FORWARD-LOOKING STATEMENTS AND RISK FACTORS

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

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

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

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

· We face intense competition in our industry.

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

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

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

· Our directors and executive officers control approximately 47% of our common stock and may have interests differing from those of other stockholders.

· The acquisition, integration or divestiture of businesses by us may not produce the desired financial or operating results.

OVERVIEW

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

· securities brokerage activities for which we earn commission revenues;

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

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

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

In addition, Paulson Capital Properties, LLC, a 100% owned subsidiary, was established for the purpose of purchasing, improving and remarketing underappreciated real estate. Through March 31, 2012, we had not purchased any real estate.

Because we operate in the financial services industry, our revenues and earnings are substantially affected by general conditions in financial markets. Further, past performance is not necessarily indicative of results to be expected in future periods. In our securities brokerage business, the amount of our revenues depends on levels of market activity requiring the services we provide. Our corporate finance activity, which consists of acting as the managing underwriter of initial and follow-on public offerings, private investments in public equity ("PIPEs") and private placements for smaller companies, is similarly affected by the strength of the market for new equity offerings, which has historically experienced substantial cyclical fluctuation. During the first quarter of 2012, global IPO volume decreased significantly, particularly in Asia. Total global IPO's declined by 52% and proceeds fell by 66% to $12.5 billion compared to the first quarter of 2011. In the United States, the number of IPO's increased, but the total proceeds declined sharply. There were 42 IPO's in the first quarter of 2012 with proceeds of $5.9 billion compared to 32 IPO's with proceeds of $13.4 billion in the first quarter of 2011. The outlook for the remainder of 2012 is encouraging, especially in the United States where as of March 31, 2012, 196 companies had filed IPO's with the SEC seeking to raise approximately $50 billion.

Although we attempt to match operating costs with activity levels, many of our expenses are either fixed or difficult to change on short notice. Accordingly, fluctuations in brokerage and corporate finance revenues tend to result in sharper fluctuations, on a percentage basis, in net income or loss.

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

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

CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES

We reaffirm the critical accounting policies and estimates as reported in our Annual Report on Form 10-K for the year ended December 31, 2011, which was filed with the Securities and Exchange Commission on March 8, 2012.

SALE OF RETAIL BROKERAGE OPERATIONS

In February 2012, the Company announced it had reached an agreement with JHS Capital Advisors, LLC (JHS) of Tampa, Florida to sell substantially all of its retail brokerage operations, including many of its branch and non-branch offices as well as registered personnel (employees and independent contractors), to JHS. Under the transaction, Paulson advisors will become registered representatives of JHS and, through JHS, will continue to use RBC Correspondent Services, a division of RBC Capital Markets, LLC, for custody of client assets and securities, trade execution and portfolio reporting.

The sale closed on April 16, 2012. Under the agreement, the Company is to be paid approximately $1,653,247 net of certain deductions for compensation expenses. $1,107,741 was received at closing, and the balance is to be paid over three installments on July 16, 2012, October 15, 2012 and January 11, 2013. The final purchase price is subject to recalculation after six months based upon the aggregate gross dealer commissions for the twelve month period ended at that time. The agreement also requires twelve directors, officers and employees of the Company to enter into non-solicitation and non-competition agreements pursuant to which they are prohibited from soliciting employees and registered representatives of JHS for two years from the closing date and, subject to a limited exception, engaging in the retail brokerage business for one year from the closing date.

The Company will continue to operate independently as a broker/dealer focused on its core competencies in boutique investment banking activities, and will continue as a public company trading under the symbol "PLCC" on the NASDAQ Exchange.

RESULTS OF OPERATIONS

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

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

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

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

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

The following tables set forth the changes in our operating results in the three-month period ended March 31, 2012 compared to the three-month period ended March 31, 2011 (dollars in thousands):

                                           Three Months Ended             Favorable
                                                March 31,               (Unfavorable)       Percentage
                                          2012             2011            Change             Change
Revenues:
Commissions                            $     3,206      $    4,394     $        (1,188 )          (27.0 )%
Corporate finance                               23              69                 (46 )          (66.7 )
Investment income (loss)                       250            (103 )               353            342.7
Trading income                               1,969             386               1,583            410.1
Interest and dividends                         121             131                 (10 )           (7.6 )
Other                                           41              45                  (4 )           (8.9 )
Total revenues                               5,610           4,922                 688             14.0
Expenses:
Commissions and salaries                     3,209           4,360               1,151             26.4
Underwriting expenses                           37              10                 (27 )         (270.0 )
Rent and utilities                             156             141                 (15 )          (10.6 )
Communication and quotation services           129             131                   2              1.5
Professional fees                              256             209                 (47 )          (22.5 )
Travel and entertainment                        38              30                  (8 )          (26.7 )
Clearing expenses                               79             105                  26             24,8
Depreciation and amortization                    4               4                   -                -
Licenses, taxes and insurance                  125             129                   4              3.1
Other                                          165             183                  18              9.8
Total expenses                               4,198           5,302               1,104             20.8
Income (loss) before income taxes      $     1,412      $     (380 )   $         1,792            471.6 %

Revenues
The markets in the United States had a very strong first quarter of 2012, with the Dow Jones Industrial Average rising 8.1% and the NASDAQ composite index rising 18.7%. Investor confidence was supported by improved economic numbers and less market turmoil internationally, particularly in Europe. This has led to expectations for improved corporate earnings, particularly from technology companies.

Commissions declined 27% during the first quarter ended March 31, 2012 compared to the first quarter of 2011, which was largely due to fewer registered representatives generating commissions in the current period. We had 67 registered representatives at March 31, 2012, compared to 98 at March 31, 2011.

Corporate finance income in the first quarter of 2012 was down 66.7% from the first quarter of 2011. The Company participated in no private placements in the first quarter of 2012, while underwriting discounts from a private placement were earned in the prior year's quarter.

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

                                                               Three Months Ended March 31,
                                                               2012                   2011
Net unrealized appreciation (depreciation) related to
underwriter warrants                                       $         257         $           (89 )
Net unrealized appreciation (depreciation) of securities
held based on quoted market prices or, for securities
that are not readily marketable, our estimate of their
fair value                                                            (7 )                   (14 )
                                                           $         250         $          (103 )

We did not exercise any underwriter warrants in the first quarter of 2012 or 2011. Generally, when we exercise a warrant to obtain the underlying common stock, the common stock is subsequently sold in the near term and the related gain is reflected as a component of investment income.

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

Trading income increased by 410% to $1.969 million in the first quarter of 2012 compared to $385,000 in the first quarter of 2011. The trading income was positively affected by the market value of certain securities in which we make a market. Our focus is on very small capitalization issues, especially those tied to our corporate finance clients.

Expenses
Total expenses decreased by $1.104 million in the first quarter of 2012 compared to the first quarter of 2011 primarily due to lower commission and salaries and other expenses, which were partially offset by higher underwriting, rent and utilities, and professional fees.

Commissions and salaries decreased $1.151 million in the first quarter of 2012 compared to the first quarter of 2011. The decrease was due to fewer registered representatives with the Company in the current quarter.

Underwriting expenses increased by $27,000 in the first quarter of 2012 compared to the first quarter of 2011. Expenses vary due to the timing and level of investment banking activity.

Professional fees increased by $47,000 in the first quarter of 2012 compared to the same quarter in 2011. The increase was due to fees incurred as a result of the agreement with JHS to sell the Company's retail brokerage operations, which closed subsequent to the end of the quarter.

LIQUIDITY AND CAPITAL RESOURCES

Our primary sources of liquidity include our cash and receivables from our clearing organization, offset by payables to our clearing organization.

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

We believe our cash and receivables from our clearing organization at March 31, 2012 are sufficient to meet our cash and regulatory net capital needs for at least the next twelve-month period from March 31, 2012. Our liquidity could be negatively affected by protracted unfavorable market conditions.

As a securities broker-dealer, we are required by SEC regulations to meet certain liquidity and capital standards. We believe we were in compliance with these standards at March 31, 2012.

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

At March 31, 2012, we owned 11 underwriter warrants from 8 issuers, all but 1 of which were exercisable. None of the warrants had an exercise price below the March 31, 2012 market price of the securities receivable upon exercise. There is little or no direct relationship between the intrinsic value of our underwriter warrants at the end of any given period and the fair value calculated using the Black-Scholes option pricing model. The prices of the securities underlying the underwriter warrants are very volatile, and substantial fluctuations in their fair value can be expected in the future.

Cash used by operating activities totaled $1,000 in the first quarter ended March 31, 2012. Our net income of $1.412 million was offset by changes in our operating assets and liabilities as discussed in more detail below.

Our net receivable from our clearing organization totaled $4.7 million at March 31, 2012 and $5.1 million at December 31, 2011. Our net receivable from our clearing organization is affected by the results of the activity in our trading and investment accounts, as well as the timing of general corporate expenditures and cash flow requirements.

Notes and other receivables increased $52,000 to $659,000 at March 31, 2012 from $607,000 at December 31, 2011, primarily due to a new loan to a third party, offset by scheduled repayments.

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

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

Balance, December 31, 2011                 $ 1,395
Receipt of underwriter warrants                  -
Net unrealized gain on value of warrants       257
Warrants exercised or expired                    -
Balance, March 31, 2012                    $ 1,652

Deferred revenue of $191,000 at March 31, 2012 was related to amounts received from our clearing firm pursuant to a five-year agreement with two, one-year extensions, and is being amortized at the rate of $12,755 per month through June 2013.

In September 2001, our Board of Directors approved a stock repurchase program pursuant to which we are authorized to repurchase up to 600,000 shares of our common stock. In June 2008, our Board of Directors approved the repurchase of up to a total of an additional 200,000 shares of our common stock. We repurchased a total of 1,000 shares of our common stock during the first quarter of 2012 at an average price of $1.25 per share for a total of $1,250. Through March 31, 2012, a total of 731,989 shares had been repurchased and 68,011 shares remained available for repurchase under the program. This repurchase program does not have an expiration date.

In March 2012, the Board of Directors approved a special cash dividend of $0.05 per common share payable April 16, 2012 to shareholders of record April 4, 2012. The ex-dividend date was April 2, 2012.

OFF-BALANCE SHEET ARRANGEMENTS

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

NEW ACCOUNTING GUIDANCE

See Note 5 of Notes to Consolidated Financial Statements.