What happened

Hedge fund Muddy Waters is out with a report critical of DLocal (DLO -0.53%), concluding that the Uruguayan payment company is "likely a fraud." Investors are reacting by selling shares, sending DLocal stock down as much as 45% on Wednesday afternoon.

So what

DLocal specializes in payment-processing services for merchants operating in emerging markets. The company was an instant success following its June 2021 initial public offering (IPO), with the shares nearly doubling in its initial months as a publicly traded company, but the company has fallen below its offering price in recent months.

Prominent short seller Muddy Waters believes that initial success was built on deception. On Wednesday, the firm revealed it is short DLocal shares, with Muddy Waters alleging that DLocal disclosures "flatly contradict one another" and saying there is a "contradictory discrepancy between two key subsidiaries' accounts payable and accounts receivable."

Muddy Waters sees "signs of cooked books" and said it has concerns about DLocal's controls to protect client funds.

The firm also notes that managers and directors sold about $1 billion worth of DLocal shares within the first five months of the company being public and said there have been a number of high-level departures, factors that Muddy Waters says "brings to mind the idiom about 'rats fleeing a sinking ship.'"

Now what

At the time of writing, DLocal had not responded to the criticism. But there is enough detail in the 47-page report for investors to be concerned.

It's worth noting that short reports, just like reports urging investors to buy a stock, tend to highlight only the information that best makes the argument. And although Muddy Waters has a strong track record, it was part of a Department of Justice probe into short selling earlier this year.

Long-term investors need to be able to do their own homework and make their own judgments based on the information that is available. There is likely to be a lot more to be written about DLocal, both for and against, in the days and weeks to come, but the market is judging Muddy Waters' research to be credible enough to make some investors head for the exits.