The association, which represents the nation's stock brokerages, argues the state is placing burdensome record-keeping requirements on brokerages that are different from federal law. And it argues the authority to place such requirements on brokerages rests with the U.S. Securities and Exchange Commission, not the state.

The law was strongly supported by Utah's Overstock.com Inc., a money-losing, Internet-based closeout retailer that has vocally complained that naked short selling has driven down the price of its shares by artificially creating more sellers than buyers.

"This is a sunshine bill that was meant simply to shed light on an abusive market practice," Overstock.com Chief Executive Officer Patrick Byrne said. "The fact that the brokerage industry is freaking out says a lot. Cockroaches are always afraid of the light."

Short selling is a legal practice in which a brokerages allows investors to borrow a company's stock on the hope its price will drop, so they can buy shares back later at a lower price. Once the shares are purchased, they are returned to the brokerage.

Naked short selling, which is illegal, takes place when a brokerage allows a investor to sell stock without first borrowing it. In market parlance the seller is "naked." The outcome of naked short selling is that it creates an artificially high volume of shares that are for sale, and that can drive down a company's share price.

With naked short selling, the transaction is never truly completed because the short seller doesn't really possess the stock that was sold. And that means they cannot deliver the shares to buyers - which in market parlance is called a "failure to deliver," or FTD.

Stock brokers argue that such failures to deliver can occur for a number of reasons and actually represent only a tiny fraction of the trades that take place on any given day in the stock market. And they maintain the problem corrects itself over time.

Utah Gov. Jon Huntsman Jr. signed the naked short selling bill into law in May after a special session of the Utah Legislature.

At the time he said it would make Utah a more attractive place for small and midsize companies that could be vulnerable to the predatory trading practice.

"We continue to feel we acted in the best interest of Utah businesses by adopting this law," said Mike Mower, Huntsman's deputy chief of staff. "It helps shine a spotlight on the challenges that companies face with naked short selling."

The lawsuit asks Salt Lake City's U.S. District Court to declare the Utah law invalid. It also is seeking a preliminary injunction to stop the law from taking effect on Oct. 1.

steve@sltrib.com