10-Q

UNITED STATESSECURITIES AND EXCHANGE COMMISSION

WASHINGTON D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2005

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

For the transition period from               to               

Commission file number: 0-18188

PAULSON CAPITAL CORP.

(Exact name of issuer as specified in its charter)

Oregon

(State or other jurisdiction of incorporation or organization)

93-0589534

(IRS employer identification number)

811 S.W. Naito Parkway
Portland, OR 97204

(Address of principal executive offices)

(503) 243-6000

(Issuer’s telephone number)

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

Indicate by check mark whether the registrant is an accelerated filer

(as defined in Rule 12b-2 of the Exchange Act): Yes  o    No  ý

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes  o    No  ý

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

Common stock, no par value, 3,103,370 as of November 11, 2005

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

PAULSON CAPITAL CORP.

INDEX TO FORM 10-Q

Part I  -	FINANCIAL INFORMATION
Item 1  -	Financial Statements:
	Consolidated Balance Sheets: –    September 30, 2005 (unaudited) and December 31, 2004
	Consolidated Statements of Income: –For the Three Months and Nine Months Ended September 30, 2005 and 2004 (unaudited)
	Consolidated Statement of Shareholders’ Equity –    For the Year Ended December 31, 2004 and the Nine Months Ended September 30, 2005 (unaudited)
	Consolidated Statements of Cash Flows: –    For the Nine Months Ended September 30, 2005 and 2004 (unaudited)
	Notes to Condensed Consolidated Interim Financial Statements (unaudited)
Item 2 -	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3 -	Quantitative and Qualitative Disclosures About Market Risk
Item 4 -	Controls and Procedures
Part II -	OTHER INFORMATION
Item 1 -	Legal Proceedings
Item 2 -	Unregistered Sales of Equity Securities and Use of Proceeds
Item 6 -	Exhibits
Signatures -
Certifications

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PART I — FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

PAULSON CAPITAL CORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS

	09/30/05		12/31/04
	(unaudited)
ASSETS
Cash and cash equivalents	$	266,144	$	132,845
Receivable from clearing organization	10,371,528		7,856,254
Notes and other receivables	1,260,966		442,934
Income taxes receivable	—		851,000
Trading securities, at market value	3,745,601		3,029,326
Investment securities, at market value	36,518,532		20,774,645
Underwriter warrants, at estimated fair value	7,495,000		9,416,000
Prepaid and deferred expenses	1,360,382		1,583,346
Furniture and equipment, net	267,096		239,028
Total assets	$	61,285,249	$	44,325,378
LIABILITIES AND SHAREHOLDERS’ EQUITY
LIABILITIES
Accounts payable and accrued liabilities	$	596,277	$	2,138,856
Dividends payable	4,457		—
Payable to clearing organization	3,037,977		1,021,860
Compensation, employee benefits and payroll taxes	4,246,064		2,108,056
Securities sold, not yet purchased, at market value	71,865		50,144
Income taxes payable	1,924,340		—
Deferred income taxes	9,741,690		5,436,000
Total liabilities	19,622,670		10,754,916
COMMITMENTS AND CONTINGENCIES	—		—
SHAREHOLDERS’ EQUITY
Preferred stock, no par value; authorized, 500,000 shares; issued and outstanding, no shares	—		—
Common stock, no par value; authorized, 10,000,000 shares; issued and outstanding, 3,103,370 at 09/30/05 and 3,190,300 at 12/31/04	1,771,693		1,745,824
Retained earnings	39,890,886		31,824,638
Total shareholders’ equity	41,662,579		33,570,462
Total liabilities and shareholders’ equity	$	61,285,249	$	44,325,378

The accompanying notes are an integral part of these statements.

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PAULSON CAPITAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)

	Three months ended					Nine months ended
	09/30/05			09/30/04		09/30/05		09/30/04
Revenues
Commissions	$	4,335,517		$	4,088,558	$	12,219,843	$	13,367,465
Corporate finance	2,176,018			3,996,238		2,761,973		10,227,410
Investment income (loss)	820,278			796,771		18,344,757		(2,742,211		)
Trading income	755,231			664,686		2,868,057		1,127,923
Interest and dividends	8,661			16,978		30,806		25,133
Other	9,544			340		10,328		1,489
	8,105,249			9,563,571		36,235,764		22,007,209
Expenses
Commissions and salaries	5,461,956			4,941,263		15,868,145		14,228,450
Underwriting expenses	76,078			303,588		210,250		766,891
Rent, telephone and quotation services	291,249			308,088		883,348		919,448
Interest expense	421			9,520		421		10,093
Professional fees	425,406			198,436		1,214,522		677,923
Bad debt expense	—			4,947		—		72,527
Travel and entertainment	14,161			31,641		175,230		328,030
Settlement expense	(175,000		)	—		343,535		32,090
Depreciation and amortization	22,559			20,950		68,319		74,748
Other	785,008			505,000		1,867,328		1,487,378
	6,901,838			6,323,433		20,631,098		18,597,578
Income before income taxes	1,203,411			3,240,138		15,604,666		3,409,631
Income tax expense (benefit)
Current	1,956,954			239,803		1,956,954		659,129
Deferred	(1,491,288		)	996,169		4,269,214		641,081
	465,666			1,235,972		6,226,168		1,300,210
Net Income	$	737,745		$	2,004,166	$	9,378,498	$	2,109,421
Earnings per share, basic	$	0.24		$	0.63	$	2.99	$	0.66
Earnings per share, diluted	$	0.24		$	0.62	$	2.97	$	0.66
Weighted average number of shares outstanding, basic	3,113,221			3,192,454		3,141,235		3,179,308
Weighted average number of shares outstanding, diluted	3,129,722			3,209,877		3,157,675		3,184,418

The accompanying notes are an integral part of these statements.

4

PAULSON CAPITAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
As of  December 31, 2004
and the nine months ended September 30, 2005

	Common Stock						Retained
	Shares		Amount				Earnings
Balance at December 31, 2004	3,190,300		$		1,745,824		$	31,824,638
Redemption of common stock (unaudited)	(94,930	)	(35,661			)	(835,686			)
Dividends to common shareholders (unaudited)	—		—				(476,564			)
Stock options exercised (unaudited)	8,000		61,530				—
Net income for the year to date (unaudited)	—		—				9,378,498
Balance at September 30, 2005 (unaudited)	3,103,370		$	1,771,693			$		39,890,886

The accompanying notes are an integral part of this statement.

5

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

	Nine months ended
	09/30/05			09/30/04
Cash flows from operating activities
Net income	$	9,378,498		$	2,109,421
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Receipt of underwriter warrants	(1,759,264		)	(6,761,240		)
Unrealized depreciation/expiration/exercise of underwriter warrants	3,271,723			3,093,668
Noncash compensation associated with underwriter warrants	408,541			1,942,572
Depreciation	68,319			74,748
Deferred income taxes	4,305,690			641,081
Change in assets and liabilities
Receivables	(818,032		)	209,418
Receivables from/payable to clearing organization	(499,157		)	658,526
Trading and investment securities	(16,460,162		)	(2,091,468		)
Prepaid and deferred expenses	222,964			125,544
Accounts payable and accrued liabilities	599,886			(1,342,388		)
Securities sold, not yet purchased	21,721			36,032
Income taxes payable/receivable	2,775,340			1,183,983
Net cash provided by (used in) operating activities	1,516,067			(120,103		)
Cash flows from investing activities
Additions to furniture and equipment	(96,387		)	(98,540		)
Cash flows from financing activities
Proceeds from exercise of stock options	61,530			539,997
Dividends paid to common shareholders	(476,564		)	(312,481		)
Payments to retire common stock	(871,347		)	(46,443		)
Net cash provided by (used in) financing activities	(1,286,381		)	181,073
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS	133,299			(37,570		)
Cash and cash equivalents at beginning of period	132,845			155,314
Cash and cash equivalents at end of period	$	266,144		$	117,744
Cash paid during the period for:
Interest	$	421		$	10,093
Income taxes	$	16,416		$	314,330

The accompanying notes are an integral part of these statements.

6

PAULSON CAPITAL CORP. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(unaudited)

1.Basis of Presentation

These financial statements are those of the Company and its wholly owned subsidiary. In the opinion of management, the accompanying unaudited consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission and include all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the Company’s financial position as of September 30, 2005 and its results of operations for the three and nine months ended September 30, 2005 and 2004, and cash flows for the nine months ended September 30, 2005 and 2004. The nature of the Company’s business is such that the results of any interim period are not necessarily indicative of results for a full fiscal year. The accompanying unaudited financial statements and related notes should be read in conjunction with the audited financial statements and Form 10-KSB of the Company for the fiscal year ended December 31, 2004.

2.Dividend

On January 27, 2005, the Company announced the authorization by the Board of Directors of a $0.15 special cash dividend to shareholders of record on February 10, 2005. The dividend was paid on March 3, 2005.

3.Securities Owned

Gains and losses from the disposition and appreciation/depreciation of trading securities are reflected as trading revenues in the income statement for the period. Gains and losses from the disposition and unrealized gains/losses of investment securities are reflected as investment revenues in the income statement for the period. Investment securities may be held for the long term or sold pursuant to the intention of management.

4.Commitments and Contingencies

In December 2004 and January 2005, the Company’s wholly owned subsidiary, Paulson Investment Company (“PIC”), settled arbitration proceedings filed by Louis Barinaga, a former PIC customer.  The December 2004 settlement related to Barinaga’s claims involving the purchases of convertible notes of E.com, which were purchased directly from E.com.  The January 2005 settlement related to Barinaga’s claims involving transactions in the stock of e.Digital.  The settlement has been consummated with Barinaga.  However, PIC’s insurance carrier, after previously providing settlement authorization to PIC regarding the e.Digital settlement, has now withdrawn that authorization.  PIC believes that the insurance carrier is obligated to provide the settlement authorization to which it previously agreed.  PIC has filed suit against the insurance carrier and intends to pursue the insurance proceeds vigorously.  As of December 31, 2004, the Company has recorded the total amount of the settlement expense in its financial statements.

In October 2002, PIC was named as a defendant in a lawsuit filed by Special Situations Fund III, LP and Special Situations Cayman Fund, LP.  The lawsuit was filed in U.S. District Court for the District of New Jersey.  It asserts various federal securities law claims and common law fraud and negligence against numerous defendants, including PIC, arising out of two follow-on offerings of Suprema Specialties, Inc.  PIC participated in one of the two offerings, the August 25, 2000 follow-on offering of Suprema Specialties, Inc., as a member of the underwriting syndicate, underwriting 75,000 shares in total.  The stock was sold in the August 25, 2000 offering at a price of $8.00 per share.  Plaintiffs seek damages for the purchase of 399,151 shares of Suprema Specialties, Inc. stock between August 25, 2000 and November 14, 2001.  The federal district court has dismissed the claims against PIC.  Plaintiffs have appealed and the case currently is pending before the United States Third Circuit Court of Appeals.  Oral argument on the appeal occurred September 16, 2005.  PIC believes it has meritorious defenses and intends to defend this matter vigorously.

7

On April 12, 2005, the NASD sent a letter to PIC’s outside counsel indicating that the NASD Department of Enforcement had made a preliminary determination to recommend that disciplinary action be brought against PIC, and certain other PIC employees, including its former president, and former employees, for violations of NASD Rules of Conduct 2110, for mutual fund market-timing, and 3010, for failure to supervise the firm’s mutual fund market-timing business.  The NASD and Paulson have agreed to resolve the action with PIC in return for a payment by PIC of $150,000 in restitution and $175,000 in fines.  The NASD and Paulson currently are negotiating the language of the settlement, and there is no assurance that an agreement will be finalized.  If this matter is not settled, it likely will proceed to a hearing before the NASD by the end of 2006.

In addition to the matters described above, PIC has been named in an NASD arbitration filed in July 2005 by a group of former customers.  The statement of claim indicates it was filed in an attempt to “toll” the running of applicable statutes of limitation.  The statement provides no specific factual allegations or any information regarding what amounts, if any, may be sought from PIC. PIC has not had an opportunity to fully investigate this claim, but believes it has meritorious defenses and intends to defend this matter vigorously if the claim is pursued.

An adverse outcome in certain of the matters described above could have a material adverse effect on PIC or the Company. From time to time, PIC is named in certain other legal proceedings and receives notice that certain customers may commence legal proceedings against PIC.  The Company has no additional legal proceedings other than through PIC. The Company believes, based upon information received to date and, where the Company believes it appropriate, discussions with legal counsel, that resolution of any additional pending or threatened litigation will have no material adverse effect on the consolidated financial condition, results of operations, or business of the Company.

5.Stock Options

The Company has a stock-based employee compensation plan. As allowed under SFAS No. 123 “Accounting for Stock-Based Compensation,” the Company continues to account for stock options for employees under APB No. 25, “Accounting for Stock Issued to Employees,” and has adopted the disclosure only requirements of SFAS No. 123. There were no stock option grants in the nine month periods ended September 30, 2005 or 2004. Accordingly, no pro forma income effect is shown.

8

6.Earnings Per Share

The following table is a reconciliation of the numerators and denominators of the basic and diluted per share computations for each of the three months ended September 30, 2005 and September 30, 2004.

	Income		Weighted Average Shares	Per Share Amount
	(Numerator)		(Denominator)
Three Months Ended September 30, 2005 Income available to common shareholders	$	737,745	3,113,221	$	0.24
Effect of dilutive securities – options			16,501
Diluted earnings per share	$	737,745	3,129,722	$	0.24
Three Months Ended September 30, 2004 Income available to common shareholders	$	2,004,166	3,192,454	$	0.63
Effect of dilutive securities – options			17,423
Diluted earnings per share	$	2,004,166	3,209,877	$	0.62

The following table is a reconciliation of the numerators and denominators of the basic and diluted per share computations for each of the nine months ended September 30, 2005 and September 30, 2004.

	Income		Weighted Average Shares	Per Share Amount
	(Numerator)		(Denominator)
Nine Months Ended September 30, 2005 Income available to common shareholders	$	9,378,498	3,141,235	$	2.99
Effect of dilutive securities – options			16,440
Diluted earnings per share	$	9,378,498	3,157,675	$	2.97
Nine Months Ended September 30, 2004 Income available to common shareholders	$	2,109,421	3,179,308	$	0.66
Effect of dilutive securities – options			5,110
Diluted earnings per share	$	2,109,421	3,184,418	$	0.66

9

7.Recently Issued Accounting Pronouncements

In December 2004, the FASB issued FAS 123R, which requires that compensation costs relating to share-based payments be recognized in the Company’s financial statements. The Company currently accounts for those payments under the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. The Company is preparing to implement this standard effective January 1, 2006.  Although we have not yet determined whether the adoption of 123(R) will result in amounts that are similar to the current pro form data, we expect the adoption may have a material impact on future financial statements.  This estimate is based on preliminary information and could materially change based on the actual facts and circumstances and the terms of future option grants.

In June 2005, the FASB issued Statement No. 154, “Accounting Changes and Error Corrections,” (SFAS 154) a replacement of APB Opinion No. 20, “Accounting Changes,” and Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements.” SFAS 154 changes the requirements for the accounting for and the reporting of a change in accounting principle. Previously, most voluntary changes in accounting principles required recognition by recording a cumulative effect adjustment within net income in the period of change. SFAS 154 requires retrospective application to prior periods’ financial statements, unless it is impracticable to determine either the specific period effects or the cumulative effect of the change. SFAS 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005. The Company does not believe SFAS 154 will have a material effect on its consolidated financial position, results of operations or cash flows.

8.Reclassifications

Certain 2004 amounts have been reclassified to conform to the 2005 presentation.

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General

FORWARD-LOOKING STATEMENTS

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

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

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

•We are subject to a very high degree of regulation and are responsible for compliance with applicable regulations by all of our personnel.  A significant regulatory infraction by us or any of our registered representatives could result in significant penalties, including the loss of our license to conduct securities business in one or more jurisdictions.

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

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

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Overview

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

•securities brokerage activities for which PIC earns commission revenues;

•corporate finance revenues consisting principally of underwriting discounts and underwriter warrants;

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

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

Because we operate in the financial services industry, our revenues and earnings are substantially affected by general conditions in financial markets. In our securities brokerage and corporate finance business, the amount of our revenues depends on levels of market activity requiring the services we provide.  Our investment banking activity, which consists primarily of acting as the managing underwriter of initial and follow-on public offerings for smaller companies, is similarly affected by the strength of the market for new equity offerings, which has historically experienced substantial cyclical fluctuation.  Although we attempt to match operating costs with activity levels, many of our expenses are either fixed or difficult to change on short notice.  Accordingly, fluctuations in brokerage and investment banking revenues tend to result in sharper fluctuations, on a percentage basis, in net income or loss.

Our investment income or loss and, to a lesser extent, our trading income or loss are affected by changes in market valuation of securities generally and, in particular, by changes in valuation of the equity securities of microcap companies in which our investments and trading activities tend to be concentrated.  Equity markets in general, and microcap equity markets in particular, have always experienced significant volatility and this volatility has, in recent years, been extreme.  The results of this volatility on the value of our investment portfolio and securities held in connection with our trading and investment activities include large quarterly fluctuations in income or loss and substantial increases or decreases in our net worth as our securities holdings are marked to market. The securities in the investment account are held for investment, not actively traded, and not deemed part of operations in accordance with management intentions.

A substantial portion of our investment banking business consists of acting as managing underwriter of initial and follow-on public offerings for microcap companies.  As a part of our compensation for this activity, we typically receive warrants exercisable to purchase securities identical to those that we offer and sell to the public.  Generally, the warrants are not exercisable for the first six months after the offering in which they are earned and are thereafter exercisable for four and one-half years, after which they expire.  The exercise price is typically 120% of the price at which the securities are initially sold to the public. Accordingly, unless there is at least a 20% increase in the price of these securities at some time more than six months and less than five years after the offering, the warrants will remain “under water” and will ultimately expire unexercised.

Critical Accounting Policies

The following discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with US GAAP.  In preparing our consolidated financial statements, we must make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our financial statements.  Actual results are likely to differ from these estimates under different assumptions and conditions.

The critical accounting policies described below include those that reflect significant judgments and uncertainties, which potentially could produce materially different results under different assumptions and conditions.  We believe our critical accounting policies are limited to those described below.

11

Use of Estimates. We are required to estimate the value of securities that we hold at the date of any financial statements and to include that value, and changes in such value, in those financial statements.  Accordingly, the aggregate estimated value of securities, including warrants, as of the date of any balance sheet is recorded as an asset on that balance sheet.  When a new warrant is received as a result of our investment banking activity, its estimated value is included in corporate finance revenue on the date on which it is earned.  Subsequently, any change in estimated value is recorded as investment income or loss.  When a warrant is exercised, the book value is adjusted to reflect the value of the securities purchased, net of the exercise price, and the adjustment amount is recorded as income or loss for the relevant period. If the warrant expires unexercised, the book value is adjusted to zero and the decrease is recorded as a loss in the relevant period.

We estimate the value of our underwriter warrants using the Black-Scholes Option Pricing Model. The Black-Scholes model requires us to use historical price data combined with certain assumptions and judgments as inputs for the model.  The most influential factor in this model is price volatility, which we calculate for each issuing company’s warrants based on the respective company’s own historical stock price movements as well as an index of historical prices for comparable companies.  When we initially receive a new underwriter warrant from an initial public offering, its calculated volatility factor is entirely based on the volatility of an index of comparable companies, since there is no price history for a new publicly traded company.  As each underwriter warrant approaches its expiration date, its volatility factor is derived primarily from the historical prices of its underlying common stock.  We cannot assure you that we will ultimately be able to exercise any of our warrants in a way that will realize the value that we attribute to them in our financial statements based on this model. As of September 30, 2005, our underwriter warrants, based on the Black-Scholes Option Pricing Model, were valued at approximately $7.5 million, down from the estimated value of $9.4 million as of December 31, 2004. During the nine months ended September 30, 2005, the Company exercised eight of its underwriter warrants.

In addition to our underwriter warrants, we hold other securities, some of which have very limited liquidity and some of which do not have a readily ascertainable market value.  We are required to carry these securities at estimated fair value.

As a result of the factors described above, our revenues and earnings are subject to substantial fluctuation from period to period based on circumstances, many of which are beyond our control.  An increase in financial market activity generally, and/or an increase in equity valuations generally, will normally result in increases in our revenues, earnings and net worth as our activity levels and the value of our investment portfolio increase.  Conversely, a general market retrenchment will typically lead to decreased revenues, earnings and net worth as a result both of decreased activity and the need to adjust high investment portfolio values to lower levels.  Accordingly, results for any historical period are not necessarily indicative of similar results for any future period.

Results of Operations

PIC’s revenues and operating results are influenced by fluctuations in the equity underwriting markets as well as general economic and market conditions, particularly conditions in the over-the-counter market, where PIC’s investment account, trading inventory positions and underwriter warrants are heavily concentrated.  Significant fluctuations can occur in PIC’s revenues and operating results from one period to another.  PIC’s results of operations depend upon many factors, such as the number of companies that are seeking public financing, the quality and financial condition of those companies, market conditions in general, the performance of previous PIC underwritings and interest in certain industries by investors.  As a result, revenues and income derived from these activities may vary significantly from year to year.  In the tables below, “Corporate Finance” revenues are a function of total proceeds from offerings done during the period, compensation per offering, and the fair value of underwriter warrants received.  “Investment Income” includes realized gains from the exercise of underwriter warrants, gains and losses from the sales of investment securities, and unrealized gains and losses from underwriter warrants and other investment securities.  “Trading Income” is the net gain or loss from trading positions before commissions paid to the representatives in the trading department.

12

Summary of Changes in Major Categories
of Revenues and Expense

Three Months Ended September 30, 2005 v. September 30, 2004

						Three Months Ended
	Increase/(Decrease)			Percent Change		September 30, 2005		September 30, 2004
Revenues:
Sales Commissions	$	246,959		6.0		$	4,335,517	$	4,088,558
Corporate Finance	(1,820,220		)	(45.5	)	2,176,018		3,996,238
Investment Income	23,507			3.0		820,278		796,771
Trading Income	90,545			13.6		755,231		664,686
Other	887			5.1		18,205		17,318
Total	(1,458,322		)	(15.2	)	8,105,249		9,563,571
Expenses:
Commissions and Salaries	520,693			10.5		5,461,956		4,941,263
Underwriting Expenses	(227,510		)	(74.9	)	76,078		303,588
Rent, Telephone & Quotes	(16,839		)	(5.5	)	291,249		308,088
Other	302,061			39.2		1,072,555		770,494
Total	578,405			9.1		6,901,838		6,323,433
Pretax Income (Loss)	$	(2,036,727	)	(62.9	)	$	1,203,411	$	3,240,138

Three Months Ended September 30, 2005 vs. Three Months Ended September 30, 2004

Revenues

Total revenues for the third quarter of 2005 decreased $1.5 million from the same quarter of the prior year primarily as a result of a decrease in corporate finance revenue. Corporate finance revenue decreased $1.8 million from the third quarter of 2004 to the third quarter of 2005. The Company completed one corporate finance transaction in each of the two respective quarters; however, the corporate finance transaction in the third quarter of 2004 had gross proceeds totaling $41.7 million as compared to the corporate finance transaction in the third quarter of 2005 with gross proceeds totaling $10.7 million.

As shown in the table above, sales commissions—which are commissions generated from the retail stock brokerage business—increased approximately $247,000 as a result of a slightly more favorable market during the third quarter of 2005 and a modest increase in trading activity. Total number of trades executed by the Company’s stock brokers for the third quarter of 2005 approximated 27,000 as compared to 23,000 trades during the comparable quarter of the prior year.

Investment income increased approximately $24,000 in the third quarter of 2005 as compared to the third quarter of 2004. Investment income can be volatile period-over-period based on the fact it is driven by the market value or fair value of the securities and underwriter warrants held by the Company. Investment income consists of (1) the unrealized appreciation and depreciation of securities held based on quoted market prices, (2) the unrealized appreciation and depreciation of securities held that are not readily marketable, based upon the Company’s estimate of their fair value, (3) the realized gain and loss on the sale of securities with quoted market prices and securities that are not readily marketable, and (4) the unrealized appreciation and depreciation of underwriter warrants held by the Company.  The depreciation/expiration/exercise of underwriter warrants of approximately $5.1 million during the third quarter of 2005, was significantly greater than the depreciation/expiration/exercise of underwriter warrants of approximately $812,000 for the third quarter of 2004. The depreciation/expiration/exercise of the underwriter warrants was offset by a $2.0 million increase in the holdings of Charles and Colvard in addition to increases in several other holdings of the Company during the third quarter of 2005. There was a decrease of $25,000 in the estimated fair value of securities not readily marketable during the third quarter of 2005. The remainder of the total investment income is the result of the unrealized and realized appreciation of securities with quoted market prices.

13

Trading income increased approximately $91,000 in the third quarter of 2005 as compared to the third quarter of 2004, as a result of stronger performance from a couple of the securities in which the Company makes a market. PIC’s focus is on very small capitalization issues, especially those tied to PIC’s corporate finance clients.

Expenses

Total expenses increased approximately $578,000 in the third quarter of 2005 from the third quarter of 2004, an increase of 9.1 percent. The largest dollar increase was in commissions and salaries with an increase of approximately $521,000 in the third quarter of 2005 as compared to the same period of the prior year. Commission expense increased approximately $540,000 primarily as a result of higher commissions paid on higher commission revenues and an increase in commissions paid based on the performance of the Company’s investments. Administrative salary expense decreased approximately $20,000 as a result of an internal reorganization resulting in the elimination of a couple of operational positions. Underwriting expenses decreased by approximately $228,000 in the third quarter of 2005 from the third quarter of 2004 as a result of the smaller corporate finance transaction completed in the third quarter of 2005 as compared to the same period of the prior year. Other expenses increased approximately $302,000, or 39.2 percent. The increase in other expenses is attributable to an approximate $254,000 increase in professional fees primarily associated with legal activity related to settlements. In addition, the Company’s contribution expense increased approximately $268,000 during the third quarter of 2005 as a result of a significant donation made to the University of Oregon. As an offset, the Company reduced its estimated settlement expense in the third quarter of 2005 by approximately $175,000 as ongoing legal negotiations resulted in a change in the estimated amount. The remainder of the net increase in other expenses consists of increases and decreases in various expense categories.

Income

The Company had pretax income of $1.2 million (14.8 percent of revenues) in the third quarter of 2005 compared to pretax income of approximately $3.2 million (33.9 percent of revenues) in the third quarter of 2004. Pretax income as a percentage of revenues was less in the third quarter of 2005 as compared to the same period the prior year due to the decrease in corporate finance revenues. Independent of the change in the Black-Scholes value of the underwriter warrants and the income and expense associated with the receipt of the underwriter warrants during the third quarter of each respective year, the Company would have had pretax income totaling $5.2 million for the third quarter of 2005, compared with pretax income of approximately $2.4 million for the third quarter of 2004. Because of the Black-Scholes value of underwriter warrants and other factors, significant fluctuations often occur in PIC’s revenues and operating results from one period to another.

14

Summary of Changes in Major Categories
of Revenues and Expense

Nine months Ended September 30, 2005 v. September 30, 2004

						Nine months Ended
	Increase/(Decrease)			Percent Change		September 30, 2005		September 30, 2004
Revenues:
Sales Commissions	$	(1,147,622	)	(8.6	)	$	12,219,843	$	13,367,465
Corporate Finance	(7,465,437		)	(73.0	)	2,761,973		10,227,410
Investment Income	21,086,968			N/A		18,344,757		(2,742,211		)
Trading Income	1,740,134			154.3		2,868,057		1,127,923
Other	14,512			54.5		41,134		26,622
Total	14,228,555			64.7		36,235,764		22,007,209
Expenses:
Commissions and Salaries	1,639,695			11.5		15,868,145		14,228,450
Underwriting Expenses	(556,641		)	(72.6	)	210,250		766,891
Rent, Telephone & Quotes	(36,100		)	(3.9	)	883,348		919,448
Other	986,566			36.8		3,669,355		2,682,789
Total	2,033,520			10.9		20,631,098		18,597,578
Pretax Income	$	12,195,035		357.7		$	15,604,666	$	3,409,631

Nine months Ended September 30, 2005 vs. Nine months Ended September 30, 2004

Revenues

Total revenues for the first nine months of 2005 increased $14.2 million. As shown in the table above, sales commissions decreased $1.1 million as a result of lackluster market performance generally and the lack of commissions associated with corporate finance transactions. The Russell 2000 Index increased a modest 2.5 percent during the first nine months of 2005 and the Nasdaq Composite Index decreased 1.1 percent during the same period. Sales commissions are also directly related to the number of brokers engaged by the Company. The Company had 94 stock brokers as of September 30, 2005, as compared to 99 as of September 30, 2004.

Corporate finance revenue decreased $7.5 million for the first nine months of 2005, from the comparable period in the prior year. The Company completed five corporate finance transactions in the first nine months of 2004 with gross proceeds totaling $76.2 million, compared with two corporate finance transactions during the first nine months of 2005 with gross proceeds totaling $13.4 million. In addition, during the first nine months of 2005 the Company had a small private placement and participated in a few small transactions in which another investment banking firm was the lead underwriter. Market conditions have resulted in a more challenging IPO market during the first nine months of 2005 as compared to the prior year.

Investment income increased $21.1 million in the first nine months of 2005 as compared to the first nine months of 2004. Investment income can be volatile period-over-period because it is driven by the market value or fair value of the securities and underwriter warrants held by the Company. Investment income consists of (1) the unrealized appreciation and depreciation of securities held based on quoted market prices, (2) the unrealized appreciation and depreciation of securities held that are not readily marketable, based upon the Company’s estimate of their fair value, (3) the realized gain and loss on the sale of securities with quoted market prices and securities that are not readily marketable, and (4) the unrealized appreciation and depreciation of underwriter warrants held by the Company.  The depreciation/expiration/exercise of underwriter warrants totaling $3.3 million during the first nine months of 2005, closely compares to the depreciation/expiration/exercise of underwriter warrants of $3.1 million for the first nine months of 2004. In the Company’s investment account, the holdings of Charles & Colvard, Ltd., increased in value $10.9 million during the first nine months of 2005, in addition to significant increases in several other holdings of the Company. The Company may sell Charles & Colvard, Ltd., or any other security in its investment account at any time deemed appropriate. There was a decrease of $25,000 in the estimated fair value of securities not readily marketable during the first nine months of 2005.  The remainder of the total investment income is the result of the unrealized and realized appreciation of securities with quoted market prices.

15

Trading income increased $1.7 million in the first nine months of 2005 as compared to the first nine months of 2004, as a result of exceptional performance from a couple of the securities in which the Company makes a market. PIC’s focus is on very small capitalization issues, especially those tied to PIC’s corporate finance clients.

Expenses

Total expenses increased $2.0 million in the first nine months of 2005 as compared to the same time period in 2004, an increase of 10.9 percent. The largest dollar increase was in commissions and salaries with an increase of $1.6 million in the first nine months of 2005. Commission expense increased approximately $1.6 million primarily as a result of higher commissions paid based on the performance of the Company’s investments. Administrative salary expense increased approximately $297,000 as a result of (1) an increase in accrued profit sharing and bonus amount of $1.6 million for the first nine months of 2005 as compared to the same period in the prior year, (2) a decrease of approximately $1.5 million in compensation expense associated with the receipt of underwriter warrants during the first nine months of 2005 as compared to the same period in the prior year, and (3) additional salary expense. Underwriting expenses decreased by approximately $557,000 from the first nine months of 2004 as a result of fewer corporate finance transactions in the 2005 period. Other expenses increased approximately $987,000, or 36.8 percent. The increase in other expenses is primarily attributable to an approximate $445,000 increase in professional fees primarily associated with legal activity related to settlements, an increase of approximately $311,000 in estimated settlement expense, and an increase of approximately $277,000 in charitable contributions. The remainder of the net increase in other expenses consists of increases and decreases in various expense categories.

Income

The Company had pretax income of $15.6 million (43.1 percent of revenues) in the first nine months of 2005 compared to pretax income of approximately $3.4 million (15.5 percent of revenues) in the first nine months of 2004. In the Company’s investment account, the holdings of Charles & Colvard, Ltd., increased $10.9 million during the first three quarters of 2005. Profitability, as a percentage of revenues, generally increases when a significant portion of the Company’s revenues is derived from investment income because fewer expenses are associated with investment income relative to the other revenue sources. Independent of the change in the Black-Scholes value of the underwriter warrants and the income and expense associated with the receipt of the underwriter warrants, the Company would have had pretax income totaling $17.5 million for the first nine months of 2005, compared with pretax income of approximately $1.7 million for the first nine months of 2004. Because of the Black-Scholes value of underwriter warrants and other factors, significant fluctuations often occur in PIC’s revenues and operating results from one period to another.

Liquidity and Capital Resources

The majority of PIC’s assets are cash and assets readily convertible to cash.  PIC’s securities inventory is stated at market value for the securities that are readily marketable and estimated fair value for the securities that are not readily marketable. The liquidity of the market for many of PIC’s securities holdings, however, varies with trends in the stock market.  Since many of the securities held by PIC are thinly traded, and PIC is in many cases a primary market maker in the issues held, any significant sales of PIC’s positions could adversely affect the liquidity of the issues held.  In general, falling prices in OTC securities (which make up most of PIC’s trading positions) lead to decreased liquidity in the market for these issues, while rising prices in OTC issues tend to increase the liquidity of the market for these securities.

16

PIC borrows money from National Financial Services, its clearing firm, in the ordinary course of its business, pursuant to an understanding under which the clearing firm agrees to finance PIC’s trading accounts.  As of September 30, 2005, no net loans were outstanding pursuant to this arrangement.  PIC and the Company are generally able to meet their compensation and other obligations out of current liquid assets.

Another source of capital to PIC and the Company has been the underwriter warrants issued to PIC in connection with its corporate finance activities and the sale of the underlying securities. There is no public market for the underwriter warrants. The securities receivable upon exercise of the underwriter warrants cannot be resold unless the issuer has registered these securities with the SEC and with the states in which the securities will be sold unless exemptions are available.  Any delay or other problem in the registration of these securities would have an adverse impact upon PIC’s ability to obtain funds from the exercise of the underwriter warrants and the resale of the underlying securities.  At September 30, 2005, PIC owned 14 underwriter warrants, all but two of which were then exercisable; three had an exercise price below the September 30, 2005 market price of the securities receivable upon exercise. The intrinsic value of these three warrants is $1.8 million. There is little or no direct relationship between the intrinsic value of PIC’s underwriter warrants at the end of any given period and the fair value calculated using the Black-Scholes pricing model, as described more fully in Critical Accounting Policies above. The prices of these securities are influenced by general movements in the prices of OTC securities as well as the success of the issuers of the underwriter warrants.  The prices of the securities underlying the underwriter warrants are very volatile, and substantial fluctuations in the Company’s estimate of their value can be expected in the future. In the nine months ended September 30, 2005, the Company exercised a total of eight underwriter warrants.

In the nine months ended September 30, 2005, approximately $1.5 million of net cash was provided by operating activities.  The major adjustments to reconcile this result to the Company’s net income include the following items that are positive adjustments to or provided cash to operating activities: depreciation/expiration/exercise of underwriter warrants of approximately $3.3 million; an increase in deferred income taxes of approximately $4.3 million; an increase of income taxes payable/receivable of approximately $2.8 million; and an increase in accounts payable and accrued liabilities of approximately $600,000. The following items are negative adjustments to or a use of cash for operating activities: receipt of underwriter warrants totaling approximately $1.8 million; an increase in trading and investment securities of approximately $16.5 million; an increase in receivables of approximately $818,000; and an increase in receivable from/payable to clearing organization of approximately $499,000. Net cash used in investing activities in the first nine months of 2005 was for additions to furniture and equipment of approximately $96,000. Net cash used in financing activities in the first nine months of 2005 approximated $1.3 million, primarily resulting from approximately $477,000 in dividends paid to common shareholders and approximately $871,000 in payments to retire common stock.

As a securities broker-dealer, PIC is required by SEC regulations to meet certain liquidity and capital standards.  We believe we are in compliance with these standards.

At September 30, 2005, the Company had no material commitments for capital expenditures.

In general, the primary sources of PIC’s, and therefore the Company’s, liquidity include PIC’s trading positions, borrowings on those positions and profits realized upon the exercise of underwriter warrants. All of these sources depend in large part on the trend in the general markets for OTC securities.  Rising OTC price levels will tend to increase the value and liquidity of PIC’s trading positions, the amount that can be borrowed from National Financial Services based upon those positions, and the value of PIC’s underwriter warrants.  The Company believes its liquidity is sufficient to meet its needs for both the short and long term horizon. The Company’s liquidity could be affected by protracted unfavorable market conditions.

Inflation

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

17

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK

Market risk is the risk of loss to the Company resulting primarily from changes in equity prices and to a significantly lesser extent, interest rates and foreign currency rates.  The Company has exposure to market risk through the market-making and trading operations of PIC, its broker-dealer subsidiary.  In connection with these activities, PIC maintains inventories in order to ensure availability of securities and to facilitate client transactions as well as trading for its own proprietary equity investment account.  PIC was a market-maker for 46 equity securities from 41 different issuers and no tax exempt or taxable debt obligations at September 30, 2005.

	September 30, 2005				December 31, 2004
	Trading and investment securities		Securities sold but not yet purchased		Trading and investment securities		Securities sold but not yet purchased
Marketable equity and other securities at fair value	$	40,222,651	$	71,865	$	23,583,728	$	50,144
Marketable debt securities	41,482		—		220,243		—
Total marketable equity, debt and other securities at fair value	$	40,264,133	$	71,865	$	23,803,971	$	50,144

Changes in the value of PIC’s trading inventories and its proprietary investment accounts result primarily from fluctuations in equity prices as well as changes in interest rates and general market and economic conditions.  PIC’s primary method of controlling risk in its trading inventories and investment accounts is through daily monitoring and use of position limits.  PIC’s trading inventories consist primarily of Nasdaq equity securities: as of September 30, 2005, the equity trading inventory limit was $2 million and the fixed income limit was $500,000.  PIC’s trading activities were within these limits at September 30, 2005.  Position limits in trading inventory accounts are monitored on a daily basis as are limit exceptions.  Debt obligation trading inventories are relatively small, since, for the most part, these securities are purchased only upon orders from customers.   Consolidated positions and exposure reports are prepared and reviewed monthly by the Senior Vice President of Trading.  Trading also monitors inventory levels and trading results on a monthly basis, with particular focus on position concentration, liquidity and volatility.  Trading prepares summary results every month to record each position at fair market value, which can require adjustments for lack of liquidity, high concentration or other reasons.

Equity Price Risk

PIC is exposed to significant equity price risk as a result of its customer transactions and market-making activity in equity securities and its concentrations in a limited number of equities, many of which are related to its investment banking projects.  PIC’s broker-dealer activities are client-driven, with the objective of meeting its clients’ needs while earning a trading profit to compensate for the risk associated with carrying inventories in equities, many of which are volatile, and some of which are illiquid, micro and small cap securities.  PIC attempts to reduce the risk of loss inherent in this activity by monitoring these securities positions continuously throughout each day. The average aggregate inventory held in PIC’s proprietary investment accounts during the quarter ended September 30, 2005 was approximately $37.4 million. Prices of the marketable equities held in these accounts are readily available and monitored on a continuous basis.

18

Interest Rate Risk

 PIC has very little direct exposure to interest rate risk.  A relatively minor amount of PIC’s trading inventory consists of debt obligations, and any of these positions PIC might have occasionally are in its trading inventory for only a very short time.  However, to the extent that interest rate fluctuations affect general market conditions and cause investors to shift away from or more heavily into equity investing, interest rates can have an effect on the value of PIC’s equity positions.

Foreign Currency Risk

PIC does not deal in securities denominated in foreign currencies and only trades foreign equities upon receipt of an order from customers, so it does not have any significant exposure to foreign currency risk in its trading inventory or investment accounts.

ITEM 4.  CONTROLS AND PROCEDURES

(a)Our management, with the participation of our President and Chief Financial Officer, conducted an evaluation of our disclosure controls and procedures, as such terms are defined under Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this report. Based on their evaluation, our President and Chief Financial Officer concluded that our disclosure controls and procedures were effective.

(b)For the quarter ended September 30, 2005, there have been no changes in our internal control over financial reporting that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

19

PART II
OTHER INFORMATION

Item 1. Legal Proceedings.

See Note 4 to Condensed Consolidated Financial Statements in Part I.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

Issuer Purchases of Equity Securities

Period	(a) Paulson Capital Corp. Total Number of Shares Purchased		(b) Paulson Capital Corp. Average Price Paid per Share			(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	(d) Maximum Number of Shares that May Yet Be Purchased Under The Plans or Programs
07/01/05 to 07/31/05	7,534		$		13.38	—	202,275
08/01/05 to 08/31/05	10,135		$	11.89		10,135	192,140
09/01/05 to 09/30/05	4,407		$		11.56	4,407	187,733
Total	22,076	(1)	$		12.33	14,542	187,733

All of the shares reflected in column (c) were open-market transactions as part of a corporate plan for stock repurchase. The stock repurchase plan, approved by the board of directors on September 17, 2001, authorizes the repurchase of up to 300,000 shares; a total of 112,267 shares have been repurchased through September 30, 2005. There is no expiration date on the stock repurchase plan.

(1) Of these 22,076 shares, 7,534 were purchased from executive officers and employees of the Company (and their affiliates), not as open-market purchases, at an average price of $13.38 per share.

Item 3. Defaults upon Senior Securities.

None

Item 4. Submission of Matters to a Vote of Security Holders.

None

Item 5. Other Information.

None

Item 6. Exhibits

31.1	Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Filed herewith electronically.
31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Filed herewith electronically.
32.1	Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Filed herewith electronically.
32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Filed herewith electronically.

20

SIGNATURES

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

	PAULSON CAPITAL CORP.
Date: November 11, 2005	By:	/s/ CHESTER L.F. PAULSON
		Chester L.F. Paulson
		President Principal Executive Officer
Date: November 11, 2005	By:	/s/ CAROL RICE
		Carol Rice
		Chief Financial Officer Principal Financial Officer

21

EX-31.1

Exhibit 31.1

CERTIFICATION

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

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

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

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

4.The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

a.Designed such disclosure controls and procedures, or caused such disclosure controls to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b.Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c.Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a.All significant deficiencies in the design or operation of internal controls which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b.Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Dated: November 11, 2005
	/s/ Chester L.F. Paulson
	(Chester L.F. Paulson)
	(President & Chief Executive Officer)

EX-31.2

Exhibit 31.2

CERTIFICATION

I, Carol A. Rice, certify that:

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

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

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

4.The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

a.Designed such disclosure controls and procedures, or caused such disclosure controls to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b.Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c.Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a.All significant deficiencies in the design or operation of internal controls which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b.Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Dated: November 11, 2005
	/s/ Carol Rice
	(Carol A. Rice)
	(Chief Financial Officer)

EX-32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the quarterly report of Paulson Capital Corporation (the “Company”) on Form 10-Q for the period ending September 30, 2005 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Chester L.F. Paulson, President, certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge:

(1)The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2)The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Chester L.F. Paulson

Chester L.F. Paulson

President

November 11, 2005

EX-32.2

Exhibit 32.2

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the quarterly report of Paulson Capital Corp., Inc. (the “Company”) on Form 10-Q for the period ending September 30, 2005 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Carol A. Rice, Chief Financial Officer of the Company, certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge:

(1)The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2)The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Carol A. Rice

Carol A. Rice

Chief Financial Officer

November 11, 2005