Why Shares of Pareteum Crashed on Friday

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What happened

Shares of Pareteum (NASDAQ: TEUM) plunged 24% on Friday after the cloud-communications platform company was the target of a short report warning of "massive downside potential" and calling the company "uninvestible."

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So what

Pareteum shares had more than doubled year to date prior to Friday on the strength of better-than-expected financial results. A report by Aurelius Capital Management out on Friday called those results into question, saying Pareteum's claims "don't hold up to investigative scrutiny."

The firm cites a $50 million contract Pareteum announced last September with South Africa's Eyethu Mobile Network. Aurelius said its investigators traveled to visit Eyethu headquarters, but "discovered only a dilapidated shack and crumbling structures near a rural African village."

Aurelius also claims that Pareteum execs have failed to disclose their ties to Catcher Holdings, which the firm describes as "a now worthless stock that was owned by a group that included an entity controlled by Barry Honig, the notorious stock operator charged by the SEC last October with fraud for alleged pump and dump schemes." Aurelius argues there are similarities between Pareteum and Catcher, calling Pareteum's backlog "significantly exaggerated or fictitious."

Pareteum, as of publication time, had not yet issued a statement or commented on the accusations.

Now what

It's important to remember that a short report only tells one side of the story. Just as growth might not come as easy as a company hopes during a conference call, things aren't always as bad as portrayed in a negative report.

That said, while shorts are hardly perfect at identifying fraud, they do sometimes unearth issues that companies would rather not discuss. And even if only a fraction of what Aurelius alleges about Pareteum is accurate, the claims could still be material to the company's business.

It's hard to blame investors for running for the exits pending more information.

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Lou Whiteman has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.