I think the post below mine is right on. I have been training to become a teacher and the reading levels were discussed in class. It was described just as the other post said.
As for getting high grades, yet still reading below grade level, I don't think that's all that far fetched. All people have strengths and weaknesses, and just because a child is weak in reading doesn't mean grades will be low. For example, I have memory and organization problems which could make schoolwork very difficult. I work very hard to compensate by going over info repeatedly, working much longer then others have to, using methods that help me retain info, highlighting and going over important info again, studying a lot, etc. By compensating I am able to keep very high grades in spite of my problem areas, but that doesn't mean those problems should not be attended to.
Do keep in mind that there are other reasons for inability to understand instructions, other than just reading. That can be one issue; there can also be issues with processing, comprehension, etc. I would ask the teacher what her reading level is, how far behind she is. If it's not that bad I would just spend some extra time at home working with her. Choose books that interest her and are a little above her reading level. If her reading levels are pretty low I would ask about testing her again, and if they don't agree get it done privately. As another person mentioned it is better to try to catch her up early. It can be very hard on children seeing they are far behind all the others.
I am reading a book right now called 'Reading David.' It's about a boy with dyslexia and all that him and his mom go thru in dealing with the many issues that exist with this learning disability. It's written by his mother, and has some portions written in the child’s view. It is very informative, and really shines light on some of the problems that can happen with the child, parent, teachers, schools, testing, getting help, etc. Anyway, I would recommend this book, especially to anyone dealing with children with learning disabilities (not just dyslexia.)