Vonage IPO flop magnifies FWP snafu.

Bill Sjostrom —  24 May 2006

As you’ve probably heard, Vonage’s IPO was a flop. It closed down 12.6% from its IPO price of $17. This represented the weakest first day performance of an IPO in nearly two years. It also greatly magnifies the apparent technical violations of the Securities Act I blogged about yesterday (see here). As Voange disclosed in its prospectus, it failed to comply with Rule 433 for its email blast and Rule 134 for its voicemail blast, and as a result these “could be determined to be . . . illegal offer[s] in violation of Section 5 of the Securities Act, in which case recipients could seek to recover damages or seek to require us to repurchase their shares at the IPO price.�

For Vonage, the best “defenseâ€? to any claimed violation would have been a nice first day pop followed by the stock staying above its IPO price until the one year statute of limitations ran. In such an event, there would have been no economic motivation for any investor to bring a lawsuit. Alas, that didn’t happen. If Vonage gets sued, it’s prospectus indicates it will rely on an “insignificant deviationâ€? defense. Per its prospectus:

We believe we would have meritorious defenses to any legal actions based on claims of alleged defects in the email, website or voicemail. The website through which the Vonage Customer Directed Share Program is being conducted requires each prospective investor to open an electronic copy of a prospectus meeting the requirements of the Securities Act prior to making a conditional offer to purchase shares of our common stock. It is, therefore, impossible for someone to place an order (or to open an account to do so) in the Vonage Customer Directed Share Program without first having received a copy of the required prospectus. As a result, we believe that the risks to us relating to any such potential claims are not significant.

The problem with an insignificant deviation defense here is that neither Rule 134 nor Rule 433 explicitly provides for it while Rule 508 of Regulation D (not applicable here) does. This of course raises the inference that had the SEC intended there to be an insignificant deviation defense under Rules 134 or 433, it would have explicitly provided for one. Note also that any claim would be under Section 12(a)(1) of the Securities Act which means no need to prove a misstatement or misleading omission of material fact, scienter, loss causation, etc. Also, since it is an IPO, tracing won’t be a problem.

As an aside, I suspect that the voicemail was intended to be a Rule 433 free writing prospectus (“FWP”) (the content of the email and voicemail are basically identical). However, after it was discovered that the email did not include the required hyperlink to the prospectus, the lawyers realized Rule 433 was unavailable for the voicemail and therefore scrambled to come up with a Rule 134 argument. Hence, you could argue that Vonage admitted that the email and the identical voicemail were prospectuses when they filed the email as an FWP. However, because the email was defective it was not in fact an FWP. Therefore the email and the voicemail were prospectuses that failed to meet the requirements of Section 10 and thus violated Section 5(b)(1) of the Securities Act (note that these mental gymnastic are likely not even necessary given the broad definition of prospectus).

One final thought. I just noticed that Vonage listed its shares on the NYSE. I wonder if the NYSE viewed this as a coup given that technology IPOs have historically gone with Nasdaq.