Former MoviePass Executive Consents and Pleads Guilty in Parallel SEC and DOJ Cases

In Hollywood, the sequel (or, even more so, the third installment) is rarely as good as the original movie. In the world of enforcement, the same rings true. On Jan. 2, 2025, a then-Gary Gensler-led SEC announced that it had obtained a consent judgment, the first of three actions, against Theodore J. Farnsworth, former CEO of Helios & Matheson Analytics Inc. (HMNY) in the U.S. District Court for the Southern District of New York for making materially false and misleading statements concerning HMNY's subsidiary, MoviePass Inc., a movie subscription service.¹ In entering the consent judgment, Farnsworth agreed to be enjoined from future violations and to an officer and director bar.

Also, on the same day, the SEC announced that it had obtained a consent judgment against Farnsworth in a related action premised on his conduct as an executive of Vinco Ventures Inc. The SEC filed this case on Dec. 23, 2024, in the same court alleging Farnsworth misled investors about Vinco's proprietary platform and his own involvement in the operations of the company.² Here, as well, Farnsworth agreed to be enjoined from future violations and to an officer and director bar. In both cases, the SEC will take up disgorgement, prejudgment interest and a civil penalty on a future motion.

On Jan. 7, 2025, the U.S. Department of Justice (DOJ) announced that Farnsworth pled guilty in a criminal case in the U.S. District Court for the Southern District of Florida related to his conduct as a MoviePass executive.³ Farnsworth's guilty plea included one count of securities fraud and one count of conspiracy to commit securities fraud. These cases present important procedural context and highlight the recent trend of so-called "AI washing cases," which we discuss below.

Background of the SEC's First Case Against Farnsworth

The SEC's judgment against Farnsworth originates out of a complaint first filed by the SEC on Sept. 26, 2022, alleging that he and two former MoviePass executives made misleading statements concerning key aspects of the company's business. MoviePass was a privately held company that offered subscribers a certain number of movie tickets per month for a flat fee. HMNY acquired a majority ownership interest in MoviePass in December 2017. Simultaneous with the acquisition, MoviePass introduced a new "unlimited" plan that purported to allow new subscribers to see unlimited movies in theaters with no blackout dates for a flat monthly fee of $9.95.

HMNY raised approximately $97 million through the issuance of new notes to acquire MoviePass in November 2017. But throughout that raise, the SEC alleged Farnsworth made materially false and misleading statements regarding MoviePass. For example, prior to the acquisition, Farnsworth allegedly made multiple statements regarding HMNY's ability to use data analytics to increase MoviePass's revenue. But HMNY did not possess any data analytics capabilities and had no plan to incorporate any such technology to increase revenue. Also, according to the SEC, Farnsworth made multiple statements regarding MoviePass having "multiple revenue streams" despite knowing outside of the monthly subscription, the company had no other significant revenue streams.

Statements regarding HMNY's data analytics capabilities quickly came to a head. In March 2018, one of Farnsworth's co-defendants gave a speech titled "Data Is the New Oil: How Will MoviePass Monetize It?" In the speech, the MoviePass employee spoke of the company's ability to monitor customer data, including demographic information. At the time of this speech, MoviePass was not collecting any demographic information from subscribers. MoviePass quickly issued an email apology that stated: "[t]hrough a mix of exuberance about our future and joking around" the speech had mischaracterized how MoviePass tracked its subscribers. HMNY's stock dropped significantly following the release, prompting Farnsworth to text his co-defendants that investors were "saying the exact thing I was afraid of that we are not a big data company and we just admitted it …."

The SEC further alleged that Farnsworth made multiple false and misleading statements regarding the viability of MoviePass's $9.95 subscription price. The SEC's complaint stated that Farnsworth knew from the time MoviePass lowered the price that the company would need to, in fact, raise the price to become profitable. Despite this, Farnsworth made statements such as "we think we can be profitable on the subscriptions at $9.95" and that they were "confident" that MoviePass would break even on subscriptions alone. But the lower subscription price offered to launch the product was a big hit as more than 3 million people signed up for the service at the lower rate and frequently saw movies.

Since the $9.95 subscription service turned out to be unsustainable, Farnsworth and his co-defendants directed MoviePass employees to implement tactics to prohibit certain subscribers from using the purportedly "unlimited" service, to ease MoviePass's cash shortfalls. These tactics included directing MoviePass employees to "throttle" subscribers who most frequently used the service from buying movie tickets and prohibiting their ability to see movies. Thus, in addition to misrepresentations about operations and profitability, the SEC alleged that Farnsworth directed employees to deviate from the company's terms of service with customers.

SEC Files and Settles a Second Related Action Against Farnsworth

The same day the SEC asked the court to reopen its case against Farnsworth to settle the nonmonetary charges against him in the MoviePass action, the SEC also sued and settled with Farnsworth in a separate lawsuit focused on his conduct as an executive of Vinco, a purported digital media and content technologies company.

Vinco, a public company that Farnsworth allegedly secretly controlled, merged with another entity called Zash Global Media and Entertainment Corp. During that merger, the company put out multiple press releases touting Vinco's proprietary platform and Zash's state-of-the-art analytics and distribution technology. But, according to the SEC, both of these statements were false – neither company possessed such capability.

Farnsworth also allegedly misled investors by concealing that he controlled Vinco. Farnsworth allegedly used handpicked officers and directors to carry out his orders at Vinco but never told investors he was actually operating the company. This allowed Vinco to raise more than $120 million through securities transactions, of which the SEC alleged Farnsworth extracted millions for his own personal use.

Parallel Criminal Prosecution and Important Procedural Consequences

The SEC filed its case against Farnsworth and others based on allegations about MoviePass on Sept. 26, 2022. A year later, on Sept. 14, 2023, Farnsworth and other defendants prevailed in part on various motions to dismiss, after which the SEC was forced to amend its complaint. But before Farnsworth or his co-defendants could move to dismiss the SEC's latest pleading, the DOJ sought leave to intervene in and stay the SEC's case. A grand jury returned an indictment against Farnsworth on Nov. 2, 2022, which was unsealed on Nov. 17, 2022. The indictment charged Farnsworth with one count of securities fraud (15 U.S.C. § 78j(b)) and three counts of wire fraud (18 U.S.C. § 1343) related to his conduct as an executive of MoviePass.

Because the criminal case is based on the same underlying facts as the SEC's civil enforcement action – and as is often the case – the DOJ asked that the SEC's case be fully stayed to avoid thorny discovery issues that could otherwise arise, including Fifth Amendment considerations for SEC defendants finding themselves also facing criminal allegations. As is typical, Farnsworth and other defendants in the SEC's action consented to staying the civil case, while the SEC took no position on the issue. The court, therefore, promptly stayed the SEC action on Nov. 6, 2023, thereby bringing the SEC's case related to MoviePass to a halt pending completion of the criminal case.

By late December 2024, however, Farnsworth and the SEC reached an agreement to partially settle their case and – by agreement – the court lifted stay of the SEC's enforcement action for the sole purpose of approving the parties' consent judgment, which resolved nonmonetary claims asserted by the SEC but saved for later litigation (or resolution) the SEC's request for disgorgement, prejudgment interest and a civil penalty – likely to be taken up at the conclusion of Farnsworth's criminal case.

Partial settlements, which, in this case, save the issue of the SEC's entitlement to recover (and the amount of any) financial remedies are commonplace. Called "bifurcated" settlements, such partial resolutions can benefit both parties – providing finality on at least some issues previously fought over and without a defendant having to admit (but being barred from denying) wrongdoing. And for some defendants, bifurcation can be seen as an opportunity at possibly securing less-pricey financial remedies where they believe they have a better chance at persuading a court that the SEC's proposed disgorgement, interest or penalty calculations are too steep when compared with the alleged underlying conduct.

But defendants considering bifurcating need to know that even though they typically are not required to admit the SEC's underlying factual allegations, in future motion practice over the SEC's desired remedies those allegations will be deemed to be true. Particularly for Farnsworth and other defendants who find themselves embroiled in parallel criminal and civil enforcement actions, bifurcation can be a good path for resolving charges while agencies deduplicate financial recovery and penalty efforts.

Outcomes with the SEC

Farnsworth agreed to both partially settle the SEC's cases against him and consent to the entry of judgments permanently enjoining him from future violations of certain antifraud provisions – Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder – among other things.

Farnsworth also agreed to be barred from serving as the officer or director of a public company and, in what the SEC refers to as a "conduct-based injunction," he agreed to be permanently enjoined from directly or indirectly promoting any securities issuer or deriving compensation from promotion of any securities issuer.

In each of its cases, the SEC is seeking financial recovery in the form of disgorgement, prejudgment interest and civil penalties, all to be determined at a later date, upon the SEC's motion once the criminal case against Farnsworth is concluded.

Farnsworth Pleads Guilty to Criminal Charges

Shortly after partially resolving the SEC's cases against him – and as previewed in his consents to settle with the SEC – DOJ announced on Jan. 7, 2025, that Farnsworth had plead guilty to certain criminal charges. Though he was originally indicted on four counts, including one count of securities fraud (15 U.S.C. § 78j(b)) and three counts of wire fraud (18 U.S.C. § 1343), Farnsworth pled guilty to one count of securities fraud and one count of conspiracy to commit securities fraud. He awaits sentencing but faces a maximum penalty of 20 years in prison on the securities fraud count and five years in prison on the conspiracy to commit securities fraud count.

Key Takeaways

• The SEC and DOJ often bring cases covering the same conduct. There has been much discussion surrounding the issue of "parallel" investigations between the agencies. As occurred here, in such instances the DOJ will more than likely move to intervene in and stay the SEC's civil action to avoid potentially thorny Fifth Amendment and other discovery issues impacting the agencies' in-common defendant. A stay obviates the need for a defendant to make the Hobson's choice of asserting his Fifth Amendment rights in the civil case, at risk of receiving an adverse inference by the civil jury, and making potentially incriminating admissions in the civil case, thus further exposing himself to criminal liability.
• The SEC continues to charge pre-acquisition statements regarding profitability of a target company, especially any such statement made during a fundraising period. Here, the SEC alleged that the statements made by Farnsworth prior to the acquisition were misleading and intended to increase investment into HMNY to purchase MoviePass because the statements had no relation to the actual business climate in which MoviePass operated. Issuers should tread lightly when making pre-acquisition statements about a target.
• Interestingly, the DOJ characterized its charges against Farnsworth as "AI washing" (making false or misleading statements about artificial intelligence (AI) tools or capabilities that the company does not have or cannot use in the way described). But the SEC did not describe its allegations against Farnsworth as AI washing, even though they are based on the same conduct as the DOJ charged. Nevertheless, the SEC and DOJ do scrutinize claims related to a company's AI or data analytics capabilities closely, and AI washing remains, for now, high on the SEC's priority list. Recall that the SEC put out an investor alert in January 2024, as we described previously, warning about the growing use of AI as a tool for raising money from investors. As Principal Deputy Assistant Attorney General Brent Wible, head of the DOJ's Criminal Division, noted, Farnsworth "falsely claimed that HMNY used artificial intelligence to monetize MoviePass' subscriber data, among other misrepresentations. The Criminal Division is committed to protecting investors from criminals who engage in fraudulent schemes, including those that employ AI washing." Issuers should pressure-test statements they intend to release about their AI tools and capabilities by confirming in advance that they can actually do what management claims they can do.
• Though the government's efforts to regulate AI may slow or pivot under the current administration, don't expect SEC or DOJ enforcement against AI washing to go away. First, there are likely enforcement actions in the pipeline that will continue, especially where demonstrable fraud has occurred or is ongoing and retail investors are involved. Expect more of these types of actions going forward. Moreover, the plaintiff's bar will no doubt continue to pursue securities class actions against companies and their directors and officers who oversell the company's AI tools and capabilities. Issuers and their executives should take caution when making disclosures about AI, as the SEC's Former Director of the Division of Enforcement, Gurbir Grewal, warned in April 2024:

If you are rushing to make claims about using AI … to capitalize on growing investor interest, stop. Take a step back, and ask yourselves: do these representations accurately reflect what we are doing or are they simply aspirational? If it's the latter, your actions may constitute the type of 'AI-washing' that violates the federal securities laws. The bottom line: you must ensure that your representations regarding your use of AI are not materially false or misleading.

Notes

¹ SEC v. Theodore J. Farnsworth, J. Mitchell Lowe, and Khalid Itum, No. 22-civ-08226 (S.D.N.Y. filed Sept. 26, 2022).

² SEC v. Farnsworth, No. 24-civ-09911 (S.D.N.Y. filed Dec. 23, 2024).

³ United States v. Theodore Farnsworth and J. Michell Lowe, No. 22-20521-CR (S.D. Fla. filed Nov. 2, 2022).