Sec. & Exch. Comm'n v. Farnsworth

692 F.Supp.3d 157

SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. Theodore J. FARNSWORTH, J. Mitchell Lowe, and Khalid Itum, Defendants.

22 Civ. 8226 (KPF)

United States District Court, S.D. New York

Filed September 14, 2023

Signed September 13, 2023

Jack Kaufman, Thomas Peter Smith, Elizabeth Ann Butler, Tiantong Wen, U.S. Securities and Exchange Commission New York Regional Office, New York, NY, Jason David Schall, U.S. Securities & Exchange Commission, Washington, DC, for Plaintiff.

Louis D. Greenstein, Benjamin Almond O'Neil, Edward Andrew Southerling, George James Terwilliger, McGuireWoods LLP, Washington, DC, Jason Cowley, McGuire Woods LLP, Charlotte, NC, for Defendant Theodore J. Farnsworth.

Adriana Riviere-Badell, Kobre & Kim LLP, Miami, FL, Kelly Spatola, William F. McGovern, Rachel Warren, Kobre & Kim LLP, New York, NY, for Defendant J. Mitchell Lowe.

Adam Fee, Paul Hastings LLP, Los Angeles, CA, Kim Bendersky Goldberg, Orrick, Herrington & Sutcliffe LLP, New York, NY, for Defendant Khalid Itum.

OPINION AND ORDER

KATHERINE POLK FAILLA, District Judge:

MoviePass, Inc. ("MoviePass") is a subscription service that, during the relevant time period, allowed subscribers to pay a fixed monthly fee to see multiple movies per month at participating theaters. In August 2017, Helios and Matheson Analytics Inc. ("HMNY," and together with MoviePass, the "Companies") acquired MoviePass. Unfortunately for HMNY and its investors, HMNY was not able to make MoviePass profitable following the acquisition, and HMNY, along with MoviePass and its other subsidiaries, ultimately filed Chapter 7 liquidation petitions in January 2020. The United States Securities and Exchange Commission (the "SEC" or "Plaintiff") brought this enforcement action against Theodore J. Farnsworth and J. Mitchell Lowe, alleging that between 2017 and 2019 — when Farnsworth and Lowe were Chief Executive Officers ("CEOs") of HMNY and MoviePass, respectively — they made material misstatements about MoviePass and engaged in a fraudulent scheme to deceive HMNY investors, in violation of Section 17(a) of the Securities Act of 1933 (the "Securities Act"), Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), and Rule 10b-5 promulgated thereunder. Additionally, the SEC claims that Farnsworth and Lowe participated in the falsification of HMNY's books and records in conjunction with another former MoviePass employee, Khalid Itum (together with Farnsworth and Lowe, "Defendants"), in violation of Section 13(b) of the Exchange Act and Rules 13b2-1 and 13b2-2 promulgated thereunder. Before the Court are Defendants' motions to dismiss. For the reasons set forth in the remainder of this Opinion, the Court grants in part and denies in part Defendants' motions.

BACKGROUND¹

A. Factual Background

1. The Parties

HMNY is a Delaware corporation with its principal place of business in New York, New York. (Compl. ¶ 16). HMNY's common stock is registered pursuant to Section 12(g) of the Exchange Act and was traded on the NASDAQ exchange until January 2019. (Id. ¶ 17). The company filed a bankruptcy petition in January 2020. (Id. ¶ 18). Farnsworth, a resident of Miami, Florida, was the Chairman and CEO of HMNY from January 2017 until September 2019. (Id. ¶ 13).

MoviePass is a privately held Delaware corporation with its principal place of business in New York, New York. (Compl. ¶ 19). Lowe, a resident of Miami Beach, Florida, and Puerto Vallarta, Mexico, was the CEO of MoviePass from 2016 to 2020. (Id. ¶ 14). MoviePass's primary product offering was a movie subscription service, whereby subscribers could pay a fixed monthly fee to see a certain number of movies each month. (Id. ¶ 20). Subscribers were issued a debit card through which they could purchase one ticket for a specific movie, theater, and show time selected through the MoviePass application on their phones. (Id.).

On August 15, 2017, HMNY announced its intention to acquire MoviePass (the "Announcement"), which it completed in December 2017 (the "Acquisition"). (Compl. ¶¶ 26-28). MoviePass then became a subsidiary of HMNY. (Id. ¶ 19). Prior to the Acquisition's closing, in November 2017, HMNY issued $100 million in convertible notes, and in February 2018, just two months after the closing, HMNY conducted a public offering of warrants that raised approximately $97 million. (Id. ¶ 29). Both of these offerings, the SEC contends, coincided with, and were impacted by, Farnsworth's and Lowe's materially false and misleading statements regarding MoviePass. (Id.).

By the time HMNY filed its Form 10-K for the 2017 fiscal year in April 2018, it owned approximately 92% of MoviePass's outstanding common stock; MoviePass became HMNY's core business and its primary source of revenue. (Compl. ¶ 28). While MoviePass's subscription model was HMNY's primary source of revenue, Farnsworth publicly identified other ancillary sources of potential revenue, including data analytics (id. ¶ 43), studio and exhibitor partnerships (id. ¶ 49), an associated film production company (id. ¶ 51), and entertainment information and marketing (id.), none of which the SEC contends generated meaningful revenue for the Companies (id. ¶¶ 52-53). Both HMNY and MoviePass filed Chapter 7 petitions in January 2020. (Id. ¶¶ 3, 18, 21).

Khalid Itum, a resident of Los Angeles, California, was hired by MoviePass as Vice President for Business Development in October 2017, and was promoted to Executive Vice President in October 2018. (Compl. ¶ 15). As Executive Vice President, Itum was responsible for MoviePass's day-to-day operations. (Id.). Itum resigned from MoviePass effective March 19, 2019. (Id.). Separately, Itum founded Kaleidoscopic Ventures, LLC (known through 2021 as Kaleidoscope Productions LLC) ("Kaleidoscope"), an experiential marketing firm, in March 2017. (Id. ¶¶ 22-24). Itum is the sole owner, officer, and employee of Kaleidoscope. (Id. ¶¶ 24-25).

2. Farnsworth's and Lowe's Public Statements and Ticket Usage Control Measures

Prior to the Announcement, the price point of MoviePass's monthly subscription had fluctuated between $12.95 and $89.95, depending on time and geographic location. (Compl. ¶ 30). Concurrent with the Announcement, and at Farnsworth's and Lowe's direction, HMNY and MoviePass publicized that all subscribers would pay $9.95 per month irrespective of their location, and could see "[a]ny movie; any theater; any day." (Id.). Farnsworth and Lowe made various statements regarding the profitability of the Company while offering the service at this price point, each time affirming that the price point was viable. Farnsworth and Lowe did so in joint interviews conducted on August 16, 2017, with Variety.com (id. ¶ 32), and on January 9, 2017, with Yahoo Finance (id. ¶¶ 34-35). Farnsworth also did so in a September 25, 2017 interview with Pipeline Data (id. ¶ 33), and Lowe did so in a February 18, 2018 appearance on an episode of the Recode Media podcast (id. ¶ 36). In the February 18, 2018 interview, Lowe stated that the price point had been "tested like crazy" (id.), and Farnsworth similarly declared that "historical data" supported the price point in the September 25, 2017 interview (id. ¶ 33). However, according to the SEC, Farnsworth and Lowe knew at the time of these statements that the price point was not based on data or market testing, and that MoviePass could not become profitable based on subscriber revenue at that price point alone. (Id. ¶ 31).

Farnsworth and Lowe made multiple public statements vaunting HMNY's data analytics capabilities and its ability to use MoviePass's subscriber data to generate additional revenue, despite the fact that such tools were not actually integrated into the Companies' business models. (Compl. ¶ 41). These statements were made not only in press releases approved by Farnsworth, but also in multiple filings with the SEC, including an October 24, 2017 Form 8-K, a January 25, 2018 Form S-3, an April 17, 2018 Form 10-K, and a May 15, 2018 Form 10-Q, each of which was approved by Farnsworth. (Id. ¶¶ 40-42). Consistent with those statements, Farnsworth stated in the January 2018 Yahoo Finance interview that "data analytics [is] how we're driving the revenues of the company right now." (Id. ¶ 43). Lowe similarly characterized HMNY as a "data analytics firm" in an October 2017 CNBC interview. (Id. ¶ 44). However, by February 2018, HMNY still lacked the data analytics capabilities described in such statements and was not monetizing subscriber data. (Id. ¶ 45). In a March 2, 2018 speech, Farnsworth similarly claimed that MoviePass collected an "enormous amount of information regarding" its subscribers, but Lowe later walked the statement back in an apology email to stakeholders that acknowledged that MoviePass did not track its subscribers. (Id. ¶ 46). Farnsworth then sent Lowe a text message stating that HMNY's stock price was "tanking" due to the situation and that "investors were 'saying the exact thing I was afraid of[,] that we are not a big data company and we just admitted it.' " (Id. ¶ 46).

Relatedly, Farnsworth and Lowe made misstatements regarding the amount of revenue the Companies were receiving from MoviePass's ancillary non-subscription model business. In the January 2018 Yahoo Finance interview, Farnsworth stated that MoviePass would be profitable "within the next sixty days" due to "multiple revenue streams." (Compl. ¶ 47). At that time, however, the Companies' non-subscription revenue streams were generating minimal income. (Id. ¶ 48). And in March 2018, the Companies stated in a press release that they were lowering the subscription price due to partnerships that did not in fact exist. (Id. ¶ 49). In point of fact, the decision to lower the subscription price was due to a need for a short-term cash injection. (Id.). In an April 12, 2018 joint interview, Farnsworth stated, with Lowe in agreement, that MoviePass could already generate $6 per month in non-subscription...