Congress returns to Washington in just over a week, and expect Wall Street to be in the crosshairs. Senator Grassley’s finance committee is slated to kick off with a hearing on executive compensation and stock options backdating. Mr. Grassley and Senator Specter of the judiciary committee are also liable to keep up the pressure they’ve been trying to put on the Securities and Exchange Commission in respect of hedge funds, although Senator Shelby’s banking committee has, thus far at least, been taking a more reasonable approach.

And there may be more. Recent developments in the states suggest that anti-short-selling crusaders might be willing to take their case to lawmakers in addition to the courts. They’ve already succeeded in persuading Utah’s legislature to pass an intrusive new short-selling law, although the legislation is on hold pending legal challenges. The Utah case bears watching because it shows what can happen when questionable lawsuits become bad law.

Utah might seem like an odd place for short selling to become an issue, but the state happens to be home to Overstock.com. Overstock is currently embroiled in litigation against a hedge fund, Rocker Partners, and a research firm, Gradient Analytics, over an alleged conspiracy to manufacture negative research on Overstock so that Rocker could profit from short positions it had taken out in the shares. Overstock’s colorful chief executive, Patrick Byrne, has used the suit as a launching pad from which to launch a jihad against “Wall Street” and naked shorting.

Short selling is a bet that a stock will go down. A trader borrows a share and sells it on the open market in the hope that the price will fall by the time he has to buy back the share to repay the loan. If it does, he pockets the difference. Naked shorting, however, happens when the trader hasn’t borrowed the stock he’s selling. It’s allowed in certain limited circumstances, but most of the time it’s banned as a form of fraud.

Mr. Byrne’s lawsuit does not actually allege that Rocker engaged in naked shorting, but that has not stopped him from railing against the practice at every opportunity. Meantime, Overstock’s lawyers — John O’Quinn and James “Wes” Christian of asbestos and tobacco fame — have been pursuing a host of other short-selling lawsuits, many of which do allege naked shorting.

Enter Utah’s legislature. The Utah law would have forced brokers to report possible naked shorting and would have imposed fines on brokers who didn’t. As reasonable as that might sound, at least in theory, the law contained one particularly mischievous provision, a section that would have made it possible for companies that thought their shares were being naked shorted to sue brokers.

That’s a significant step because a problem with the suits filed on behalf of companies by Messrs. O’Quinn and Christian thus far is that companies aren’t the ones defrauded by naked shorting — the unwitting purchasers who buy non-existent shares are. So Utah’s law would have been a sop to the trial lawyers, creating from scratch a legal basis for short selling suits launched by companies.

It’s unlikely that Utah’s law will ever go into effect. Federal law clearly reserves securities regulation for Washington instead of the states. In the National Securities Market Improvement Act of 1996, Congress spared financial markets from state-by-state regulation, largely to prevent the stock market from becoming as expensive and inefficient as the health insurance market. The Utah law would have applied to any brokerage that had even one outlet in the state, and would have required those brokerages to report information on trades made by non-Utah individuals as long as they were buying or selling shares in a Utah-based company.

From a practical point of view, it makes little sense to allow states to set their own financial regulations — commerce doesn’t get much more interstate than modern capital markets — but in this instance, the “laboratory of the states” has produced an interesting result.The fact that this law passed is a warning to Wall Street that lawmakers across the country, and perhaps even eventually those in Congress, are starting to pay attention to this issue and that they’re especially susceptible to being misled on it. The fear now will be that the lawsuits were only the beginning.