1 The Court may grant a motion to dismiss under Rule

12(b)(6) "only if, accepting all well pleaded allegations in the

complaint as true, and viewing them in the light most favorable

to plaintiff, plaintiff is not entitled to relief." In re

Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1420 (3d Cir.

1997). "The issue is not whether a plaintiff will ultimately

prevail but whether the claimant is entitled to offer evidence to

support the claims." Scheuer v. Rhodes, 416 U.S. 232, 236

(1974). In other words, we will not grant such a motion "unless

it appears beyond doubt that the plaintiff can prove no set of

facts in support of his claim which would entitle him to relief." 

Conley v. Gibson, 355 U.S. 41, 45-46 (1957); see also Semerenko

v. Cendant Corp., 223 F.3d 165, 173 (3d Cir. 2000) (permitting

dismissal "only if it appears that the [plaintiffs] could prove

no set of facts that would entitle [them] to relief"). "The

complaint will be deemed to have alleged sufficient facts if it

adequately put the defendants on notice of the essential elements

of the plaintiffs' cause of action." Nami v. Fauver, 82 F.3d 63,

65 (3d Cir. 1996). We shall review factual background for

plaintiffs' claims with these principles in mind.

IN THE UNITED STATES DISTRICT COURT 

FOR THE EASTERN DISTRICT OF PENNSYLVANIA

IN RE STONEPATH GROUP, INC. : CIVIL ACTION

SECURITIES LITIGATION :

:

:

: NO. 04-4515

MEMORANDUM

Dalzell, J. October 27, 2005

This is a putative class action brought on behalf of 

purchasers of Stonepath Group, Inc. securities between March 29,

2002 and September 20, 2004 (the claimed "Class Period"). Lead

plaintiff Globis Capital Partners, L.P., here sues nominal

defendant Stonepath and three of its current and former officers

and directors, Dennis L. Pelino, Bohn H. Crain and Thomas L.

Scully (collectively the "Individual Defendants") for violations

of the Securities Exchange Act of 1934. We now address the

defendants' motion to dismiss, which largely challenges whether

plaintiffs have sufficiently pleaded the requisite scienter.1

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 1 of 39
2 The current business model was adopted in the first

quarter of 2001. Prior to that time, Stonepath had focused on

"developing early-stage technology businesses with significant

Internet features." Compl. ¶ 4, 51. Stonepath is said to have

changed its business model due to declines in the technology

business and access to venture financing. Id. ¶ 4.

2

Factual Background

Stonepath is said to be "a non-asset based third-party

logistics services company providing supply chain solutions on a

global basis." Am. Consolidated Class Action Compl. ("Compl.") 

¶ 3. It is incorporated in Delaware and maintains its principal

place of business in Philadelphia. Id. ¶ 33. The company

derives income primarily from freight forwarding, customs

brokerage and warehousing. Id. ¶ 3. As a freight forwarder,

Stonepath does not own or lease any significant equipment. Id.

It generates most revenues "by purchasing transportation services

from direct (asset-based) carriers" to transport the property of

Stonepath's customers.2 Id.

According to Stonepath's annual reports for 2001 and

2003 and its amended annual report for 2002, the company's

"strategic objective is to build a leading global logistics

services organization that integrates established logistics

companies with innovative technologies." Id. ¶ 52. To achieve

the objective, Stonepath stated it was "pursuing an aggressive

acquisition strategy" to build on its position in current markets

and acquire operations in new markets. Id. Two of its early

acquisitions were M.G.R., Inc. (d/b/a Air Plus Limited) and its

operating affiliates (collectively "Air Plus") and Global

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 2 of 39
3 A "platform acquisition" is "one that creates a

significant new capability for the Company, or entry into a new

global geography." Id. ¶ 53.

3

Transportation Services ("Global"), acquired on October 5, 2001,

and on April 4, 2002, respectively. Id. ¶ 53. Air Plus is said

to have "provided the platform3 for Stonepath's Domestic Services

organization," while "Global provided the platform for

[Stonepath's] International Services organization." Id.

To fund further acquisitions and provide on-going

working capital, on May 15, 2002, Stonepath obtained a revolving

credit facility of $15 million from LaSalle Business Credit, Inc. 

Id. ¶ 57. This facility included a covenant that limited funded

debt to no more than 2.75 times Stonepath's consolidated earnings

before interest, taxes, depreciation and amortization ("EBITDA"). 

Id. The remedy for breach of the covenant was the acceleration

of all outstanding debt under the agreement. Id. About two

years later, on July 28, 2004, the credit facility was increased

to $25 million, and the covenant's terms were amended to provide

that Stonepath's domestic funded debt could not exceed a 3.75

multiple of its domestic EBITDA. Id.

From May 30, 2002 through February 9, 2004, Stonepath

made eleven acquisitions. See id. ¶¶ 54-55. Because of so many

acquisitions, Stonepath was subject to large and frequent "onetime non-cash amortization charges." Id. ¶ 56. These charges

prompted Stonepath to announce -- in a July 17, 2003 press

release and the 2003 Form 10-K -- that EBITDA was the most

meaningful measure of the company's financial performance. Id.

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 3 of 39
4 For confidential witnesses, the "underlying prerequisite

[is] that each source is described sufficiently to support the

probability that the source possesses the information alleged." 

Cal. Pub. Employees' Ret. Sys. v. Chubb Corp., 394 F.3d 126, 155

(3d Cir. 2004).

5 CW5 is said to be a former Transportation Coordinator at

Stonepath's Government Services Division in Sterling, Virginia,

who worked for Stonepath from April 2003 until December 2003. 

Compl. ¶ 75. CW5 was responsible for the movement of

international and domestic shipments and used both Freight Soft

and the Global system. Id.

4

The Stonepath-acquired companies used disparate

information systems and operating policies and procedures. Id.

¶¶ 6, 58. During the Class Period, Stonepath stated that it was

in the process of integrating the various information systems and

that it intended to create its own "best-of-breed" solution,

called Technology in Logistics or Tech-Logis. Id. ¶¶ 6, 59. 

While developing Tech-Logis, Stonepath permitted acquired

companies to continue using their pre-existing, or legacy,

information systems, as well as their own operating policies and

procedures. Id. ¶ 6. 

Using information said to have been provided by

confidential witnesses,4 the complaint details various problems

with these legacy systems, as well as accounting problems and

difficulties with paying vendors and carriers on time. 

Global's legacy information system, the Global system,

was used mostly to record shipment data for international

operations. Id. ¶ 74. According to Confidential Witness (CW)

5,5 the Global system regularly rejected charges, failed to

record charges, crashed, and sometimes generated cost figures

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 4 of 39
6 CW2 is claimed to be a former Lead Technician in the Rate

Management Team in the IT department at Domestic Services'

headquarters in Eagan, Minnesota. Id. ¶ 64. CW2 worked for

Stonepath from August 2003 until November 2004. Id. During that

time CW2 worked with the Tech-Logis system, and was responsible

for updating carrier and vendor rates and services, correcting

file loading errors, and analyzing data for accuracy. CW2

reported to Dustin Nelson, who reported to Tim Ritter, Director

of Operations of Domestic Services. Id. According to CW2, the

problem with stale rates developed when carriers and vendors, who

generally increased their rates annually, did not provide Air

Plus, and later Stonepath, with new electronic tapes or hard

copies with updated rate data. Id. ¶ 65. Also, some carriers

and vendors who provided new electronic tapes failed to update

their own rate increases. Id.

5

that had not been entered. Stonepath's staff at its Government

Services Division tried to make the Global system work properly,

but could not. Id. ¶ 77. In late June or early July 2003, upper

management in CW5's office directed CW5 to record all

international shipments in the Freight Soft information system. 

Id. This was purportedly done to correct accounting problems and

phase out the Global system. Id. During the summer of 2003, CW5

was told that some data was "being double read" because the

Freight Soft and Global systems were both generating reports for

the same international shipments. Id. ¶ 78.

Stonepath had acquired Freight Soft when it purchased

Air Plus, and Freight Soft continued to be used throughout

Stonepath's Domestic Services organization. Id. ¶ 62. According

to CW2, Freight Soft used transportation cost estimates based on

pre-programmed carrier rates, rather than actual purchased

transportation costs.6 Id. Some of these carrier rates are said

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 5 of 39
7 CW3 corroborated that much of Freight Soft's rate data was

outdated and "useless." Id. ¶ 69. CW3 is a former Data Rates

Technician Manager who also worked in Domestic Services'

headquarters and, for one and a half years, was in charge of

importing all cost-related items from the Freight Soft program

into Tech-Logis. Id. ¶ 68. 

6

to have been four to five years outdated.7 Id. ¶ 65. 

Stonepath's policy of allowing acquired companies to use existing

operating policies and procedures meant that Air Plus's

procedures and internal guidelines governed what was now the

Domestic Services organization. Id. ¶ 66. However, CW2 states

that Air Plus had no procedures and guidelines for monitoring of

tariff and vendor rates prior to being acquired. Id. As a

result, the Domestic Services organization also lacked any

procedures or policies for monitoring its tariff and vendor

rates. Id.

According to CW2, the rates' staleness became clear

while Stonepath was attempting to transition the Domestic

Services division from Freight Soft to Tech-Logis, from December

2003 to January 2004. Id. ¶ 67. The Carrier Management Team

(CMT) saw large discrepancies between Freight Soft's rate data

and the rates in invoices that carriers submitted, and determined

that the discrepancies stemmed from the use of outdated carrier

rate data. Id. ¶¶ 15, 67, 309. CW2 states that the CMT

immediately reported these discrepancies to Tim Anderson,

Domestic Services' Controller. Id. ¶ 67. In early January 2004,

Anderson is said to have directed the CMT to contact all carriers

with which Stonepath did business to obtain updated tariff rates

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 6 of 39
8 CW3 corroborated that CMT had to obtain new rate data from

the carriers. Id. ¶ 69.

9 CW4 is said to be a former terminal manager who worked for

Air Plus prior to its acquisition and then for the Domestic

Services division until September 2004. Id. ¶ 70. CW4 oversaw a

large-scale distribution program, receiving and shipping outbound

merchandise in three states for Stonepath's largest customer,

Best Buy Co., Inc. ("Best Buy"). Id.

10 CW8 is reported to be a former Assistant Terminal Manager

who worked at Domestic Services' Plainfield Business Center in

Indiana from September 2003 to May 2004. Id. ¶ 84. CW8's

responsibilities included maintaining profitability at the

Plainfield facility, which twice weekly handled shipment of

entertainment software to all Best Buy stores in the country. 

Id. CW8 states this was the largest portion of Stonepath's Best

Buy business. Id.

7

that were to be loaded into Tech-Logis.8 Id.

CW49 identified two further problems with Freight Soft. 

First, it could not process costs for "multiple stops." Id. ¶

71. It generated a single master shipping manifest for a

customer, such as Best Buy Co., Inc., Stonepath's largest

customer, even though multiple shipments had been delivered by

various carriers -- who charged varying rates -- to different

store locations on different dates. Id. Because of the many

variables involved, making accurate lump-sum cost estimates on

the manifests was not possible. Id. ¶¶ 71-72. Second, when

Stonepath closed out shipping manifests at the end of each month,

carriers had sometimes not yet invoiced Stonepath. Id. ¶ 73. 

Because Freight Soft required cost data to be entered before

closing out manifests, Stonepath's regional management told CW4

to either "zero-out" costs or enter $0.01. Id.

CW4 and CW810 also explain that terminal managers were

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 7 of 39
11 CW6 is a former Operations Coordinator in the Accounts

Payable Department of the Domestic Services division's Romulus,

Michigan office. Id. ¶ 79. CW6 had joined United American

Freight Services ("United") in 2002, two months before Stonepath

acquired it, and stayed with Stonepath until January 2005. Id.

12 CW7 is a former Human Resources employee who also

performed accounting work at the Romulus office. Id. ¶ 82. CW7

had worked for United for twenty years prior to its acquisition,

and continued to work for Stonepath until November 2004. Id.

8

not required to obtain prior authorization for special deliveries

or other related delivery costs. Id. ¶¶ 83-85. According to

CW8, at the Plainfield facility of the Domestic Services

organization, special delivery expenditures were often a large

part of the facility's costs due to late processing. Id. ¶¶ 84-

85. CW8 submitted a report on this problem, "Daily Freight

Accounting Process," to Jim Such, Regional Vice-President of the

Domestic Services organization. Id. ¶ 85.

A different problem arose with accounting programs. In

January 2004, Tim Anderson directed the Romulus, Michigan office

of the Domestic Services division to switch from the Champ

accounting system to Stonepath's Great Plains accounting system. 

According to CW611 and CW7,12 the Great Plains system had

limitations that resulted in financial reporting inaccuracies. 

Id. ¶¶ 80, 82. Specifically, the system did not allow the entry

of vendor invoice data for closed months. Id. ¶¶ 81-82. 

Personnel in the Romulus office entered the data the following

month, resulting in vendor costs consistently being reported

late. Id.

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 8 of 39
13 CW9 is a former Stonepath employee who worked as an

Accounts Payable Auditor at Domestic Services's headquarters in

Eagan, Minnesota from June 2003 through March 2004. Id. ¶ 317. 

14 CW10 is said to be a former Operations Coordinator in the

Accounts Payable Department of Domestic Services's Romulus,

Michigan location. Id. ¶ 318. CW10 began working for American

Freight Services in March 2002, and when it was acquired by

Stonepath two months later, CW10 continued working for Stonepath

until January 5, 2005. Id.

9

Two other former Stonepath employees, CW913 and CW10,14

described Stonepath's delays in paying vendors. CW9, who worked

at Domestic Services' headquarters, stated that around August

2003, Stonepath stopped doing regular weekly check runs and

delayed vendor payments, sometimes by three weeks. Id. ¶ 317. 

About a quarter of the carriers decided to only do business with

Stonepath in cash. Id. CW10, who worked at the Romulus office,

stated that Stonepath stopped paying vendors on time after it

acquired United American Freight Services ("United") in May 2002,

so many vendors put the Romulus office on a cash-only basis. Id.

¶¶ 318-19. Within a month and a half of Stonepath's acquisition,

almost 100 carriers had also moved to a cash-only basis. Id. ¶

319. Stonepath delayed payments to some carriers for as long as

a month, lost discount advantages on freight charges, and

received daily complaint calls from vendors, which increased from

May 2002 to December 2004 to more than 100 a day. Id.

During the Class Period, Stonepath issued three

restatements revising figures it had previously reported to the

Securities and Exchange Commission.

On July 17, 2003, Stonepath issued a press release

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 9 of 39
15 The press release quoted Crain as stating:

Through the integration process, review of internal controls

and centralization of the financial reporting process the

Company has recently determined that the revenues and costs

of transportation for its International Services division

were overstated in like amounts because certain intercompany

transactions representing the buying and selling of

transportation services were not being appropriately

eliminated in consolidation within the division’s legacy

accounting system. This had no impact on net revenues,

10

stating that it was discussing with the SEC the allocation of the

purchase price from certain acquired companies -- Air Plus,

Global and United. Id. ¶ 86. Then, on August 28, 2003,

Stonepath made its first Class Period restatement when it filed

with the SEC an amended interim financial report on a Form 

10-Q/A. This restated its consolidated financial statements for

the periods ended June 30, 2003 and March 31, 2003, and for the

years ended December 31, 2001 and December 31, 2002. Id. ¶ 89. 

According to the Form 10-Q/A, the restatement related to:

(i) allocating more value to the customer

relationship intangible assets for the

Company's acquisitions and (ii) revising the

amortization method and life used for such

assets. The restatement did not impact the

amounts presented in the consolidated

statements of cash flows for net cash used in

operating activities, net cash used in

investing activities or net cash provided by

(used in) financing activities in any of the

restated periods . . . .

Id.

On December 29, 2003, Stonepath issued a press release

announcing its second Class Period restatement, necessitated by a

problem in the legacy accounting process of the International

Services division.15 Id. ¶¶ 10, 90. Revenues and costs of

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 10 of 39
EBITDA or net earnings; however, the Company’s

transportation and net revenue margin percentages were

understated.

Id. ¶ 90.

11

transportation had been overstated in offsetting amounts, about

$26.8 million for the nine months ended September 30, 2003, and

$16.9 million for the year ended December 31, 2002. Id. ¶ 90. 

Stonepath stated there would be no impact on net revenues, EBITDA

or net earnings. Id. 

During a December 31, 2003 conference call held to

discuss the restatement and answer questions from analysts and

investors, Pelino said: 

The duplication of gross revenues at our

international division should not have

happened in a perfect world but it did. We

discovered it and we corrected it. We have

also taken steps to ensure that this never

happens again by working closely with our

external and internal auditors to improve

their due diligence and field testing

methodologies.

Id. ¶ 91. 

During the call, Crain stated:

As part of our normal business process, we

have audits done for all material

transactions. As part of our public reporting

process, we have our auditors do field work

on a quarterly basis at each of our material

business locations. Today that means we have

people in the field every quarter in

Minneapolis, Detroit, Seattle, and here in

Philadelphia to make sure we’re rolling up

the right numbers. Also, as part of our

public reporting process and the 302

certifications under Sarbanes-Oxley, we hold

quarterly calls with the leadership of each

of the business units and go through a

rigorous series of questions to try to ferret

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 11 of 39
12

out any areas of concern or weakness in our

financial reporting processes. We also meet

regularly with the leadership of management

of the business units to review business

results.

Id. ¶ 92.

Responding to a question by Andrew Ponzo, a private

investor, about financial reporting by the acquired companies'

senior management, Crain said that "a local senior financial

executive reports in to the local CEO. So specifically, Jim

Hilgert reports to Jason Totah in Seattle, and Tim Anderson

report[s] in to Joe DiGiacomo and Gary Koch in Minneapolis with a

dotted line responsibility back to me." Id. ¶ 93. Pelino said: 

With respect to kind of the formality of the

reporting, I think at the end of the day,

people will have different views about where

the dotted and solid line should be, but as

long as the communication remains open and we

have good candid conversations taking place,

I think that can be made to work, and I do

have the utmost confidence in the Jim

Hilgert's and Tim Anderson's out there and

their ability to do a good job for us.

Id. 

Mr. Ponzo then said that he believed the same type of

incident would not occur again, but asked "without having direct

reporting into you or complete control over that, are there other

instances that can happen, and if not [sic], how do we control

that?" Id. ¶ 94. Pelino responded:

[A]s I’m sure you’re aware, Andrew, under

Sarbanes-Oxley we’re right now effectively

identifying every material business process

that exists across the business organization

and will be going out and effectively

benchmarking those practices against what are

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 12 of 39
13

deemed to be best practices under general

standards out there, and making sure that we

have state-of-the-art internal controls

across the entire organization. So through

this process to the extent that there are any

weaknesses they will be identified, and we’ll

either change them or put other mitigating

processes in places to make sure that we

cover our basis [sic]. So I think we can all

take some comfort in getting our arms around

the universe of potential gotcha’s and make

sure that we’re focused on them.

Id.

On January 20, 2004, Stonepath filed a Form 10-K/A and

three Forms 10-Q/A, which restated Stonepath's financial results

by decreasing revenue and costs in like amounts for the year

ended December 31, 2002 and the three-month periods ended March

31, 2003, June 30, 2003, and September 30, 2003. Id. ¶ 95. 

On September 20, 2004, Stonepath announced the need for

a third Class Period restatement to revise its financial

statements for fiscal year 2003 and the first and second quarters

of 2004. Id. ¶¶ 22, 271. An internal review of the Domestic

Services unit revealed that its accrual process did not account

for the differences between estimated and actual purchased

transportation costs. Id. The under-accrual of actual costs was

estimated to be from $4.0 to $6.0 million for 2003 and from

$500,000 to $1.0 million for the first six months of 2004. Id.

¶¶ 23, 271. Stonepath stated that its reported EBITDA would be

reduced to the range of $2.6-$4.6 million for 2003 and $200,000-

$700,000 for the first six months of 2004. Id. ¶ 271.

Stonepath's press release described the need for the

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 13 of 39
14

restatement as follows:

In using its legacy operating system, to be

replaced by Tech-Logis later this year,

Domestic Services relied on trend analysis to

estimate its costs of purchased

transportation. In reviewing the process by

which Domestic Services maintained the

accrual for its costs of purchased

transportation, the Company has concluded

that the process did not accurately account

for the differences between the estimates and

the actual freight costs incurred. This

allowed for the accumulation of previously

unidentified costs of purchased

transportation and an under reported

liability for the accrued costs of purchased

transportation.

Id. ¶ 272.

Furthermore, Pelino announced changes in management,

including that Jason Totah, the CEO of international operations,

would also become the CEO at Domestic Services, putting "all of

our logistics operations under one proven leader." Id. ¶ 273. 

Pelino described restructuring of financial and accounting

processes, including that "senior financial staff of [the]

Domestic Services and International Services operations [would]

report directly to Bohn Crain, the Company's Executive Vice

President and Chief Financial Officer." Id.

The day of this announcement, on a trading volume of

4,830,200 shares, Stonepath stock closed at $0.86 per share, down

46% from the September 19, 2004 closing price of $1.59. Id. 

¶ 274. The day after the announcement, and a day after the Class

Period ended, Stonepath held a conference call in which Pelino

and Crain participated. Id. ¶ 275. Plaintiffs allege that when

asked about Stonepath's discovery of the understatement of

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 14 of 39
15

transportation costs, "Crain stated that it would be fair to say

that the Company discovered the issue in the last 30 days." Id.

¶ 277.

On January 6, 2005, Stonepath issued a press release

concerning its financial results for the third quarter of 2004. 

In that release, Stonepath also stated that the estimated

restatement figures announced in September would be increased,

and would now extend back to 2001 and 2002:

The Company expects to report an aggregate

reduction in the previously reported net

income for 2001 through the first six months

of 2004 of approximately $16.3 million. Net

income for 2001, 2002, 2003 and the first six

months of 2004 is expected to be reduced by

$0.4 million, $2.0 million, $7.8 million and

$6.1 million, respectively.

Id. ¶ 281. As a result, the previously reported 2003 profit of

$7.13 million would be replaced by a loss of $670,000. Id. For

the first six months of 2004, the previously reported net loss of

$785,000 would grow by $6.1 million. Id. 

Also on January 6, 2005, Stonepath filed its quarterly

report for the third quarter of 2004 on Form 10-K. Id. ¶ 282. 

It disclosed that the restatement announced on September 20, 2005

"resulted in technical default of certain financial covenants of

[its credit] Facility." Id. However, the defaults were "waived"

and Stonepath entered into an amended credit facility which,

inter alia, reduced the amount of credit available from

$25,000,000 to $22,500,000, established new minimum quarterly

EBITDA targets, precluded acquisitions, and eliminated LIBORbased borrowing. Id.

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 15 of 39
16

On February 11, 2005, Stonepath finally filed the

restatement it had announced the previous September and then

again in January 2005. On a Form 10-K/A filed with the SEC,

Stonepath restated its financial results for fiscal years 2001

through 2003. The Form 10-K/A stated that since the September

21, 2004 announcement, Stonepath had analyzed its costs of

purchased transportation and revenue transactions. It found

that:

These errors resulted in an overstatement of

revenues by $0.2 million in 2003, an

understatement in purchased transportation

costs by $4.4 million in 2003, $1.6 million

in 2002, and $0.3 million in 2001 and an

understatement of income tax expense of $2.0

million in 2003, $0.3 million in 2002 and

$0.1 million in 2001. These restatements

also reduced goodwill by $4.3 million at

December 31, 2003 and $1.3 million at

December 31, 2002. Net income was reduced by

$7.9 million, including a reserve of $1.3

million related to excess earn-out payments

in 2003, $1.9 million in 2002 and $0.3

million in 2001.

Id. ¶ 284. This restatement did not change net income for the

first and second quarters of 2004, which, according to the

January 6, 2005 press release, is expected to be reduced by $6.1

million. Id. ¶ 281. 

On September 24, 2004, four days after Stonepath first

announced its third restatement, Globis filed this suit against

nominal defendant Stonepath and three of its current and former

officers and directors, Dennis L. Pelino, Bohn H. Crain and L.

Scully. Pelino is the Chairman of the Board of Directors and

served as Chief Executive Officer of Stonepath from June 21, 2001

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 16 of 39
17

through October of 2004. Id. ¶ 34. Crain was the Chief

Financial Officer from January 10, 2002, and Treasurer from May

30, 2002 through the end of the Class Period. Id. ¶ 35. Scully

is a certified public accountant who served as Vice-President and

Controller throughout the Class Period. Id. ¶ 36. 

The complaint states two counts. Under Count I,

plaintiffs sue all defendants for violations of Section 10(b) of

the Exchange Act and Rule 10b-5 promulgated thereunder. Under

Count II, plaintiffs sue the Individual Defendants for violation

of Section 20(a) of the Exchange Act. 

Defendants seek dismissal, contending that plaintiffs

have failed to state a claim under either count.

Analysis

A. Section 10(b) and Rule 10b-5

Count I of the amended complaint alleges that

defendants violated Section 10(b) of the Act and Rule 10b-5

promulgated thereunder. Section 10(b) makes it illegal "[t]o use

or employ, in connection with the purchase or sale of any

security registered on a national securities exchange . . . any

manipulative or deceptive device or contrivance . . . ." 15

U.S.C. § 78j(b) (2003). Rule 10b-5 provides an enforcement

mechanism for Section 10(b) by creating "a private cause of

action for investors harmed by materially false or misleading

statements." In re Alpharma Inc. Sec. Litig., 372 F.3d 137, 147

(3d Cir. 2004). Rule 10b-5 "makes it unlawful for any person

'[t]o make any untrue statement of a material fact or to omit to

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 17 of 39
18

state a material fact necessary to make the statements made in

the light of the circumstances under which they were made, not

misleading . . . in connection with the purchase or sale of any

security.'" In re IKON Office Solutions, Inc., 277 F.3d 658, 666

(3d Cir. 2002) (quoting 17 C.F.R. § 240.10b-5(b)). 

Our Court of Appeals has instructed that, to state a

valid claim for a violation of Section 10(b) and Rule 10b-5, a

plaintiff must show that "the defendant (1) made a misstatement

or an omission of a material fact (2) with scienter (3) in

connection with the purchase or the sale of a security (4) upon

which the plaintiff reasonably relied and (5) that the

plaintiff's reliance was the proximate cause of his or her

injury." In re IKON, 277 F.3d at 666; see also Sowell v. Butcher

& Singer, Inc., 926 F.2d 289, 296 (3d Cir. 1991) (collapsing the

first and third elements). 

Plaintiffs' securities fraud claim is also subject to

the heightened pleading requirements of Federal Rule of Civil

Procedure 9(b) and the Private Securities Litigation Reform Act

of 1995 ("PSLRA") § 101(b), Pub. L. No. 104-67, 109 Stat. 737,

743 (codified at 15 U.S.C. § 78u-4 (2004)). Rule 9(b) requires

that "[i]n all averments of fraud or mistake, the circumstances

constituting fraud or mistake shall be stated with

particularity." See also In re Westinghouse Sec. Litig., 90 F.3d

696, 710 (3d Cir. 1996) (explaining that Section 10(b) claims

must comply with Rule 9(b)); Denny v. Barber, 576 F.2d 465, 470

n.4 (2d Cir. 1978) (suggesting that Rule 9(b) applies to Section

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 18 of 39
19

18 claims); McHale v. NuEnergy Group, No. 01-4111, 2002 WL

321797, at *3 (E.D. Pa. Feb. 27, 2002) (Giles, C.J.) (discussing

applicability of Rule 9(b) to common law fraud claim); but see

In re U.S. Interactive, Inc. Sec. Litig., No. 01-522, 2002 WL

1971252, at *20 (E.D. Pa. Aug. 23, 2002) (Giles, C.J.) (holding

that "heightened pleading requirements of Rule 9(b) do not apply

to claims under Section 20(a)"). Our Court of Appeals has

further explained that "Rule 9(b) requires, at a minimum, that

plaintiffs support their allegations of securities fraud with all

of the essential factual background that would accompany 'the

first paragraph of any newspaper story'--that is, the 'who, what,

when, where and how' of the events at issue." In re Rockefeller

Ctr. Props., Inc. Sec. Litig., 311 F.3d 198, 217 (3d Cir. 2002)

(quoting In re Burlington Coat Factory, 114 F.3d at 1422).

The PSLRA imposes an additional "layer of factual

particularity" for pleadings. In re Rockefeller, 311 F.3d at

217. It requires a plaintiff who alleges that a defendant made

an untrue statement of material fact to "specify each statement

alleged to have been misleading [and] the reason or reasons why

the statement is misleading." 15 U.S.C. § 78u-4(b)(1) (2004). 

Moreover, when the plaintiff must prove that the defendant acted

with a particular state of mind, the complaint must "state with

particularity facts giving rise to a strong inference that the

defendant acted with the required state of mind." 15 U.S.C. §

78u-4(b)(2) (2004); see In re Advanta Corp. Sec. Litig., 180 F.3d

525, 530-35 (3d Cir. 1999) (discussing how PSLRA modified

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 19 of 39
20

pleading requirements in securities fraud cases). 

Plaintiffs here allege that the defendants used public

statements and SEC filings throughout the Class Period to

"portray[] Stonepath as an increasingly profitable company

positioned to expand and continue earnings growth through

strategic acquisitions," but that they "knew, or recklessly

disregarded that Stonepath was plagued by internal control

deficiencies that caused the Company to consistently understate

its most significant operating cost." Compl. ¶ 2. Plaintiffs

contend that "financial benchmarks cited by Defendants as the

most useful measures of the Company’s performance were materially

overstated" and that "earnings estimates, which were based on

Stonepath’s past financial performance, had no reasonable basis

because the financial assumptions upon which they were based

included the materially overstated Class Period earnings." Id. 

Plaintiffs also allege that Stonepath represented that its

financial statements were prepared in compliance with generally

accepted accounting principles ("GAAP"), which was materially

false and misleading. Id. ¶ 9. Instead of "being a profitable

growth company," restatements revealed that "Stonepath was, in

fact, a company with a greater than reported loss for 2001,

minimal earnings for 2002, and no earnings for 2002 through the

first six months of 2004." Id. ¶ 2. 

Plaintiffs assert that defendants delayed disclosing

Domestic Services' understatement of costs in order to (1)

artificially maintain Stonepath's reported EBITDA, thereby

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 20 of 39
21

remaining in compliance with the terms of its credit facility,

id. ¶ 311, and (2) artificially maintain the value of Stonepath's

stock, which is said to have reduced the costs of an acquisition

that was partly paid with it, id. ¶ 321. Credit was purportedly

needed because of liquidity problems arising from, inter alia,

"earn-out" payments due to sellers of acquired companies when

those companies reached certain targets and costs incurred in

implementing the Tech-Logis system. Id. ¶¶ 313-14. The

disclosure of Domestic Services' understated transportation costs

caused Stonepath to breach the EBITDA ratio covenant of its

credit facility. Id. ¶ 312. As a result, Stonepath's lender has

now precluded it from making further acquisitions, which is said

to be Stonepath's "primary strategic objective." Id. ¶ 2. 

Plaintiffs' complaint identifies the allegedly

materially false and misleading statements by quoting from

Stonepath press releases, SEC filings and conference calls,

alleging in each instance that defendants knew or recklessly

disregarded that the statements made were materially false and

misleading. Id. ¶¶ 96-270. Plaintiffs attribute each of the

statements to one or all of the Individual Defendants, identify

what was said and when it said, and explain why the statement was

false or misleading.

Defendants, in their motion to dismiss, portray this as

a strike suit and argue that plaintiffs have failed to plead

specific factual allegations, as Rule 9(b) and the PSLRA require. 

Defendants' motion focuses solely on the second of the five Rule

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 21 of 39
22

10b-5 elements, scienter, so we now address that element.

1. Scienter

Plaintiffs must plead scienter adequately if their

complaint is to survive a motion to dismiss. See Ernst & Ernst

v. Hochfelder, 425 U.S. 185, 193, 96 S. Ct. 1375, 1381 & n.12

(1976). Scienter, in the context of securities fraud, is: 

a mental state embracing intent to deceive,

manipulate or defraud, or, at a minimum,

highly unreasonable (conduct), involving not

merely simple, or even inexcusable

negligence, but an extreme departure from the

standards of ordinary care, . . . which

presents a danger of misleading buyers or

sellers that is either known to the defendant

or is so obvious that the actor must have

been aware of it. 

In re IKON, 277 F.3d at 667 (citations and internal quotations

omitted).

Conclusory allegations will not do under this

jurisprudence. "[A]llegations that a securities-fraud defendant,

because of his position within the company, 'must have known' a

statement was false or misleading are 'precisely the types of

inferences which [courts], on numerous occasions, have determined

to be inadequate to withstand Rule 9(b) scrutiny.'" In re

Advanta Corp. Sec. Litig., 180 F.3d 525, 539 (3d Cir. 1999)

(quoting Maldonado v. Dominguez, 137 F.3d 1, 10 (1st Cir. 1998));

cf. In re Aetna Inc. Sec. Litig., 34 F.Supp.2d at 953 (explaining

that Advanta did not address scienter where corporation's core

business activities were at issue). Most pertinently here,

"claims essentially grounded on corporate mismanagement are not

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 22 of 39
23

cognizable under federal law." In re Advanta, 180 F.3d at 540

(quoting Craftmatic Sec. Litig. v. Kraftsow, 890 F.2d 626, 638-39

(3d Cir. 1989)). It is not enough for plaintiffs to "allege

generally that defendants knew or recklessly disregarded each of

the false and misleading statements for which [they were] sued,"

but rather "plaintiffs must allege facts that could give rise to

a 'strong' inference of scienter." In re Burlington, 114 F.3d at

1422 (citation and internal quotation omitted). Interpreting the

"strong inference" requirement, our Court of Appeals has

explained that "[p]laintiffs must either (1) identify

circumstances indicating conscious or reckless behavior by

defendants or (2) allege facts showing both a motive and a clear

opportunity for committing the fraud." Id.; see also In re

Advanta, 180 F.3d at 534-35 (discussing standards for pleading

scienter in light of PSLRA).

A reckless statement involves "not merely simple, or

even inexcusable negligence, but an extreme departure from the

standards of ordinary care, and which presents a danger of

misleading buyers or sellers that is either known to the

defendant or is so obvious that the actor must have been aware of

it." In re Advanta, 180 F.3d at 535 (quoting McLean v.

Alexander, 599 F.2d 1190, 1197 (3d Cir. 1979) (citations and

internal quotations omitted). Allowing scienter to be

established through recklessness "promotes the policy objectives

of discouraging deliberate ignorance and preventing defendants

from escaping liability solely because of the difficulty of

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 23 of 39
24

proving conscious intent to commit fraud." Id. For conscious

behavior, "scienter may be alleged by stating with particularity

facts giving rise to a strong inference of conscious wrongdoing,

such as intentional fraud or other deliberate illegal behavior." 

Id.

Motive and opportunity "must now be supported by facts

stated 'with particularity' and must give rise to a 'strong

inference' of scienter." Id. (quoting 15 U.S.C.A. § 78u-4(b)(2).

"Catch-all allegations that defendants stood to benefit from

wrongdoing and had the opportunity to implement a fraudulent

scheme are no longer sufficient." Id. 

Plaintiffs contend that the defendants were reckless

and that they had motive and opportunity to commit fraud. We now

address each argument.

2. Recklessness

Plaintiffs assert that the allegations in their

complaint, when viewed together, raise a strong inference of

defendants' recklessness. Plaintiffs highlight five points: (1)

defendants violated their duty to monitor and report a core part

of Stonepath's business, transportation costs; (2) the three

restatements during the Class Period are probative of scienter;

(3) the restatement of September 29, 2004 was very large; (4) the

restatements occurred over two and a half years; and (5) regular

reports to defendants kept them informed about internal control

problems. Because plaintiffs' second, third and fourth points

involve the restatements, we address those first, and then turn

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 24 of 39
25

to plaintiffs' first and last points.

Plaintiffs claim that the size of Stonepath's third

restatement supports a strong inference of scienter. In this

circuit, district courts have found magnitude relevant when

viewed together with other factors. See In re Rent-Way

Securities Litigation, 209 F.Supp.2d 493, 506 (W.D. Pa. 2002)

("In and of itself, the magnitude of an erroneous financial

statement is insufficient to raise a strong inference that a

defendant acted with scienter."); P. Schoenfeld Asset Management

LLC v. Cendant Corp., 142 F.Supp.2d 589, 609 (D.N.J. 2001)

(strong inference of scienter established by allegations of

"hundreds of fraudulent accounting entries, in combination with

the sheer magnitude of the revenue and earnings overstatements,

as well as [other] 'red flags'"). 

Defendants do not dispute the magnitude of the third

restatement, which Stonepath issued because of Domestic Services'

under-accrual of transportation costs. When the restatement was

formally made on February 11, 2005, it eliminated $7.1 million in

net income for 2003 and replaced it with a loss. Compl. ¶ 26. 

Also in that restatement, net revenues for 2001 and 2002 were

decreased, net loss for 2001 was increased, and net income for

2002 was decreased. Id. ¶ 27. While the September 2004 press

release announced that the first and second quarters of 2004

would be restated, id. ¶ 271, this has yet to happen. We know

from the January 6, 2005 press release that net income for that

period is expected to be reduced by $6.1 million. Id. ¶ 281.

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 25 of 39
26

The third restatement not only materially changed

earnings statements, but it also indisputably prompted sales of

stock that reduced stock value, reduced the amount of credit

available and precluded further acquisitions. The magnitude of

the restatement is undeniably large, and therefore relevant, but

alone it does not establish recklessness.

Plaintiffs also assert that repeated restatements are

probative of scienter, and that the second restatement was a

"'red flag' to Defendants that [legacy information] systems were

inherently unreliable and generating inaccurate financial data." 

Id. ¶ 305. "When plaintiffs 'allege the existence of specific

facts that should put defendants on notice of errors in

recognizing revenue or indicate reasons to question management's

representations,' a refusal to react to these 'red flags' can

support a strong inference of scienter." In re Rent-Way Sec.

Litig., 209 F.Supp.2d 493, 508-509 (W.D. Pa. 2002) (quoting In re

SCB Computer Technology, Inc. Sec. Litig., 149 F.Supp.2d 334, 363

(W.D.Tenn. 2001)).

Defendants argue that repeated restatements do not here

suggest scienter since each restatement responded to issues that

were different in kind. The first restatement concerned

allocating value to intangible assets for acquired companies and

revising the amortization method and useful life assumed for such

assets. The second restatement involved duplication of gross

revenues at the International Services division. The third

restatement concerned Domestic Services' under-accrual of

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 26 of 39
27

transportation costs. Since the restatements addressed such

unrelated problems, it cannot be said that the mere fact that

there were three restatements shows defendants acted recklessly.

Plaintiffs offer no facts suggesting that problems with

under-accrual of transportation costs were revealed when

Stonepath identified the duplication error, so we cannot say

defendants had a "red flag" as to that problem. However,

Pelino's and Crain's comments during the December 31, 2003

conference call reveal that they were aware there might be

further risks in Stonepath's financial reporting processes. 

Pelino and Crain reassured analysts and investors they were

working closely with auditors. Compl. ¶ 91-92. Crain stated

that they were identifying steps "to reduce, if not eliminate,

any remaining risk in our financial reporting processes." Id. 

¶ 92. Pelino also stated that they were "identifying every

material business process" to ensure there were "state-of-the-art

internal controls across the entire organization." Id. ¶ 94. 

Significantly, plaintiffs do not allege that either internal or

external auditors or any participant in the comprehensive review

process alerted defendants to the problems leading to the third

restatement. 

Plaintiffs instead rely on the reporting process Crain

described in the December 31, 2003 conference call. Id. ¶ 91. 

Crain had told analysts and investors that Tim Anderson reported

to Joe DiGiacomo and Gary Koch, the men who reported to Crain. 

Id. ¶ 93. By early January of 2004 at the latest, Tim Anderson

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 27 of 39
28

knew Domestic Services had serious financial reporting problems,

id. ¶ 67, but not until nine months later (on September 20,

2004) did defendants reveal that Domestic Services had been

greatly under-accruing transportation costs, id. ¶ 271. On the

September 21, 2004 conference call, Crain allegedly stated that

Stonepath discovered the problem in the last thirty days. Id. ¶

177. Plaintiffs state that "[a]ccording to another former

employee, Anderson reported the issue to someone in senior

management at Stonepath, believed to be Crain, and that

individual 'sat on' the information." Id. ¶ 277. 

Defendants argue that plaintiffs never adequately

allege that Anderson forwarded this information to defendants. 

Defendants are correct that plaintiffs' statement, which fails to

identify the "former employee" with any particularity, cannot

pass 9(b) or PSLRA muster. Plaintiffs simply have not provided

the requisite particularized facts showing that the information

about under-accrual -- or, for that matter, any of the alleged

accounting and financial reporting problems described by their

confidential witnesses -- reached defendants well before

Stonepath's restatements.

Finally, plaintiffs argue that knowledge of activities

central to Stonepath's business -- namely, transportation costs -

- can be imputed to the Individual Defendants. Defendants

concede that high-level officers can be charged with knowing

information about a company's core business, though they contend,

without citing any authority in this circuit, that this rule

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 28 of 39
29

generally applies when facts at issue are readily discoverable

and directly affect the company. 

Our courts have repeatedly held that knowledge of core

activities can be imputed to high-level officers. See In re

Campbell Soup Co. Sec. Litig., 145 F.Supp.2d 574, 599 (D.N.J.

2001) ("While asserting that defendants approved or helped

prepare public disclosures is insufficient to establish knowledge

of all aspects of the company's business, knowledge may be

imputed to [officers of the company] when the [public]

disclosures involve the company's core business") (citations

omitted); In re Aetna Inc. Sec. Litig., 34 F.Supp.2d 935, 953

(E.D. Pa. 1999) (finding allegations of CEO's and CFO's scienter

sufficient where the alleged fraud related to the company's core

business); In re Viropharma, Inc., Sec. Litig., No. 02-1627,

2003 WL 1824914, at *9 (E.D. Pa. Apr. 7, 2003) (knowledge of

facts could be imputed to "the highest ranking members of the

company" because a drug was the company's "leading product"). 

These cases do not hold that facts must be easily discoverable,

as defendants contend, although by their nature core activities

can be said to directly affect the corporation. 

Plaintiffs cite to Stonepath's 2002 10-K/A and 2003 

10-K to show the significance of transportation costs:

Our cost of transportation includes direct

costs of transportation, including motor

carrier, air, ocean and rail services. We act

principally as the service provider to add

value in the execution and procurement of

these services to our customers. Our net

transportation revenues (gross transportation

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 29 of 39
16 Plaintiffs' figure in their complaint is "$ 113,510." 

Id. ¶ 225. We assume plaintiffs meant $113,510,000.

17 Plaintiffs' figure is "$203,407,00." Id. ¶ 225. We

again assume this was a typographical error and that plaintiffs

meant to include an additional zero at the end.

30

revenues less the direct cost of

transportation) are the primary indicator of

our ability to source, add value and resell

services provided by third parties, and are

considered by management to be a key

performance measure. Management believes that

net revenues are also an important measure of

economic performance. Net revenues include

transportation revenues and our fee-based

activities, after giving effect to the cost

of purchased transportation.

Compl. ¶ 63 (emphasis added). 

Plaintiffs further allege that transportation costs

were Stonepath's "single largest expense," and that because of

their importance, they were reported separately from on-going

operating expenses. Id. ¶ 303. Plaintiffs do not break down all

Stonepath's expenses, but they do state that Stonepath reported

the following figures, which we place in a table for ease of

reference:

2002 2003

Transportation revenues $ 113,510,00016 $ 203,407,00017

Transportation costs $ 84,478,000 $ 153,718,000 

Net transportation revenues $ 29,032,000 $ 42,689,000 

Net income $ 2,380,000 $ 7,139,000 

Id. ¶ 225.

 Based on these asserted facts, plaintiffs claim that

Domestic Services' transportation costs and the reporting process

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 30 of 39
31

for such costs were a "critical component of [Stonepath's] core

business" and that defendants "had a duty to monitor the

accuracy" of these costs and reporting processes. Id. ¶ 303. 

Defendants do not contradict the importance of

transportation costs. Instead, they assert that knowledge cannot

be imputed to defendants merely because defendants' subordinates

may have known of alleged accounting irregularities. For this

proposition, defendants rely on In re Alpharma Inc. Securities

Litigation, 372 F.3d 137 (3d Cir. 2004), a securities fraud class

action brought against a multinational pharmaceutical company. 

While Alpharma supports defendants’ proposition as stated, see

id. at 150, a closer examination of that case is instructive. 

In Alpharma, employees in the Brazil division of

Alpharma's Animal Health Division ("AHD") allegedly used improper

accounting methods to increase revenue figures, which in turn

affected Alpharma's net income. In finding that plaintiffs did

not adequately plead that defendants knew about the accounting

irregularities, the court noted the complaint was "devoid of any

allegations" that AHD's Brazil division was "so central to

Alpharma's business" that company executives should have noticed

the Brazil division's increased reported revenues. Id. at 151. 

It further noted that "the Brazil division's total revenue

accounted for only slightly more than one half of one percent of

the company's total revenue in 1999." Id. (emphasis in

original). 

Here, we can surmise that Domestic Services is not as

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 31 of 39
32

remote a subsidiary as the one in Alpharma, though the complaint

does not provide particularized facts about the role various

subsidiaries played within Stonepath. To be sure, plaintiffs

have adequately pled that transportation revenues are central to

Stonepath's business by providing statements from SEC filings and

figures to support that claim. However, plaintiffs must do

something more: they must show that Domestic Services'

transportation costs are at the core of Stonepath's business. 

We know from the figures provided that transportation

costs are a very large, if not the largest, expense for

Stonepath. What we do not know is how Domestic Services fits

into the picture. To illustrate, transportation costs for 2003

were $153,718,000, and for 2002 they were $84,478,000. According

to the third restatement, transportation costs were understated

by $4.4 million for 2003 and $1.6 for 2002, i.e., less than 2.9%

of transportation costs for 2003 and 1.9% in 2002. Alpharma

teaches that courts must look to the numbers involved and decide

whether their magnitude should have alerted defendants to

accounting improprieties. At variances of 2.9% and 1.9%,

plaintiffs have not shown that the costs Domestic Services

reported for the restated years were of such size that defendants

should have been suspicious. Plaintiffs have, in short, failed

to sufficiently plead that transportation costs at Domestic

Services are so central to Stonepath's business that knowledge of

financial reporting and accounting problems could be imputed to

defendants. 

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 32 of 39
33

In sum, the complaint alleges various accounting and

financial reporting problems within Stonepath, and it reveals the

effects of a large third Class Period restatement. It does not,

however, allege facts showing that defendants had knowledge of or

recklessly disregarded information about the alleged problems and

intentionally concealed those problems from investors. We find

that plaintiffs have failed to provide sufficiently

particularized facts that would support the conclusion that

defendants behaved recklessly. 

3. Motive and Opportunity

Because the Individual Defendants served as Stonepath's

senior officers and/or directors, their opportunity to control

the dissemination of information about Stonepath is undisputed. 

The parties dispute whether the motives alleged are sufficient. 

Plaintiffs rely primarily on two alleged motivations: (1) to

inflate Stonepath stock to use it in various acquisitions, and

(2) to inflate EBITDA to comply with Stonepath's debt covenants. 

Defendants assert that both motivations are insufficient as a

matter of law.

Plaintiffs rely mainly on one acquisition to establish

motive under their first theory. On February 9, 2004, Stonepath

acquired 55% of Shaanxi Sunshine Cargo Services International

Co., Ltd. ("Shaanxi") for $3.5 million in cash and $2 million in

stock. Compl. ¶ 21. Defendants point to further relevant

information in the Form 8-K filed on February 9, 2004, which

shows that, in addition to the $5.5 million paid at closing:

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 33 of 39
18 Under Oran v. Stafford, 226 F.3d 275, 289 (3d Cir. 2000),

the court can take judicial notice of SEC filings.

34

The Company has agreed to issue additional

shares of its common stock to Mr. Tsai if at

the end of the one year restrictive period,

the Company's common shares are trading at a

price of less than $3.17 per share. The

Company also agreed to an earn-out

arrangement over a period of five (5) years

of up to $5.5 million ($1.1 million per year)

contingent upon Shaanxi realizing pre-tax net

income of at least $4 million per year during

the earn-out period. As additional purchase

price, on a post-closing basis, the Company

has also agreed to pay for excess closing

date working capital estimated at between $1

and $2 million.

Defs.' Mot. to Dismiss, Ex. J.18 Therefore, the deal was worth

up to $13 million dollars, and stock was $2 million of that. 

Our Court of Appeals has instructed that "[m]otives

that are generally possessed by most corporate directors and

officers do not suffice; instead, plaintiffs must assert a

concrete and personal benefit to the individual defendants

resulting from this fraud." GSC Partners CDO Fund v. Washington,

368 F.3d 228, 237 (3d Cir.) (emphasis added) (quoting Kalnit v.

Eichler, 264 F.3d 131, 139 (2d Cir. 2001)). In GSC Partners, a

company's acquisition was primarily financed by a $300 million

note offering, and, to acquire the company, the defendant

allegedly committed fraud by concealing the company's true

financial condition in the note offering. 368 F.3d at 235, 237.

Plaintiffs alleged that the notes would not have sold at or near

the price sought if the company's true financial condition had

been revealed. Id. The court found that allegation insufficient

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 34 of 39
35

and explained that a corporation and its directors have a desire

to complete all corporate transactions, and typically officers

benefit financially from successful transactions. Id. at 237.

The court made clear that "such allegations alone cannot give

rise to a 'strong inference' of fraudulent intent," and cited a

number of cases to illustrate this proposition, including Herzog

v. GT Interactive Software Corp., 98 Civ. 0085, 1999 WL 1072500,

at *9 (S.D.N.Y. Nov. 29, 1999), which held that "a defendant's

'desire to consummate [a] corporate transaction does not

constitute a motive for securities fraud.'" 368 F.3d at 237-38. 

In another case decided less than a month after GSC

Partners, our Court of Appeals found that plaintiffs had not

established motive where they pled that defendant benefitted from

selling shares at prices allegedly inflated by defendants' false

and misleading statements. In re Alpharma Inc. Sec. Litig., 372

F.3d 137, 152-53. The court approvingly cited a case from the

Ninth Circuit, In re Vantive Corp. Sec. Litig., 283 F.3d 1079,

1097 (9th Cir. 2002), which concluded "that a corporation's

desire to increase its stock value as part of an acquisition

strategy is an insufficient basis upon which to maintain a claim

for violation of federal securities laws." 372 F.3d at 153.

Plaintiffs here have alleged that defendants

artificially maintained high stock prices to complete an

acquisition. This is hardly the "concrete and personal benefit"

that GSC Partners had in mind. Since this is precisely the type

of motive that our Court of Appeals deemed insufficient in GSC

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 35 of 39
36

Partners and Alpharma, we find that under this theory plaintiffs

have not established scienter.

To support their second motive theory, plaintiffs

contend that Stonepath needed access for on-going working

capital, in part because costs associated with implementing TechLogis increased from $0.2 million in 2002 to $3.2 million in

2003. Compl. ¶ 314. Also, Stonepath's rapid acquisitions had

caused increasing liquidity problems, evidenced by its

difficulties paying vendors and carriers on time. Therefore,

defendants, in need of working capital, were allegedly motivated

to delay or avoid disclosing Domestic Services' understated

transportation costs since that would result in the breach of

Stonepath's credit facility's EBITDA ratio covenant. In fact,

the disclosure made in the third restatement did breach that

covenant, but lenders waived the breach and renegotiated the

terms, decreasing available credit, shortening the repayment

period, and prohibiting acquisitions. Id. ¶ 320.

Defendants argue that maintaining access to credit is a

generalized corporate motive that does not raise a strong

inference of scienter.

In GSC Partners, the court approvingly cited San

Leandro Emergency Medical Group Profit Sharing Plan v. Philip

Morris Cos., 75 F.3d 801, 813-14 (2d Cir.1996), and noted that

the Second Circuit found "that a 'company's desire to maintain a

high bond or credit rating' [was] insufficient motive for fraud

because such motive could be imputed to any company." 368 F.3d

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 36 of 39
37

at 238. That reasoning applies where plaintiffs allege that

defendants were motivated by a desire to comply with debt

covenants. See Wilson v. Bernstock, 195 F.Supp.2d 619, 637

(D.N.J. 2002) (explaining that a company's desire to maintain a

high credit rating is insufficient motive for fraud and applying

the same reasoning where defendants were allegedly motivated to

commit fraud to comply with a debt covenant). At most, the need

to comply with debt covenants can be a contributing motive to

commit securities fraud, but standing alone even severe cash flow

problems are insufficient to establish motive. See In re Loewen

Group Inc. Sec. Litig., No. 98-6740, 2004 WL 1853137, at *21

(E.D. Pa. Aug. 18, 2004). Otherwise, any corporation that was

subject to debt covenants and whose stock price declined would be

susceptible to a securities fraud action. Id. In short, wanting

good credit ratings proves too much to serve as a scienter

motive; it most assuredly cannot be a requisite "concrete and

personal benefit."

In sum, plaintiffs have here alleged the type of

generalized motive regarding access to credit that is

insufficient to support scienter. Neither of plaintiffs' motive

theories go beyond "[m]otives that are generally possessed by

most corporate directors and officers" and neither "assert a

concrete and personal benefit to the individual defendants

resulting from this fraud." GSC Partners, 368 F.3d at 237 (3d

Cir.) (emphasis added) (quoting Kalnit v. Eichler, 264 F.3d 131,

139 (2d Cir.)). Plaintiffs have, therefore, not established

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 37 of 39
38

scienter under a motive and opportunity theory.

B. Section 20(a)

In Count II, the complaint alleges that the defendants

violated Section 20(a) of the Act, 15 U.S.C. § 78t(a) (2004). 

That section imposes joint and several liability on one who

controls a corporation that violates federal securities laws. 

The defendants suggest that we should dismiss this claim because

plaintiffs failed to plead their other federal claim adequately

and a Section 20(a) claim will not lie when there are no

actionable independent underlying violations of the Act. See In

re Advanta Corp. Sec. Litig., 180 F.3d at 541; see also In re

Rockefeller Center Properties, Inc., 311 F.3d 198, 211 (3d Cir.

2002) ("[I]t is well-settled that controlling person liability is

premised on an independent violation of the federal securities

laws."). 

Because we read the allegations in the complaint as

insufficient to state a claim for violation of Sections 10(b) of

the Act for purposes of this motion to dismiss, we shall dismiss

the Section 20(a) claim.

Conclusion

Plaintiffs have failed to allege particularized facts

that create a strong inference that defendants acted with

scienter. Therefore, we grant defendants’ motion to dismiss.

Because leave to amend a complaint "shall be freely

given when justice so requires," Fed. R. Civ. P. 15(a), and

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because we are "hesitant to preclude the prosecution of a

possibly meritorious claim because of defects in the pleadings,"

In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1435

(3d Cir. 1997), we also grant plaintiffs leave to amend their

complaint if they can do so conformably with the foregoing

analysis and with Fed. R. Civ. P. 11.

An appropriate Order follows.

Case 2:04-cv-04515-SD Document 52 Filed 10/27/05 Page 39 of 39