By RANDALL SMITH and SHAWN YOUNG
June 9, 2006; Page C1
Securities regulators have launched an investigation into how short sellers may have played a role in the steep decline in the stock price of Internet phone carrier Vonage Holdings Corp. since its initial public offering last month, people familiar with the situation say.
The regulatory unit of the New York Stock Exchange sent a letter to Wall Street securities firms yesterday asking questions about how the dealers may have facilitated short sales, according to someone who had a copy of the letter. The letter asked that the information be provided no later than Wednesday, June 21.
Because some short sellers are effectively betting that a stock will decline, companies sometimes blame them when their share price slides. A spokeswoman for Vonage, based in Holmdel, N.J., declined to comment on any short selling in its stock. In a short sale, a trader or investor sells borrowed stock in hopes of buying it back later at a lower price.
Another regulator, the National Association of Securities Dealers, last week initiated a look at other aspects of the Vonage IPO, according to people familiar with the deal. The stock has fallen as much as 32% since the IPO, stirring controversy partly because 13.5% of the $531 million stock sale was earmarked for Vonage telephone customers.
Some of the NYSE regulatory questions in the letter appear aimed at determining whether dealers or their customers may have violated rules curbing the practice of "naked short selling," or selling shares without having them available or knowing how they can be provided to the buyer when the transaction settles after a few days.
The rules against naked shorting were tightened in mid-2004 by the Securities and Exchange Commission, and took effect in January 2005. They put new requirements on exchanges to police trading. As an SEC official noted at the time, naked shorting could drive down a stock price in an "abusive or manipulative way."
Founded in 2001, Vonage is among the first Internet calling start-ups, offering consumers cut-rate calls using their regular phones linked to a high-speed Internet connection. But Vonage's steep losses, heavy spending and well-funded cable and phone-company competitors have made many analysts and investors skeptical about its prospects.
Many of the NYSE questions were focused on the first day of trading in Vonage on May 24. That day the stock fell 13% from its IPO price of $17 a share to a 4 p.m. price of $14.85 on the NYSE on volume of 33.8 million shares. The stock price hit a 4 p.m. low of $11.63 June 1 and at 4 p.m. yesterday was down 20 cents on the day to $11.79.
WALL STREET JOURNAL VIDEO
Randall Smith discusses a probe into how short sellers may have played a role in Vonage's stock plunge.On the first day of trading, more than five million shares were sold short, according to someone familiar with the IPO. The bulk of such short-sale orders were placed early in the day, just as the stock began trading.
Other NYSE questions asked for information about failures to deliver stock after the offering. The questions specifically sought information about trades by prime-brokerage customers. Prime brokerage is a booming business in which Wall Street dealers provide services including stock lending to hedge funds, some of which use borrowed stock for short sales.
In recent days, Vonage has appeared on an NYSE list of companies that have significant numbers of trades that haven't settled on time, a list mandated by the new short-selling rules. Such failures to settle can be associated with naked short selling. Once a stock appears on the list, traders have 13 days to settle their trades.
Dealers are allowed to execute short sales on behalf of customers that don't actually hold the borrowed shares if the dealers have "reasonable grounds" to believe the stock can be borrowed by the time the stock is due to be delivered, according to a Big Board Web site.
However, under the new SEC rules, dealers executing short sales based on a customer's assurance that a stock had been "located" elsewhere must document the customer's source, and whether the same customer's prior assurances resulted in delivery failures.
Some Vonage customers say the stock's plunge was aggravated by missteps by the Internet phone company and the offering's underwriters. Some customers have threatened to refuse to pay for shares they pledged to buy at the $17 IPO price. Many questioned why the price was set so high, particularly as the market weakened in the weeks leading up to the offering.
But Vonage and the underwriters -- led by Citigroup Inc., Deutsche Bank AG and UBS AG -- have responded that the deal was more than five times oversubscribed.
Write to Randall Smith at randall.smith@wsj.com and Shawn Young at shawn.young@wsj.com
