Updated from 11:01 a.m. EDT

In a stunning rebuke to one of its own advisory panels, the Food and Drug Administration rejected an application by

Cyberonics

(CYBX)

to market a pacemaker-like device to treat depression.

The decision, announced by Cyberonics on Thursday, flattened shares of the Houston-based company, which had expected FDA clearance since

an advisory panel supported the device in a 5-2 vote in June. The company had been seeking approval of its VNS Therapy device for treating patients with long-term depression that isn't helped by medication, psychiatry or shock treatments.

The stock plunged $9.78, or 40.8%, to $14.17 in early afternoon trading Thursday. It fell as low as $12.78 earlier. By noon, more than 19 million shares had been traded, or nine times the average volume during the last three months.

After the company's announcement, two investment banking firms cut their ratings on a stock that had enjoyed strong Wall Street support. Until Thursday, seven analysts had buy ratings on the stock, according to Thomson First Call. Now, one has reduced his rating to neutral and another has told clients to sell the stock. More downgrades can be expected.

By noon, more than 19 million shares had been traded, or 9 times the average volume during the last three months.

Cyberonics had

previously been the subject of skeptical reporting by Adam Feuerstein, a columnist for

TheStreet.com's

sister site,

Real Money

.

Cyberonics responded angrily to the agency's ruling. "We are shocked and bewildered by FDA's decision to ignore its expert advisory panel's recommendation," said Robert P. Cummins, the company's chairman and chief executive, in a prepared statement.

In a conference call with analysts and investors Thursday morning, Cummins' comments were less measured. He attacked the FDA as "one of the most unpredictable groups we have dealt with" and repeatedly called the agency's decision "inexplicable."

He accused the agency of demanding clinical tests that he alleged are "inconsistent" with the FDA's regulations governing the testing of experimental medical devices. "This unprecedented decision was a mistake," he said.

Cummins said Cyberonics executives want to meet with FDA officials as soon as possible to discuss what additional research information would be needed to get the VNS Therapy device approved for marketing. Asked by one analyst how long it might take for Cyberonics to develop, conduct and evaluate the necessary research, Cummins said it could take three years -- "give or take six months" -- to get the information to an FDA advisory panel again. "The rules seem to change at FDA's whim," he said.

The VNS Therapy device was approved six years ago by the FDA for treating epilepsy.

Given the FDA's latest decision, Cummins said it will take a few weeks for the company to revise its financial guidance for the second quarter, which ends Oct. 31.

On Wednesday, he said a successful launch of VNS as a depression treatment would take six months. At the time, he noted that second-quarter expenses will rise and that second-quarter revenue will be "essentially flat" vs. the first quarter. On Wednesday, Cyberonics also warned that the second-quarter loss will be approximately $9 million, or 38 cents a share. The consensus of Thomson First Call analysts had called for a loss of $3.4 million, or 11 cents.

Now, Cummins said, he is worried that company morale would be deflated. "The negative news is a substantial distraction" to the company's efforts to hire new sales representatives and train them, he said.

But despite the setback, Cummins vowed that Cyberonics won't conduct so-called off-label marketing of the device. Once the FDA approves a product for a single disease or condition, doctors may prescribe the product for any use. But companies can only market a product for FDA-approved uses.

Cummins also noted that the VNS Therapy device is approved for treating depression in Canada and Europe, adding. VNS is approved as an epilepsy treatment in European countries, Canada and Australia.

The FDA sent the company a "not approvable" letter -- the most negative response for a product application -- saying in part that the tests conducted by Cyberonics were inadequate, especially in regard to comparing the response of VNS-treated patients to patients being given a placebo or other treatments over a one-year test period. Cummins maintained that these issues had been discussed by the advisory panel members on June 15, prior to their vote on the product.

"FDA has now chosen inexplicably to ignore not only the recommendation of its panel of experts, but also the strong recommendations of numerous psychiatric thought leaders," Cummins said. He maintained that the FDA's decision would deprive 4.4 million Americans suffering from treatment-resistant depression of a chance for long-term care.

He said combinations of drugs have been used to treat long-term depression "without evidence of long-term safety and efficacy." He added that electro-convulsive therapy ? more commonly called shock therapy ? is effective but is often declined by patients, can produce significant side effects and has a high rate of relapse within six months of treatment.

"Patient and clinician outrage will take its course," Cummins said.

"We are actively considering all regulatory and legal options, including those successfully employed by other device companies to reverse inexplicable decisions and obtain

FDA approval," said David S. Wise, the company's vice president and general counsel.

One analyst, Jan David Wald, of A.G. Edwards, told clients Thursday that he doubted the FDA would change its mind. Wald cut his rating from buy to sell. "We do not believe the FDA will reverse its decision," Wald said in a research report. "We also do not believe epilepsy will take up the slack."

Less than 24 hours earlier, Wald had reaffirmed his buy rating on Cyberonics having reviewed the company's first quarter financial results. Although the first quarter fell below his expectations, Wald told clients then: "Is the long-term depression story intact? We think it is."

Wald said he dropped his rating because of the "devastating" FDA news on depression and because the epilepsy market has been weak for Cyberonics recently.

"While some of that might be due to the company preparing itself internally for a depression launch, we see little reason why epilepsy may take up the slack in the interim," he wrote. In fact, he added, Cyberonics may have to spend more money on its epilepsy business " to keep key members of its sales force in place and attempt to jump start demand."

Wald now predicts Cyberonics will lose $1.07 for the fiscal year instead of 73 cents, adding that the stock's fair value is now $8 a share. (Wald doesn't own shares; his firm is a market maker and says it plans to receive or seek investment banking-related compensation in the next three months).

First Albany analyst William J. Plovanic dropped his rating to neutral from buy, also citing the FDA's decision and the "cloudy' near-term prospects for the company. "We believe that any catalyst for the stock in the near term will center around a possible acquisition of the company," he said in a research report to clients. (He doesn't own shares; his firm is also a market maker in Cyberonics' stock).

Cyberonics's stock has been experienced dramatic ups and down in recent months. It jumped 78% to $34.81 on June 16, the day after the FDA advisory committee endorsed the device for treating depression. But after hitting a 52-week high of $40.07 on June 17, shares slipped steadily to $23.95 on Wednesday.