In examining Vonage's governance practices, we rate the company using our standard CGQ rating criteria. Because Vonage's publicly available information is limited to only a few SEC filings--and minimal Web site disclosure--we are not able to determine some of Vonage's governance characteristics. In instances where the lack of disclosure prevents us from classifying Vonage's practices, we give Vonage the benefit of the doubt and rate it with the maximum number of points for the CGQ factors in question. The company's charter and bylaws are to be filed in an S-1 amendment: We also assume that immediately following its IPO, Vonage would be classified as an S&P 600 company. Vonage earned a pro forma Index CGQ of 18.2 (in the lowest quintile) and a pro forma Industry CGQ of 62.3, slightly above average for telecommunications companies.

A red flag has already been raised in the press regarding this offering. The S-1 registration statement filed with the SEC discloses that the founder of the company, Jeffrey Citron, paid $22.5 million in 2003 to settle with the SEC over civil charges that he engaged in improper trading while employed at Datek. The past background of Mr. Citron is listed as one of the risk factors in the registration statement. The preliminary prospectus states, "There is a risk that some third parties will not do business with us, that some prospective investors will not purchase our securities or that some customers may be wary of signing up for service with us as a result of allegations against Mr. Citron and his past SEC and NASD settlements." (These allegations dealt with accusations of improper use of the Nasdaq SOES trading system by Mr. Citron, Sheldon Maschler (a Datek principal, large shareholder, and family friend of Mr. Citron), and others during the period 1993 to 1998.) In early February, Vonage named a new CEO, Michael Snyder, to take over for Mr. Citron, who will remain with Vonage in the capacity of Chairman and Chief Strategist. From all appearances, one surmises that Vonage is attempting to name a CEO that is more palatable to investors. If that is the case, Vonage did not take into account the fact that Mr. Snyder was president of ADT, a division of Tyco, at a time when Tyco took $600 million in charges for accounting problems at ADT.

A review of the officer and director biographies in the IPO filings raises additional questions about the potential effectiveness of the management and oversight team in place at Vonage:

-John Rego, the CFO at Vonage, served in a number of positions at Winstar Communications from 1998 to 2000. In April of 2001, Winstar filed for bankruptcy and laid off 44% of its workforce.
-Morton David, Director, served on the board of the aforementioned Datek Online Holdings from 1998 to 2002. From 1998 to June 2001--Mr. David was a director of Datek during this time--the SEC alleges that the abuse of the Nasdaq SOES system continued after Datek was sold to Heartland Securities. Mr. David will serve on the Vonage Audit Committee.
-Hugh Panero, Director, joined the Vonage board in January 2005, and served as President and CEO of XM Satellite Radio. He continues to serve on XM's board. XM announced a lost of $270 million for the fourth quarter of 2005. XM's loss for the 2005 fiscal year was $ 675.3 million.

As prudent analysts of governance issues, we wrestle with the question of how to best measure the effectiveness of current and prospective board members. As part of the evaluation process, we logically examine the track record of officers and directors when deciding if they succeed, or will succeed, in aligning the interests of management with the interests of shareholders.

Overall, Vonage scores well on independent director composition on both its board and committees, but has a mixed rating on antitakeover rating factors. Mr. Citron owns 41% of the stock (the ownership levels after the IPO have yet to be determined), thus the threat of a hostile takeover is lower than in companies with more dispersed shareholdings. The company also has authorized the issuance of blank check preferred stock, another deterrent to shareholder action. The combination of these factors with the mixed track records of the board and executive team warrant close examination by shareholders.

Board Practices

Vonage has a board controlled by a majority of between 75% and 90% independent outsiders. The nominating, compensation, and audit committees are fully independent. The company has not yet disclosed whether its directors will stand for annual elections or if the board will be classified. To date the company has not disclosed governance guidelines-- the only disclosure on the company Web site related to corporate governance is the leadership team summary biographies.

Two positive aspects of Vonage's governance practices are:

-The board has a performance review process in place
-There are no related-party transactions involving the CEO.

Three negative aspects of Vonage's board practices are:

-There is a related-party transaction with an officer or director other than the CEO
-There is a former CEO on the board
-Though the positions of Chairman and CEO are separate, the Chairman is an inside director.

Compensation and Ownership Practices

A number of factors related to compensation and ownership have yet to be disclosed. In all fairness to Vonage, it will not be possible to assess these factors until additional SEC filings have been made.

All officers and directors as a group beneficially own 74% of the company's shares outstanding--however this figure will change after the public offering. This number will be of interest to investors, as it will determine if Vonage will be a "controlled entity" under SEC rules.

Academic research suggests that the optimal level of officer and director ownership is between one and 30 percent of shares outstanding. The CGQ methodology incorporates these conclusions into its weighting system.

From the progressive governance perspective of the CGQ model, Vonage's compensation and ownership practices reflect some positive attributes:

-Directors receive all or a portion of their fees in company stock
-All directors with more than one year of service own stock
-Vonage does not have compensation committee interlocks

Anti-takeover Defenses

The aggregate level of officer and director ownership combined with the authorization of blank check preferred creates formidable takeover defenses. Though the company has a number of practices in place that would normally be considered progressive (shareholders may call special meetings or act by written consent, no poison pill), the high level of stock ownership by officers and directors trumps the other shareholder friendly measures.

Audit-related Issues

Because so little information was disclosed regarding audit-related issues, we give Vonage the benefit of the doubt in the calculation of the CGQ score. Vonage's audit fees are assumed to be reasonable, and we assume that its auditors will be ratified at the annual meeting. Vonage does have a fully independent audit committee and has at least one financial expert on the audit committee, as required by Sarbanes-Oxley.

Conclusions

While CGQ can measure certain aspects of a company's board and its governance practices, the real test for Vonage will be how its governance practices are implemented and whether the checks and balances of an independent board and committees serve their intended purpose in aligning the interests of management with those of shareholders.