After the worst-performing IPO of the year, the Internet telephony company Vonage now faces a class action lawsuit that charges the company illegally created an artificial demand for its stock and misled Vonage customers into buying shares.

The suit is yet another black eye for the company’s poorly executed IPO. Vonage’s public debut on May 24 was supposed to be a symbol of the emerging power of the VoIP industry, and the return of reformed former CEO and major shareholder Jeffrey Citron.

Instead, the IPO, which lost 30 percent of its stock price in its first week of trading, has turned into a lesson on how not to take a company public, and has delivered a blow to both the maturing VoIP industry and Mr. Citron.

According to court documents filed late Friday, the lawsuit claims that Vonage’s filings for its IPO contained “materially false and misleading” statements and omitted important information for people considering buying Vonage stock.

The lawsuit also claims that Vonage and company executives “embarked on a scheme and illegal course of conduct, the purpose and effect of which was to load up Vonage customers with company shares and to create an artificial demand for company stock prior to and in the offering.”

The suit was filed against not only Vonage, but also Mr. Citron, along with several other company executives, as defendants. It was filed in the United States District Court in New Jersey.

The class action suit could contain hundreds or even thousands of angry customers and investors who feel they were misled into buying Vonage shares.

Bad Decisions

Part of the backlash is due to the company’s unusual decision to reserve 13.5 percent of Vonage’s pre-IPO shares for customers.

Analysts called the company’s decision to tie together the company’s customer perception and financial success a very poor move.

IDC analyst Will Stofega called the latest lawsuit against Vonage “not unexpected” and the entire IPO execution “a shame.”

“It really amazes me with the experience of the executives on Wall Street, including Jeff Citron, that things happened the way they did,” said Mr. Stofega.

The lawsuit states that Vonage’s recommendation of stock to customers violates NASD Rule 2310, which contends that companies that sell stock to customers must have reasonable grounds to sell to “suitable investors.”

Suitable investors are based on a customer’s financial status, investment objectives, and tax status, according to the lawsuit.

The other part of the backlash is the fact that the company’s stock dropped 30 percent in its first week of trading, causing customers and investors that participated to lose money.

Vonage shares went on sale at $17 per share and are trading at $12.47, up $0.49 in recent trading.

VoIP Suits

Vonage isn’t the only company facing a lawsuit in the swiftly growing VoIP industry. The other well-known VoIP firm, Skype, is facing a patent lawsuit from VoIP competitor Net2Phone.

Last Thursday Net2Phone filed a suit that said Skype is infringing on a patent for its Internet telephony business. The suit was filed in the U.S. District Court of New Jersey.

Skype was bought by eBay last September in a deal worth up to $4.1 billion, and Net2Phone is owned by IDT Corporation.

Analysts weren’t sure of the merit of the suit, but as the VoIP industry matures, companies are increasingly looking to protect technology that can differentiate their VoIP products.

Contact the writer: KFehrenbacher@RedHerring.com