            
            1,259,000
            
            
            27
            %*Total
                Operating Expenses*
            
            
            2,404,000
            
            
            2,570,000
            
            
            -6
            %
            
            8,047,000
            
            
            7,161,000
            
            
            12
            %




**Selling,
      General and Administrative**




General
      and administrative compensation costs
      were 5% higher in the third quarter of 2008 as compared to the third quarter
      of
      2007 which was primarily due to the impact of a bonus reversal of approximately
      $41,000 in the 2007 period, which offset the impact of salary reductions made
      by
      the Company during 2008. In addition, the 2008 amount reflects an increase
      in
      the cash compensation of the non-employee members of the Company’s board of
      directors.




Professional
      fees -
      The
      decrease in professional fees during the third quarter and first nine months
      of
      2008 reflect significant decreases in non-patent related legal fees, accounting
      fees, and stock transfer and investor relations fees. These costs savings
      reflect reduced SEC compliance costs and decreased legal activity, along with
      the impact of the Company’s cost-cutting program it initiated in March 2008. For
      the nine months ended September 30, 2008, these cost savings were partially
      offset by increases in the use of consultants for sales and business development
      efforts during the first three months of 2008.




**Three Months**
              **Ended September**
              **30, 2008**
            
            **Three Months**
              **Ended September**
              **30, 2007**
            
            **% change vs.**
              **2007**
            
            **Nine Months**
              **Ended September**
              **30, 2008**
            
            **Nine Months**
              **Ended September**
              **30, 2007**
            
            **% change vs.**
              **2007***Professional
                Fees Detail*Accounting
                and auditing
            
            $
            40,000
            
            $
            71,000
            
            
            -44
            %
            $
            213,000
            
            $
            236,000
            
            
            -10
            %Consulting
            
            
            79,000
            
            
            95,000
            
            
            -17
            %
            $
            341,000
            
            
            292,000
            
            
            17
            %Legal
                Fees
            
            
            43,000
            
            
            120,000
            
            
            -64
            %
            $
            94,000
            
            
            255,000
            
            
            -63
            %Stock
                Transfer, SEC and Investor Relations
            
            
            44,000
            
            
            66,000
            
            
            -33
            %
            $
            132,000
            
            
            253,000
            
            
            -48
            %$
            206,000
            
            $
            352,000
            
            
            -41
            %
            $
            780,000
            
            $
            1,036,000
            
            
            -25
            %




Sales
      and marketing expenses, including sales and marketing personnel costs, decreased in the third
      quarter and the first nine months of 2008 as the Company reduced sales and
      marketing headcount by four, reduced public relations and marketing costs and
      significantly reduced the amount spent on travel and entertainment. The Company
      reduced these costs as it realigned its sales process in order to maximize
      the
      results of its sales and marketing efforts with the goal of focusing of near
      term revenue opportunities.




Other
      operating expenses are
      primarily rent and utilities, office supplies, IT support, bad debt expense
      and
      insurance costs. Increases in the third quarter an first nine months of 2008
      reflect costs increases associated with an increase in rent costs and one time
      costs associated with the move of the Company’s plastic printing division to a
      larger facility, higher utility costs, and an increase in insurance
      costs.


19




Stock-Based
      Compensation. Stock-based compensation includes expense charges for all stock-based awards
      to
      employees, directors and consultants. Such awards include option grants, warrant
      grants, and restricted stock awards. Stock-based compensation increases in
      the
      three and nine month periods ended September 30, 2008 reflect equity-based
      payments made to employees, directors, and third-party consultants, including
      approximately $194,000 of expense as the result of the acceleration of vesting
      of restricted shares and $18,000 due to the modification of options to the
      Company’s former President as the result of his separation from the Company in
      May 2008. In addition, on August 13, 2008, the Company cancelled 330,500
      employee stock options with exercise prices ranging from $6.24 to $12.50, and
      replaced the cancelled options with 330,500 employee stock options with an
      exercise price of $6.00. No other terms of the options were modified. On the
      date of grant, the fair market value of the Company’s Common Stock was $5.15.
      The repricing was treated as a modification under FAS123R, and resulted
      additional aggregate fair value expense determined using the Black- Scholes
      option pricing model of approximately $225,000, of which approximately $170,000
      was expensed as of the grant date for fully vested options. The remaining fair
      value of the modified options will be expense proratably during the expected
      vesting period of the options thru 2010.




**Research
      and Development**




We
      invest
      in research and development to improve our existing technologies and develop
      new
      technologies that will enhance our position in the document security market.
      Research and development costs consist primarily of compensation costs, and
      costs for the use of third-party printers’ facilities to test our technologies
      on equipment that we do not have access to internally. During the third quarter
      of 2008, the Company reduced its research and development by one person who
      was
      replaced on October 1, 2008.




**Impairment
      of Patent Defense Costs**




On
      March
      19, 2008, the Company received notification that its appeal of the invalidation
      of its European Patent 455750B1 in the UK was not successful. As result of
      the
      adverse court decision, the Company recognized an impairment loss of $292,000
      associated with the U.K appeal as of March 31, 2008. The impairment loss
      includes a judgment for reimbursement of estimated counterpart legal fees.
      The
      Company may be obligated to pay additional counter party legal fees associated
      with the decision, which the Company will expense as soon as the amount, if
      any,
      is estimatable.




**Amortization
      of Intangibles**




Amortization
      of intangibles expense increased 13% in the third quarter of 2008 as compared
      to
      the third quarter of 2007 which was primarily the result of an increase of
      $1.1
      million in the Company’s capitalized patent defense costs from December 2007 to
      September 2008. We amortize the costs associated with patent rights that we
      acquired in 2005 and legal costs associated with the registration and defense
      of
      our patents, including the costs associated with our lawsuit against the ECB
      for
      patent infringement and the related ECB countersuits for patent validity. A
      significant portion of these assets were acquired by the issuance of
      equity-based instruments. On August 20, 2008, the Company entered into an
      agreement with Trebuchet Capital Partners which agreed to pay substantially
      all
      of the litigation costs associated with its ECB litigation. Under the terms
      of
      the agreement the Company transferred and assigned a 49% interest of all of
      the
      Company’s rights, title and interest in its European Patent 0455750B1 and the
      two parties agreed to equally share all proceeds generated from litigation
      relating to the Patent, including judgments and licenses or other arrangements
      entered into in settlement of any such litigation. The Company considered this
      a
      triggering event and reviewed its remaining capitalized patent costs related
      to
      the Patent for impairment as of September 30, 2008. With the assistance of
      Trebuchet, the Company determined that the expected eventual outcome of the
      legal action and recoverability of proceeds or added economic value of the
      patent was still in excess of the current carrying amount.




As
      a
      result of the Trebuchet agreement, and the transfer and assignment of our 49%
      interest in the patent, or $1,670,000, our net amortizable patent asset base
      at
      September 30, 2008 was approximately $2.9 million and will generate
      approximately $1.0 million in annual amortization expense during the next 3
      years, as compared to approximately $2.0 million in annual amortization expense
      the Company was recognizing prior to the Trebuchet transaction.




In
      addition, the Company has approximately $683,000 of net other intangible assets
      as of September 30, 2008 that consist of a royalty right, a non-exclusive
      marketing right, as well as acquired intangibles including customer lists and
      a
      trade name. These assets will generate approximately $250,000 of annual
      amortization expense during the next 2.5 years. In addition, the Company has
      approximately $1,397,000 in goodwill derived from acquisitions. Goodwill is
      not
      amortized, but could become a component of expense if an impairment is
      determined. The Company reviews these assets for impairment annually or if
      a
      triggering event occurs. If an impairment, such as unfavorable ruling in the
      Company’s patent validity or infringement lawsuits or an assessment of
      non-commerciability of certain of its patents, then the Company would write-off
      a portion of these assets, which could be a significant expense in the period
      incurred.


20





**Other
      Income and Expense**




On
      May
      31, 2008, the Company was awarded a judgment of approximately $126,000 pursuant
      to a counterclaim by the Company in the matter “Frank LaLoggia v. Document
      Security Systems, Inc”, which the Company won in June 2006. The Company expects
      to collect the full amount of the judgment.




On
      August
      20, 2008, the Company entered into an agreement with Trebuchet Capital Partners,
      LLC. Pursuant to the Agreement, Trebuchet has agreed to pay substantially all
      of
      the litigation costs associated with pending validity proceedings initiated
      by
      the European Central Bank in eight European countries relating to the Company’s
      European Patent 0 455 750B1 that the Company has claimed the European Central
      Bank ("ECB") infringed in printing of the Euros currency. Under the terms of
      the
      Agreement, and in consideration for Trebuchet’s funding obligations, the Company
      assigned and transferred a 49% interest of the Company’s rights, title and
      interest in the Patent to Trebuchet which allows Trebuchet to have as a separate
      and exclusive interest including a separate and distinct right to exploit the
      Patent. Pursuant to this transaction, the Company recognized a loss on the
      sale
      of patent assets for its assignment and transfer of 49% of its ownership rights
      in the patent, which had a net book value of approximately $1,670,000, for
      proceeds of $500,000, As a result, the Company recognized a loss on sale of
      patent assets of approximately $1,170,000.




**Net
      Loss and Loss Per Share**




**Three Months**
              **Ended September**
              **30, 2008**
            
            **Three Months**
              **Ended September**
              **30, 2007**
            
            **% change vs.**
              **2007**
            
            **Nine Months**
              **Ended September**
              **30, 2008**
            
            **Nine Months**
              **Ended September**
              **30, 2007**
            
            **% change vs.**
              **2007**Net
                loss
            
            
            (2,664,000
            )
            
            (1,881,000
            )
            
            42
            %
            
            (6,182,000
            )
            
            (4,792,000
            )
            
            29
            %Net
                loss per share, basic and diluted
            
            $
            (0.19
            )
            $
            (0.14
            )
            
            36
            %
            $
            (0.45
            )
            $
            (0.35
            )
            
            29
            %Weighted
                average common shares outstanding, basic and diluted
            
            
            14,286,192
            
            
            13,676,030
            
            
            4
            %
            
            13,879,891
            
            
            13,629,241
            
            
            2
            %




During
      the third quarter of 2008, the Company experienced a net loss of $2.7 million,
      a
      42% increase from the net loss of the third quarter of 2007. The increase in
      net
      loss during the quarter was primarily the result of the Company’s recognition of
      a one-time loss on the sale of patent assets of $1.2 million. Otherwise, net
      loss for the third quarter of 2008 quarter without the impact of this one time
      loss would have been approximately $1.5 million, a decrease of approximately
      20%
      from the third quarter of 2007. The improvement in net loss, other than the
      effect of the one-time loss on sale of patent, was due the Company’s ability to
      increase its sales and gross profits while reducing its operating expenses.




**LIQUIDITY
      AND CAPITAL RESOURCES**




The
      Company’s cash flows and other key indicators of liquidity are summarized as
      follows:


21




**As Of And For The Nine Months Ended:****September 30,**
              **2008**
            
            **September 30,**
              **2007**
            
            **% change vs.**
              **2007**Cash
                flows from:Operating
                activities
            
            $
            (2,116,000
            )
            $
            (2,562,000
            )
            
            17
            %Investing
                activities
            
            
            (871,000
            )
            
            (1,495,000
            )
            
            42
            %Financing
                activities
            
            
            2,688,000
            
            
            (369,000
            )
            
            828
            %Working
                capital
            
            
            (836,000
            )
            
            352,000
            
            
            -338
            %Current
                ratio
            
            
            0.68
            x
            
            1.12
            x
            
            -39
            %Cash
                and cash equivalents
            
            $
            443,000
            
            $
            1,377,000
            
            
            -68
            %Revolving
                credit notes
            
            $
            1,858,000
            
            $
            -Funds
                Available from Open Credit Facilities
            
            $
            1,742,000
            
            $
            -




As
      of
      September 30, 2008, our cash and cash equivalents were approximately $443,000,
      down from approximately $742,000 at December 31, 2007. The decrease was
      primarily due to the use of cash for operations and the use of cash to defend
      the Company’s patent rights offset by the receipt of $2,358,000 from the
      Company’s three credit facilities. During the third quarter of 2008, the Company
      used $500,000 proceeds from the sale and assignment of certain of its patent
      rights to a third party to pay down one of its credit facilities. As of
      September 30, 2008, the Company had approximately $1.9 million outstanding
      under
      two credit agreements, which are due and payable over the next two years. As
      of
      September 30, 2008, the Company was in default of both agreements due to a
      failure to pay interest when due. Both Fagenson and Co., Inc. and Patrick White
      have agreed to waive the defaults through January 1, 2010.




**Payment Due by Period****Total**
            
            **Less than 1**
              **year**
            
            **1-3 years**
            
            **3-5 years**
            
            **More than 5**
              **years**Credit Facilities
            
            $
            1,858,000
            
            $
            -
            
            $
            1,858,000
            
            $
            -
            
            $
            -




The
      Company expects to continue to use cash for its operations and the remainder
      of
      2008. In March 2008, the Company initiated a cost reduction program in order
      to
      bring its cash expenditures to a level closer to its current revenue base.
      As a
      result of these cost cuts, the Company has reduced its annual cash operating
      expense base by approximately $1.5 million. In addition, in August 2008, the
      Company sold 49% of its patent related to its ECB litigation to a third party
      in
      exchange for the third party’s commitment to fund nearly all of the remaining
      costs associated with pending litigation efforts. This agreement, while reducing
      the potential proceeds that the Company could receive upon a successful outcome
      of litigation by half, essentially eliminates the Company’s cash requirements
      for its ECB litigation efforts, which has historically been a significant use
      of
      cash for the Company.




As
      of
      September 30, 2008, the Company has an aggregate of $1,742,000 remaining
      available under two revolving notes that terminate on January 4, 2010. In
      addition, the Company has $1,300,000 in subscriptions receivable which it
      expects to receive in six-month installments over the next two years. Based
      on
      these funding sources, the Company believes that it has sufficient available
      funds to meet is cash needs for the at least the next twelve months.


22




**ITEM
      3:   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
      RISK**




The
      market risk disclosures as set forth in Item 7A of our Annual Report on Form
      10-K for the year ended December 31, 2007 have not changed
      materially.




**ITEM
      4 - CONTROLS AND PROCEDURES**




**Evaluation
      of Disclosure Controls and Procedures**





Management
      is responsible for establishing and maintaining effective disclosure controls
      and procedures. Our Chief Executive Officer and Chief Financial Officer
      participated with our management in evaluating the effectiveness of our
      disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
      under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)).
      Based on this evaluation, and in light of the material weaknesses in our
      internal control over financial reporting that are discussed in our Annual
      Report on Form 10-K for the fiscal year ended December 31, 2007 these officers
      have concluded that our disclosure controls and procedures were not effective.
      To address the material weaknesses described in Annual Report on Form 10-K
      for
      the fiscal year ended December 31, 2007, we performed additional analyses and
      other post-closing procedures to ensure our consolidated financial statements
      were prepared in accordance with accounting principles generally accepted in
      the
      United States of America (U.S. GAAP). Accordingly, management believes that
      the
      financial statements included in this Quarterly Report on Form 10-Q fairly
      present, in all material respects, our financial condition, result of operations
      and cash flows for the periods presented.





**Changes
      in Internal Control Over Financial Reporting**





During
      the second quarter of 2008, the Company eliminated the use of an outside
      consultant formerly used to enhance the segregation of duties for financial
      reporting. Concurrently, the Company modified and expanded one of its existing
      internal positions to accommodate some of the control objectives affected by
      the
      elimination of the outside consultant role. The Company will evaluate the effect
      of its changes in internal controls during its annual assessment of its internal
      controls.




**PART
      II**


**OTHER
      INFORMATION**




**ITEM
      1 - LEGAL PROCEEDINGS**




Information
      concerning pending legal proceedings is incorporated herein by reference to
      Note
      10 to the Condensed Consolidated Financial Statements (Unaudited) in Part I
      of
      this Form 10-Q.





On
      August
      1, 2005, we commenced a suit against the European Central Bank (“ECB”) alleging
      patent infringement by the ECB and claimed unspecified damages. We brought
      the
      suit in European Court of First Instance in Luxembourg. We alleged that all
      Euro
      banknotes in circulation infringe the Company European Patent 0 455 750B1 (the
      “Patent”), which covers a method of incorporating an anti-counterfeiting feature
      into banknotes or similar security documents to protect against forgeries by
      digital scanning and copying devices. The Court of First Instance ruled on
      September 5, 2007 that it does not have jurisdiction to rule on the patent
      infringement claim, and also ruled that we will be required to pay attorneys
      and
      court fees of the ECB. The ECB formally requested the Company to pay attorneys
      and court fees in the amount of Euro 93,752 ($144,000), which, unless the amount
      is agreed will be subject to an assessment procedure that will not likely be
      concluded until approximately the end of 2008, which the Company will accrue
      as
      soon as the assessed amount, if any, is estimatable.





On
      March
      24, 2006, we received notice that the ECB has filed a separate claim in the
      United Kingdom and Luxembourg courts seeking the invalidation of the
      Patent. Proceedings were commenced before the national courts seeking revocation
      and declarations of ****** invalidity  of
      the
      Patent in each of the Netherlands, Belgium, Italy, France, Spain, Germany and
      Austria. On March 26, 2007, the High Court of Justice, Chancery Division,
      Patents Court in London, England (the “English Court”) ruled that the Patent was
      deemed invalid in the United Kingdom, and on March 19, 2008 this decision was
      upheld on appeal. The English Court rejected the ECB’s allegations of invalidity
      based on lack of novelty, lack of inventive step and insufficiency, but held
      that the patent was invalid for added subject matter. The English Court’s
      decision does not affect the validity of the Patent in other European countries.
      On March 30, 2007, the English Court awarded the ECB 30%
      of
      their costs (including legal fees) of the initial trial ,
      of
      which the Company paid 90,000 British pounds ($182,000) on April 19, 2007.
      We
      expect that an additional 90,000 pounds ($162,000 at September 30, 2008) will
      become payable by the Company for the costs of the initial trial, which is
      included in accrued expenses as of September 30, 2008. In July 2007, the Company
      posted a bond of 87,500 British pounds ($157,500 at September 30, 2008), as
      collateral for the appeal costs which is recorded as restricted cash at
      September 30, 2008. On June 19, 2008, the Company paid 87,500 British pounds
      ($177,000 based on the applicable exchange rate on that date) towards
      the **** ECB’s
      costs of the English appeal. The Company may also owe additional legal fees
      associated with the Court of Appeal decisions, which, unless otherwise agreed
      by
      the parties, will be subject to an assessment procedure that will not likely
      be
      concluded earlier than the first quarter of 2009. The Company will record the
      assessed amount, if any, as soon as it is estimatable.


23


On
      March
      27, 2007 the Bundespatentgericht of the Federal Republic of Germany ruled that
      the German part of the Patent was valid, having considered the English Court’s
      decision. As a result of this ruling, the Company expects to be awarded
      reimbursements for its costs associated with the German validity case, which
      is
      Euro 44,692 ($64,000 at September 30, 2008), which the Company will record
      when
      the amount, if any, is received. The ECB has filed an appeal against that
      decision, which is not expected to be decided before 2010. On January 9, 2008
      the French Court held that the Patent was invalid in France for the same reasons
      given by the English Court. The Company is required to pay de minimus attorneys’
fees of the ECB as a result of the French decision. The Company filed an appeal
      against the French decision on May 7, 2008. On March 12, 2008 the Dutch Court,
      having considered the English, German and French decisions, ruled that the
      Patent is valid in the Netherlands. The ECB filed an appeal against the Dutch
      decision on March 27, 2008. A trial was also held in Madrid, Spain on June
      3 and
      5, 2008 and oral and written closing submissions were made on July 19, 2008.
      A
      judgment is expected in the fourth quarter of 2008.




The
      Patent has thus been confirmed to be valid and enforceable in two jurisdictions
      (Germany and the Netherlands) that use the Euro as its national currency.
      Additional trials on the validity of the Patent are expected in other European
      jurisdictions in 2008 and 2009.


On
        August
        20, 2008, the Company entered into an agreement with Trebuchet Capital Partners,
        LLC (“Trebuchet”) under which Trebuchet has agreed to pay substantially all of
        the litigation costs associated with pending validity proceedings initiated
        by
        the European Central Bank (“ECB”) in eight European countries relating to the
        Company’s European Patent 0 455 750B1 that the Company has claimed the ECB
        infringed in printing of the Euro currency (the “Patent”). Trebuchet also agreed
        to pay substantially all of the litigation costs associated with future validity
        challenges filed by the ECB or other parties, provided that Trebuchet elects
        to
        assume the defense of any such challenges, in its sole discretion, and patent
        infringement suits filed against the ECB and certain other alleged infringers
        of
        the Patent, all of which suits may be brought at the sole discretion of
        Trebuchet and may be in the name of the Company, Trebuchet or both. The Company
        provided Trebuchet with the sole and exclusive right to manage infringement
        litigation relating to the Patent in Europe, including the right to initiate
        litigation in the name of the Company, Trebuchet or both and to choose whom
        and
        where to sue, subject to certain limitations set forth in the agreement.
        Under
        the terms of the Agreement, the Company and Trebuchet have agreed to equally
        share all proceeds generated from litigation relating to the Patent, including
        judgments and licenses or other arrangements entered into in settlement of
        any
        such litigation. Trebuchet is also entitled to recoup any litigation expenses
        specifically awarded to the Company in such actions.


On
      January 31, 2003, the Company commenced an action, unrelated to the above ECB
      litigation, entitled New Sky Communications, Inc., As Successor-In-Interest
      To
      Thomas M. Wicker, Thomas M.Wicker Enterprises, Inc. and Document Security
      Consultants V. Adler Technologies, Inc. N/K/A Adlertech International, Inc.
      and
      Andrew McTaggert (United States District Court, Western District Of New York
      Case No.03-Cv-6044t(F)) regarding certain intellectual property in which the
      Company have an interest. The Company commenced this action alleging various
      causes of action against Adler Technologies, Inc. and Andrew McTaggert for
      breach of contract, breach of the duty of good faith and fair dealing, various
      business torts, including unfair competition and declaratory relief. Adler
      distributes and supplies anti-counterfeit document products and Mr. McTaggert
      is
      a principal of Adler. Adler had entered into several purported agreements with
      Thomas M. Wicker Enterprises and Document Security Consultants, both of which
      the Company acquired in 2002. These alleged agreements, generally, would have
      authorized Adler to manufacture in Canada the Company’s “Checkmate®” patented
      system for verifying the authenticity of currency and documents. Other purported
      agreements were signed between these parties and Thomas Wicker regarding other
      technology claimed to have been owned by Wicker and assigned to the Company.
      Among other things, the Company contends that certain of the purported
      agreements are not binding and/or enforceable. To the extent any of them are
      binding and enforceable, the Company claims that Adler has breached these
      purported agreements, failed to make an appropriate accounting and payments
      under them, and may have exceeded the scope of its license. Adler has denied
      the
      material allegations of the complaint and has counterclaimed against the
      Company, claiming Adler owns or co-owns or has a license to use certain of
      the
      Company’s technologies. In May 2005, the Company filed a first amended and
      supplemental complaint adding Blanks/USA and Raymond Maxon as additional
      defendants. In February 2007, the Company filed a second amended and
      supplemental complaint adding Judith Wu (McTaggert’s wife) and Arcis Digital
      Security, Inc. (a company in which Ms. Wu is involved) as additional defendants.
      Maxon has asserted a counterclaim against the Company contending that the
      Company’s purported acquisition of a certain patent from Thomas Wicker in 2002
      gave rise to an alleged right on the part of Maxon to receive a portion of
      Thomas Wicker’s proceeds from such acquisition. The Company has denied the
      material allegations of all of the counterclaims. If Adler or Maxon is
      successful, it may materially affect the Company, the Company’s financial
      condition, and the Company’s ability to market and sell certain of the Company
      technology and related products. This case is in discovery phase, and it is
      too
      soon to determine how the various issues raised by the lawsuit will be
      determined.





In
      addition to the foregoing, we are subject to other legal proceedings that have
      arisen in the ordinary course of business and have not been finally adjudicated.
      Although there can be no assurance in this regard, in the opinion of management,
      none of these legal proceedings to which we are a party will have a material
      adverse effect on our results of operations, cash flows or our financial
      condition.


24




**ITEM
      1A – RISK FACTORS**




An
      investment in our securities is subject to numerous risks, including the Risk
      Factors described below. Our business, operating results or financial condition
      could be materially adversely affected by any of the following risks. The risks
      described below are not the only ones we face. Additional risks we are not
      presently aware of or that we currently believe are immaterial may also
      materially affect our business. The trading price of our Common Stock could
      decline due to any of these risks. In assessing these risks, you should also
      refer to the other information contained or incorporated by reference in this
      Form 10-Q, including our financial statements and related notes and information
      contained in our Form 10-K for the year ended December 31, 2007.





***We
      have a limited operating history with our business model, which limits the
      information available to you to evaluate our
      business.***




Since
      our
      inception in 1984, we have accumulated deficits from historical operations
      of
      approximately $30,397,000 at September 30, 2008. In 2002, we changed our
      business model and chose to strategically focus on becoming a developer and
      marketer of secure technologies for all forms of print media. We have continued
      to incur losses since we began our new business model. Also, we have limited
      operating and financial information relating to this new business to evaluate
      our performance and future prospects. Due to the change in our business model,
      we do not view our historical financials as being a good indication of our
      future. We face the risks and difficulties of a company going into a new
      business including the uncertainties of market acceptance, competition, cost
      increases and delays in achieving business objectives. There can be no assurance
      that we will succeed in addressing any or all of these risks, and the failure
      to
      do so could have a material adverse effect on our business, financial condition
      and operating results.





***We
      have secured credit facilities that have large principal payments due and if
      we
      are unable to repay them with cash we may be forced to repay, in whole on in
      part, with each credit facility’s applicable collateral, which would have a
      material adverse effect on our financial position.***




On
      January 4, 2008, we entered into two credit facilities with and aggregate
      borrowing capacity of $3.6 million that is repayable in full on January 4,
      2010.
      One of these credit facilities has a borrowing limit of $3.0 million and is
      secured by our stock in our Plastic Printing Professionals, Inc. subsidiary
      (“P3”), and the other credit facility has a borrowing limit of $600,000 and is
      secured by our accounts receivable, excluding the accounts receivable of P3.
      As
      of September 30, 2008, the Company was in default of both agreements due to
      a
      failure to pay interest when due. Both Fagenson and Co., Inc. and Patrick White
      have agreed to waive the default through January 1, 2010. If we cannot generate
      sufficient cash from operations or raise cash from other sources, including
      without limitation, fund-raising through sales of equity, and if we cannot
      refinance the credit facilities, we may have to repay, in whole or in part,
      one
      or both of the credit facilities with each credit facility’s applicable
      collateral, which would have a material adverse effect on our financial
      position.





***Due
      to our low cash balance and negative cash flow, we may have to further reduce
      our costs by curtailing future operations.***





We
      have
      incurred significant net losses this year and previous years. Our ability to
      fund our capital requirements out of our available cash and cash generated
      from
      our operations depends on a number of factors. Some of these factors include
      our
      ability to (i) increase paper and plastic card sales and (ii) increase sales
      of
      our digital products. If we cannot generate positive cash flow from operations,
      we will have to continue to reduce our costs and raise working capital from
      other sources. These measures could include selling or consolidating certain
      operations or assets, and delaying, canceling or scaling back product
      development and marketing programs. These measures could materially and
      adversely affect our ability to operate profitably.





***Our
      ability to effect a financing transaction to fund our operations could adversely
      affect the value of your stock.***





If
      we
      seek additional financing through raising additional capital through public
      or
      private equity offerings or debt financing, such additional capital financing
      may not be available to us on favorable terms and our stockholders will likely
      experience substantial dilution. Material shortage of capital will require
      us to
      take steps such as reducing our level of operations, disposing of selected
      assets, effecting financings on less than favorable terms or seeking protection
      under federal bankruptcy laws.


25





***Our
      limited cash resources may not be sufficient to fund continuing losses from
      operations and the expenses of the current patent validity and patent
      infringement litigations.***





The
      cost
      to defend and prosecute current and future patent litigation may be significant.
      We cannot assure you that the ultimate cost of current known or future unknown
      litigation and claims will not exceed our current expectations and/or our
      ability to pay such costs and it is possible that such litigation costs could
      have a material adverse effect on our business, financial condition and
      operating results. In addition, litigation is time consuming and could divert
      management attention and resources away from our business, which could adversely
      affect our business, financial condition and operating results.





***If
      we lose our current litigation, we may lose certain of our technology rights,
      which may affect our business plan.***





We
      are
      subject to litigation and alleged litigation, including without limitation
      our
      litigation with the European Central Bank, in which parties allege, among other
      things, that certain of our patents are invalid. For more information regarding
      this litigation, see Part II Item 1- Legal Proceedings. If the ECB or other
      parties are successful in invalidating any or all of our patents, it may
      materially affect us, our financial condition, and our ability to market and
      sell certain of our products based on any patent that is invalidated.
      Furthermore, we have granted nearly all control over our ECB Litigation a third
      party, Trebuchet Capital Partners, LLC., who may or may not have the resources
      or capabilities to successfully defend our patent rights.





***If
      we lose our current validity or infringement litigation we may be liable for
      significant legal costs of our counterparts.***




We
      have
      been able to mitigate the cash outlays that we have been required to make for
      legal costs of our current invalidity cases against the European Central Bank
      by, among other things, negotiating legal fee caps and using shares of our
      common stock for payments. However, if we receive adverse rulings in any of
      our
      infringement or related invalidity cases against the European Central Bank,
      we
      will likely be responsible for a large portion of the legal costs that were
      expended by the European Central Bank in such case, which would likely be
      significant, with our current estimates of between $1,000,000 to $2,000,000.
      The
      payment of these amounts could have a material adverse impact on our operations,
      cash available and liquidity.




***If
      we are unable to adequately protect our intellectual property, our competitive
      advantage may disappear.***




Our
      success will be determined in part by our ability to obtain United States and
      foreign patent protection for our technology and to preserve our trade secrets.
      Because of the substantial length of time and expense associated with developing
      new document security technology, we place considerable importance on patent
      and
      trade secret protection. We intend to continue to rely primarily on a
      combination of patent protection, trade secrets, technical measures, copyright
      protection and nondisclosure agreements with our employees and customers to
      establish and protect the ideas, concepts and documentation of software and
      trade secrets developed by us. Our ability to compete and the ability of our
      business to grow could suffer if these intellectual property rights are not
      adequately protected. There can be no assurance that our patent applications
      will result in patents being issued or that current or additional patents will
      afford protection against competitors. We rely on a combination of patents,
      copyrights, trademarks and trade secret protection and contractual rights to
      establish and protect our intellectual property. Failure of our patents,
      copyrights, trademarks and trade secret protection, non-disclosure agreements
      and other measures to provide protection of our technology and our intellectual
      property rights could enable our competitors to more effectively compete with
      us
      and have an adverse effect on our business, financial condition and results
      of
      operations. In addition, our trade secrets and proprietary know-how may
      otherwise become known or be independently discovered by others. No guarantee
      can be given that others will not independently develop substantially equivalent
      proprietary information or techniques, or otherwise gain access to our
      proprietary technology.





In
      addition, we may be required to litigate in the future to enforce our
      intellectual property rights, to protect our trade secrets, to determine the
      validity and scope of the proprietary rights of others, or to defend against
      claims of infringement or invalidity. Any such litigation could result in
      substantial costs and diversion of resources and could have a material adverse
      effect on our business, financial condition or results of operations, and there
      can be no assurances of the success of any such litigation.





***We
      may face intellectual property infringement or other claims against us, our
      customers or our intellectual property that could be costly to defend and result
      in our loss of significant rights.***





Although
      we have received or applied for U.S., European and International Patents with
      respect to certain technologies of ours, there can be no assurance that these
      patents will afford us any meaningful protection. Although we believe that
      our
      use of the technology and products we developed and other trade secrets used
      in
      our operations do not infringe upon the rights of others, our use of the
      technology and trade secrets we developed may infringe upon the patents or
      intellectual property rights of others. In the event of infringement, we could,
      under certain circumstances, be required to obtain a license or modify aspects
      of the technology and trade secrets we developed or refrain from using same.
      We
      may not have the necessary financial resources to defend an infringement claim
      made against us or be able to successfully terminate any infringement in a
      timely manner, upon acceptable terms and conditions or at all. Failure to do
      any
      of the foregoing could have a material adverse effect on us and our financial
      condition. Moreover, if the patents, technology or trade secrets we developed
      or
      use in our business are deemed to infringe upon the rights of others, we could,
      under certain circumstances, become liable for damages, which could have a
      material adverse effect on us and our financial condition. As we continue to
      market our products, we could encounter patent barriers that are not known
      today. A patent search will not disclose applications that are currently pending
      in the United States Patent Office, and there may be one or more such pending
      applications that would take precedence over any or all of our
      applications.


26


Furthermore,
      third parties may assert that our intellectual property rights are invalid,
      which could result in significant expenditures by us to refute such assertions.
      If we become involved in litigation, we could lose our proprietary rights,
      be
      subject to damages and incur substantial unexpected operating expenses.
      Intellectual property litigation is expensive and time-consuming, even if the
      claims are subsequently proven unfounded, and could divert management’s
      attention from our business. If there is a successful claim of infringement,
      we
      may not be able to develop non-infringing technology or enter into royalty
      or
      license agreements on acceptable terms, if at all. If we are unsuccessful in
      defending claims that our intellectual property rights are invalid, we may
      not
      be able to enter into royalty or license agreements on acceptable terms, if
      at
      all. This could prohibit us from providing our products and services to
      customers, which could have a material adverse effect on us and our financial
      condition.





***If
      our products and services do not achieve market acceptance, we may not achieve
      our revenue and net income goals in the time prescribed or at
      all.***





We
      are at
      the early stage of introducing our document security technology and products
      to
      the market. If we are unable to operate our business as contemplated by our
      business model or if the assumptions underlying our business model prove to
      be
      unfounded, we could fail to achieve our revenue and net income goals within
      the
      time we have projected, or at all, which could have a material adverse effect
      on
      our business. As a result, the value of your investment could be significantly
      reduced or completely lost.





We
      cannot
      assure you that a sufficient number of companies will purchase our products
      or
      services or other document security products. In addition, we cannot predict
      the
      rate of market’s acceptance of our document security solutions. Failure to
      maintain a significant customer base may have a material adverse effect on
      our
      business.





***Certain
      of our recently developed products are not yet commercially accepted and there
      can be no assurance that those products will be accepted, which would adversely
      affect our financial results.***





Over
      the
      past one to two years, we have spent significant funds and time to create new
      products by applying our technologies onto media other than paper, including
      plastic and cardboard packaging, and delivered our technologies digitally.
      We
      have had limited success in selling our products that are on cardboard packaging
      and those that are delivered digitally. If we are not able to successfully
      sell
      these new products, our financial results will be adversely affected.





***The
      results of our research and development efforts are uncertain and there can
      be
      no assurance of the commercial success of our
      products.***





We
      believe that we will need to continue to incur research and development
      expenditures to remain competitive. The products we currently are developing
      or
      may develop in the future may not be technologically successful. In addition,
      the length of our product development cycle may be greater than we originally
      expect and we may experience delays in future product development. If our
      resulting products are not technologically successful, they may not achieve
      market acceptance or compete effectively with our competitors’
products.





***Changes
      in document security technology and standards could render our applications
      and
      services obsolete.***





The
      market for document security products, applications, and services is fast moving
      and evolving. Identification and authentication technology is constantly
      changing as we and our competitors introduce new products, applications, and
      services, and retire old ones as customer requirements quickly develop and
      change. In addition, the standards for document security are continuing to
      evolve. If any segments of our market adopt technologies or standards that
      are
      inconsistent with our applications and technology, sales to those market
      segments could decline, which could have a material adverse effect on us and
      our
      financial condition.


27


***The
      market in which we operate is highly competitive, and we may not be able to
      compete effectively, especially against established industry competitors with
      greater market presence and financial resources.***





Our
      market is highly competitive and characterized by rapid technological change
      and
      product innovations. Our competitors may have advantages over us because of
      their longer operating histories, more established products, greater name
      recognition, larger customer bases, and greater financial, technical and
      marketing resources. As a result, they may be able to adapt more quickly to
      new
      or emerging technologies and changes in customer requirements, and devote
      greater resources to the promotion and sale of their products. Competition
      may
      also force us to decrease the price of our products and services. We cannot
      assure you that we will be successful in developing and introducing new
      technology on a timely basis, new products with enhanced features, or that
      these
      products, if introduced, will enable us to establish selling prices and gross
      margins at profitable levels.





***Our
      growth strategy depends, in part, on our acquiring complementary businesses
      and
      assets and expanding our existing operations to include manufacturing
      capabilities, which we may be unable to do.***





Our
      growth strategy is based, in part, on our ability to acquire businesses and
      assets that are complimentary to our existing operations and expanding our
      operations to include manufacturing capabilities. We may also seek to acquire
      other businesses. The success of this acquisition strategy will depend, in
      part,
      on our ability to accomplish the following:





·
            identify
                suitable businesses or assets to buy;


·
            complete
                the purchase of those businesses on terms acceptable to us;


·
            complete
                the acquisition in the time frame we expect;
                and


·
            improve
                the results of operations of the businesses that we buy and successfully
                integrate their operations into our
                own.





Although
      we were able to successfully acquire our Plastic Printing Professionals, Inc.
      subsidiary in February 2006, there can be no assurance that we will be
      successful in pursuing any or all of these steps on future transactions. Our
      failure to implement our acquisition strategy could have an adverse effect on
      other aspects of our business strategy and our business in general. We may
      not
      be able to find appropriate acquisition candidates, acquire those candidates
      that we find or integrate acquired businesses effectively or profitably.





Our
      acquisition program and strategy may lead us to contemplate acquisitions of
      companies in bankruptcy, which entail additional risks and uncertainties. Such
      risks and uncertainties include, without limitation, that, before assets may
      be
      acquired, customers may leave in search of more stable providers and vendors
      may
      terminate key relationships. Also, assets are generally acquired on an “as is”
basis, with no recourse to the seller if the assets are not as valuable as
      may
      be represented. Finally, while bankrupt companies may be acquired for
      comparatively little money, the cost of continuing the operations may
      significantly exceed expectations.





We
      have
      in the past used, and may continue to use, our Common Stock as payment for
      all
      or a portion of the purchase price for acquisitions. If we issue significant
      amounts of our Common Stock for such acquisitions, this could result in
      substantial dilution of the equity interests of our stockholders.





***If
      we fail to retain our key personnel and attract and retain additional qualified
      personnel, we might not be able to pursue our growth
      strategy.***





Our
      future success depends upon the continued service of our executive officers
      and
      other key sales and research personnel who possess longstanding industry
      relationships and technical knowledge of our products and operations. The loss
      of any of our key employees, in particular, Patrick White, our Chief Executive
      Officer and David Wicker, our Vice-President of Operations, could negatively
      impact our ability to pursue our growth strategy and conduct operations.
      Although we believe that our relationship with these individuals is positive,
      there can be no assurance that the services of these individuals will continue
      to be available to us in the future. We have extended our employment agreements
      with Patrick White to June 2009. Our employment agreement with David Wicker
      expires in June 2009. There can be no assurance that these persons will continue
      to agree to be employed by us after such dates.





***Future
      growth in our business could make it difficult to manage our
      resources.***





Our
      anticipated business expansion could place a significant strain on our
      management, administrative and financial resources. Significant growth in our
      business may require us to implement additional operating, product development
      and financial controls, improve coordination among marketing, product
      development and finance functions, increase capital expenditures and hire
      additional personnel. There can be no assurance that we will be able to
      successfully manage any substantial expansion of our business, including
      attracting and retaining qualified personnel. Any failure to properly manage
      our
      future growth could negatively impact our business and operating
      results.


28





***We
      cannot predict our future capital needs and we may not be able to secure
      additional financing.***





We
      may
      need to raise additional funds in the future to fund more aggressive expansion
      of our business, complete the development, testing and marketing of our
      products, or make strategic acquisitions or investments. We may require
      additional equity or debt financings, collaborative arrangements with corporate
      partners or funds from other sources for these purposes. No assurance can be
      given that these funds will be available for us to finance our development
      on
      acceptable terms, if at all. Such additional financings may involve substantial
      dilution of our stockholders or may require that we relinquish rights to certain
      of our technologies or products. In addition, we may experience operational
      difficulties and delays due to working capital restrictions. If adequate funds
      are not available from operations or additional sources of financing, we may
      have to delay or scale back our growth plans. In June 2008, we sold 350,000
      shares for an aggregate purchase price of $1.4 million, with $100,000 payable
      at
      closing and the remaining $1.3 million payable in six-month installments over
      two years. If the Purchaser of such 350,000 does not pay some or all of such
      remaining $1.3 million purchase price, we will have limited, if any, recourse
      against the purchaser other than recouping a pro-rata amount of the 350,000
      shares. If we do not receive the remaining $1.3 million of the purchase price
      on
      schedule, our financial position and financing resources may be materially
      adversely affected.





**Risks
      Related to Our Stock**





***Provisions
      of our certificate of incorporation and agreements could delay or prevent a
      change in control of our company.***





Certain
      provisions of our certificate of incorporation may discourage, delay, or prevent
      a merger or acquisition that a stockholder may consider favorable. These
      provisions include:





·
            the
                authority of the Board of Directors to issue preferred stock;
                and


·
            a
                prohibition on cumulative voting in the election of directors.





***We
      have a large number of authorized but unissued shares of common stock, which
      our
      management may issue without further stockholder approval, thereby causing
      dilution of your holdings of our common stock.***





As
      of
      September 30, 2008, there are approximately 185 million shares of
      authorized but unissued shares of our common stock. Our management will continue
      to have broad discretion to issue shares of our common stock in a range of
      transactions, including capital-raising transactions, mergers, acquisitions,
      for
      anti-takeover purposes, and in other transactions, without obtaining stockholder
      approval, unless stockholder approval is required for a particular transaction
      under the rules of the American Stock Exchange, New York law, or other
      applicable laws. We currently have no specific plans to issue shares of our
      common stock for any purpose. However, if our management determines to issue
      shares of our common stock from the large pool of such authorized but unissued
      shares for any purpose in the future without obtaining stockholder approval,
      your ownership position would be diluted without your further ability to vote
      on
      that transaction.





***The
      exercise of our outstanding options and warrants and vesting of restricted
      stock
      awards may depress our stock price.***





As
      of
      September 30, 2008, there were outstanding stock options and warrants to
      purchase an aggregate of 1,306,343 shares of our Common Stock at exercise prices
      ranging from $2.20 to $12.65 per share and a weighted average exercise price
      of
      $10.24. In addition, as of September 30, 2008, there were 237,793 restricted
      shares of our common stock that are subject to various vesting terms. To the
      extent that these securities vest, dilution to our stockholders will occur.
      Moreover, the terms upon which we will be able to obtain additional equity
      capital may be adversely affected, since the holders of these securities can
      be
      expected to exercise or convert them at a time when we would, in all likelihood,
      be able to obtain any needed capital on terms more favorable to us than the
      exercise and conversion terms provided by those securities.





Sales
      of
      these shares in the public market, or the perception that future sales of these
      shares could occur, could have the effect of lowering the market price of our
      common stock below current levels and make it more difficult for us and our
      stockholders to sell our equity securities in the future.





Sale
      or
      the availability for sale of shares of common stock by stockholders could cause
      the market price of our common stock to decline and could impair our ability
      to
      raise capital through an offering of additional equity securities.


29





***We
      do not intend to pay cash dividends.***





We
      do not
      intend to declare or pay cash dividends on our common stock in the foreseeable
      future. We anticipate that we will retain any earnings and other cash resources
      for investment in our business. The payment of dividends on our common stock
      is
      subject to the discretion of our Board of Directors and will depend on our
      operations, financial position, financial requirements, general business
      conditions, restrictions imposed by financing arrangements, if any, legal
      restrictions on the payment of dividends and other factors that our Board of
      Directors deems relevant.




**ITEM
      2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
      PROCEEDS**




On
      August
      20, 2008, the Company entered into an agreement with Trebuchet Capital Partners,
      LLC which agreed to pay substantially all of the litigation costs associated
      with pending validity proceedings initiated by the ECB in eight European
      countries relating to the Company’s European Patent 0 455 750B1 that the Company
      has claimed the ECB infringed in printing of the Euro currency. Trebuchet has
      also purchased 100,000 shares of the Company’s common stock, subject to the
      American Stock Exchange approving the listing of such shares, for an aggregate
      purchase price of $400,000, the proceeds of which will be used by the Company
      to
      pay existing, accrued costs related to the Litigation. On
      July
      18, 2008, the Company issued 19,266 shares to a vendor as payment for $94,000
      of
      the vendor’s outstanding bills.




**ITEM
      3 - DEFAULTS UPON SENIOR SECURITIES**




On
      January 4, 2008, the Company entered into a Credit Facility Agreement with
      Fagenson and Co., Inc., as agent, a related party to Robert B. Fagenson, the
      Chairman of the Company's Board of Directors. Under the Fagenson Credit
      Agreement, the Company can borrow up to a maximum of $3,000,000 from time to
      time up to and until January 4, 2010. The advances are generally limited to
      $400,000 unless otherwise mutually agreed upon by both parties per fiscal
      quarter, with the exception of $600,000 that can be advanced at any time for
      patent litigation related bills. Any amount borrowed by the Company pursuant
      to
      the Fagenson Credit Agreement will have an annual interest rate of 2% above
      LIBOR and will be secured by the Common Stock of Plastic Printing Professionals,
      Inc., (“P3”) the Company's wholly owned subsidiary. Interest is payable
      quarterly in arrears and the principal is payable in full at the end of the
      term
      under the Fagenson Credit Agreement. In addition, on January 4, 2008, the
      Company also entered into a Credit Facility Agreement with Patrick White, the
      Company's Chief Executive Officer and a member of the Board of Directors. Under
      the White Credit Agreement, the Company can borrow up to $600,000 from time
      to
      time up to and until January 4, 2010. Any amount borrowed by the Company
      pursuant to the White Credit Agreement will have an annual interest rate of
      2%
      above LIBOR and will be secured by the accounts receivable of the Company,
      excluding the accounts receivable of P3. Interest is payable quarterly in
      arrears and the principal is payable in full at the end of the Term under the
      White Credit Agreement. Mr. White can accept common stock as repayment of the
      loan upon a default. Under the terms of the agreement the Company is required
      to
      comply with various covenants. During the year ended December 31, 2007, Patrick
      White advanced the Company $300,000 while the terms of the credit facility
      were
      being finalized. As of September 30, 2008, the Company was in default of both
      agreements due to a failure to pay interest when due. Both Fagenson and Co.,
      Inc. and Patrick White have agreed to waive the default through January 1,
      2010.




**ITEM
      4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**




None




**ITEM
      5 - OTHER INFORMATION**




None


30




**ITEM
      6 - EXHIBITS**




The
      Exhibits listed below designated by an * are incorporated by reference to the
      filings by Document Security Systems, Inc. under the Securities Act of 1933
      or
      the Securities and Exchange Act of 1934, as indicated. All other exhibits are
      filed herewith.




(a)    Exhibits




Item
      3.1  Articles
      of Organization of the Registrant, as amended (incorporated by reference to
      exhibit 3.1 to the Company's Registration Statements No. 2-98684-NY on Form
      S-18).*




Item
      3.2  By-laws
      of the Registrant, as amended (incorporation by reference to exhibit 3.2 to
      the
      Company's Registration Statement No. 2-98684-NY on Form S-18).*




Item
      10.1
      Agreement, dated August 20, 2008, between Document Security Systems, Inc. and
      Trebuchet Capital Partners, LLC





Item
      31.1  Certifications
      of Chief Executive Officer Pursuant to Section 302 of the Sarbanes Oxley
      Act




Item
      31.2  Certifications
      of Acting Chief Financial Officer Pursuant to Section 302 of the Sarbanes Oxley
      Act





Item
      32.1  Certification
      of Chief Executive Officer Pursuant to Section 906 of the Sarbanes Oxley
      Act





Item
      32.2  Certification
      of Acting Chief Financial Officer Pursuant to Section 906 of the Sarbanes Oxley
      Act




**SIGNATURES**




In accordance with the requirements of the Exchange Act, the registrant caused
      this report on Form 10-Q to be signed on its behalf by the undersigned,
      thereunto duly authorized.




**DOCUMENT
                SECURITY SYSTEMS, INC.**November
                10, 2008
            
            By:
            /s/
                Patrick WhitePatrick
                White
              Chief
                Executive OfficerNovember
                10, 2008
            
            By:
            /s/
                Philip JonesPhilip
                JonesActing
                Chief Financial Officer
              (Vice
                President of Finance)


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