Neer v. Pelino

• Decision Date: 27 September 2005
• Docket Number: No. CIV.A. 04-4791.,CIV.A. 04-4791.
• Citation: 389 F.Supp.2d 648
• Parties: Ronald Jeffrey NEER, derivatively on behalf of Stonepath Group, Inc., v. Dennis L. PELINO, et al.
• Court: U.S. District Court — Eastern District of Pennsylvania

Page 648

389 F.Supp.2d 648

Ronald Jeffrey NEER, derivatively on behalf of Stonepath Group, Inc., v. Dennis L. PELINO, et al.

No. CIV.A. 04-4791.

United States District Court, E.D. Pennsylvania.

September 27, 2005.

Marc M. Umeda, Robbins, Umeda & Fink, LLP, San Diego, CA, Steven A. Schwartz, Chimicles & Tikellis, LLP, Haverford, PA, for Plaintiff.

Howard D. Scher, Steven E. Bizar and Thomas P. Manning, Buchanan Ingersoll, PC, Philadelphia, PA, for Defendants.

MEMORANDUM

DALZELL, District Judge.

Plaintiff Ronald Jeffrey Neer, a shareholder in Stonepath Group, Inc. ("Stonepath"), here sues nominal defendant Stonepath and fourteen of its current and former officers and directors in this shareholder derivative action. He alleges violations of the Sarbanes-Oxley Act of 2002, breaches of fiduciary duties, abuse of control, gross mismanagement, waste of corporate assets, and unjust enrichment that happened between January 1, 2001 and now. Stonepath allegedly suffered large losses and damages.

Defendants move to dismiss for lack of subject matter jurisdiction, lack of standing, time-barred claims, and lack of personal jurisdiction. We now address that motion.¹

Factual Background

Stonepath is said to be "a non-asset based third-party logistics services company." Am. Compl. ("Compl.") ¶ 5. It is incorporated in Delaware and maintains its headquarters in Philadelphia. Id. ¶ 26. The company derives income primarily from freight forwarding, customs brokerage, and warehousing and other valueadded services. Id. ¶¶ 1, 7. As a freight forwarder, Stonepath does not own or lease any significant equipment. Id. ¶ 7. It generates most revenues "by purchasing transportation services from direct (asset-based) carriers" to transport the property of Stonepath's customers. Id.

Stonepath is said to have issued four restatements — in August and November of 2003, January, 2004 and January, 2005 — that modified financial statements earlier filed with the Securities and Exchange Commission ("SEC" or "Commission"), and further restatements are said to be expected.

Specifically, on August 28, 2003, Stonepath issued its first restatement, which corrected previously reported financial data that had been obtained using improper methods to account for depreciation and amortization. Id. ¶¶ 11, 97. This restatement covered fiscal years ("FY") 2001 and 2002 and the first two quarters of 2002 and 2003. Id. ¶¶ 10, 97. Net income was reduced by $262,667 (27%) for the first quarter of FY 2001, $1,185,389 (33%) for the second quarter of FY 2002, $267,223 (97%) for the first quarter of FY 2003, and $290,066 (52%) for the second quarter of FY 2003, for a combined reduction of about two million dollars.² Id. ¶¶ 11, 97, 118.

On November 17, 2003, Stonepath filed a Form 10-Q with the SEC for the third quarter of 2003, and this form also restated financial information for the second quarter of 2003. Id. ¶¶ 10, 104. Net income for the second quarter of 2003 was reduced by $350,834 (15%).³ Id. ¶ 12.

On January 20, 2004, Stonepath issued a third restatement, this one for fiscal year 2002 and the first, second and third quarters of 2003. Id. ¶¶ 10, 109. This restatement corrected an overstatement of total revenue and a corresponding overstatement of transportation costs in the same amount. Id. ¶¶ 13, 105. It did not alter reported net income. Id.

Stonepath issued a fourth restatement in January of this year, correcting information for the first and third quarters of 2003.⁴ Id. ¶¶ 10, 20, 125. The need for this restatement had been announced on September 20, 2004, when Stonepath reported that it would restate financial statements for fiscal year 2003 and the first and second quarters of 2004. Id. ¶¶ 15, 126. An internal review of Stonepath's Logistics Domestic Services ("Domestic Services") subsidiary revealed the "trend analysis" method used to estimate costs of purchased transportation did not accurately account for the differences between the estimates of freight costs and the actual freight costs. Id. ¶ 120. As a result, actual costs were underreported. Id. Costs were understated for 2003 in the range of $4.0 to $6.0 million, and in the range of $500,000 to $1.0 million for the first six months of 2004. Id. Stonepath stated it expected the reported earnings before interest, taxes and depreciation ("EBITDA") to be reduced to the range of $2.6 to $4.6 million for 2003, and $200,000 to $700,000 for the first six months of 2004. 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. Id. ¶¶ 18, 123.

After the September 20, 2004 announcement, Stonepath disclosed two additional process errors concerning Domestic Services' revenue transactions.⁵ Id. ¶¶ 19, 124. First, revenues were overstated because of a billing error. Second, an accounting error affected revenue recognition and depreciation in the second quarter of 2004. Id.

In the January 6, 2005 press release that announced that the restatement for the first and third quarters of 2003 had been filed, Stonepath also disclosed that, because of the accounting problems identified in its September 20, 2004 announcement, it would be reducing net income results for fiscal years 2001, 2002 and 2003, and the first six months of 2004 by $0.4 million, $2.0 million, $7.8 million and $6.1 million, respectively. Id. ¶¶ 21, 127. Accordingly, in future restatements, the aggregate reduction in previously reported income will be about $16.3 million for 2001 through the first six months of 2004. Id. ¶¶ 21, 22, 127.

From January 1, 2001 to now, Stonepath has allegedly undergone several changes in structure and personnel. First, the senior financial representatives within the Domestic Services and International Services units now report directly to the Chief Financial Officer ("CFO"). Id. ¶¶ 23, 130. Second, the Chief Executive Officer ("CEO") and CFO were replaced and the new position of President was created. Id. Third, Stonepath announced it would move the corporate headquarters to Seattle, Washington in the first half of 2005. Id. ¶¶ 24, 130.

On October 12, 2004, plaintiff initiated this action, and on January 19, 2005 he filed an amended complaint. The amended complaint asserts six counts, all against the fourteen Individual Defendants⁶ except for the first count: (1) violation of Section 304 of the Sarbanes-Oxley Act ("SarbOx") by defendants Dennis L. Pelino and Bohn H. Crain; (2) breach of fiduciary duty; (3) abuse of control; (4) gross mismanagement; (5) waste of corporate assets; and (6) unjust enrichment.

Defendants move to dismiss on four grounds: (1) lack of subject matter jurisdiction because plaintiff cannot bring suit under Section 304 of the SarbOx; (2) lack of standing due to failure to make a pre-suit demand upon the directors; (3) time-barred claims against certain Individual Defendants; and (4) lack of personal jurisdiction over certain Individual Defendants.

Because it touches on the federal question that is the keystone of this action, we first consider the SarbOx claim.

Section 304 of the Sarbanes-Oxley Act

Plaintiff asserts federal jurisdiction under 28 U.S.C. § 1331, claiming that we may infer that Section 304 of SarbOx ("the Act") provides a private cause of action against defendants Pelino and Crain. He invokes our supplemental jurisdiction under 28 U.S.C. § 1367(a) to assert his five other claims.

Defendants contend that this Court does not have subject matter jurisdiction. They argue that Section 304 does not provide a private cause of action, and without the presence of a federal question, this Court should not entertain the remaining state law claims.

Section 304 provides for forfeiture of certain bonuses and profits by CEOs and CFOs when a restatement is required due to an issuer's noncompliance with any financial reporting requirements of the securities law, if the noncompliance arises from misconduct. In its entirety, Section 304 states:

(a) Additional compensation prior to noncompliance with Commission financial reporting requirements

If an issuer is required to prepare an accounting restatement due to the material noncompliance of the issuer, as a result of misconduct, with any financial reporting requirement under the securities laws, the chief executive officer and chief financial officer of the issuer shall reimburse the issuer for —

(1) any bonus or other incentive-based or equity-based compensation received by that person from the issuer during the 12-month period following the first public issuance or filing with the Commission (whichever first occurs) of the financial document embodying such financial reporting requirement; and (2) any profits realized from the sale of securities of the issuer during that 12-month period.

(b) Commission exemption authority

The Commission may exempt any person from the application of subsection (a) of this section, as it deems necessary and appropriate.

15 U.S.C. § 7243 (2002).

Section 304 does not explicitly afford a private right of action,⁷ and no court has ruled on whether this section creates an implied private right of action. See Karpus v. Borelli (In re Interpublics Secs. Litig.), 2004 WL 2397190, at *9, 2004 U.S. Dist. LEXIS 21429, at *26 (S.D.N.Y. Oct. 26, 2004) (approving derivative class action settlement and noting that plaintiff's claims were "perilously weak," including his assertion that he had standing to bring a claim under Section 304); In re Cree, Inc. Secs. Litig., 333 F.Supp.2d 461, 478 (M.D.N.C.2004) (granting leave to amend a complaint and explicitly deferring the question of whether Section 304 can be enforced through a private cause of action); In re AFC Enters., Inc. Derivative Litig., 224 F.R.D. 515 (N.D.Ga.2004) (denying motion to dismiss in diversity case without discussing whether shareholders who raised a Section 304 claim had a right to do so).

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