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Vonage Keeps Sinking

The stock drops again as observers ponder the next move.

Updated from 5:10 p.m. EDT


(VG) - Get Vonage Holdings Corp. Report

late Wednesday backed away from statements it made two days ago promising to buy back shares from some investors burned by its initial public offering.

"If a customer was allocated shares in the Customer Directed Share Program, that customer is obligated to purchase their share allocation from the underwriters," the Internet phone company said in a statement. "To be clear, we have not offered and are not offering to repurchase any shares of common stock for our customers."

This will only add to the mounting confusion surrounding the special share allotment that Vonage set aside to reward its customers. Two days ago, Vonage told


that it couldn't imagine "alienating our customers" and that it expected to repurchase shares from the underwriters if needed.

Such a move would be unprecedented, according to academics who follow the IPO market. Securities lawyers have also questioned whether it would be legal since companies that issue public offerings aren't able to treat one class of shareholders differently than another.

"This is certainly an unusual situation," says Jerry Ritter, a professor of finance at the University of Florida who has studied the IPO market for 25 years. "This will be something that investment bankers will be using as an excuse for many, many years when they try and convince a company to lower their offer."

Vonage apparently figured that there would be some risk associated with its decision to reserve as much as 13.5% of its offering for its 1.6 million customers. The company notes in its prospectus that it has decided to indemnify its underwriters against liabilities should people in the program fail to "pay for and accept delivery of the common stock," according to the prospectus.

Although such indemnifications are commonplace, this language is attracting attention from securities lawyers who are concerned about whether this means that some shareholders will be treated differently than others.

"My firm is looking at this very carefully," says Sal Graziano, a partner at Bernstein Litowitz Berger & Grossman, which has been involved in litigation against WorldCom and Refco.

So-called affinity programs are not the norm for IPOs because most companies find they are not worth the bother. Vonage may have had to use the gimmick to spur interest in its stock sale.

"It's the fundamentals of the company that matter," says Georgetown University Professor Reena Aggarwal. "The gimmicks are aimed at a very small percentage of customers. Institutional investors don't care about the gimmicks."

Investors have found much to dislike about the Holmdel, N.J., company. Vonage isn't profitable and is spending huge amounts of money on marketing to compete against much larger rivals including

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. It's because of this heavy spending that Vonage needed to raise cash in the first place.

Further complicating the picture is Vonage Chief Executive Jeffrey Citron. The company has disclosed to investors that companies may be put off doing business with Citron because of his past association with the daytrading firm Datek Online. Citron settled the SEC allegations against him and agreed to accept a ban from the securities industry.

"Jeff was one of the true characters of the late '90s market revolution," says New York securities attorney Bill Singer, whose former firm did work for Datek.

Timing didn't help Vonage either. The IPO came as tech stocks of all stripes were selling off. The

Nasdaq Composite Index

is off about 2% this year, dragged down by double-digit declines in bellwethers including


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Shares of Vonage, which were offered for $17 when they first traded last week, recently traded at $12.02, down 48 cents.

"I am very surprised that they decided to go ahead and do the offering," says Georgetown's Aggarwal. "Today's market is not going to support a company whose future looks pretty uncertain. During the Internet bubble, it was possible for any company to go public."