Morgan Stanley ordered to pay $11.5 million over covered call strategy

An investor alleges the firm made unauthorized trades. The Finra arbitration decision comes as the regulator is conducting an exam sweep on options.

Finra arbitrators ordered Morgan Stanley to pay $11.5 million in compensatory damages to an investor who alleged large portions of his accounts were sold without his approval.

Anthony E. Nowak accused the firm of violating a Florida securities law when it made unauthorized transactions in several technology stocks as part of a covered call writing strategy. He claimed that he suffered “lost opportunity damages” when stocks, including Nvidia, Tesla Motors, Apple Computers, Salesforce and Microsoft, were “called away” from his trust account.

A covered call strategy involves the owner of stock transferring for cash the right to sell the stock. The holder of the covered call option can then sell the stock at the strike price. But the seller of the call option still owns the underlying securities.

The strategy generates revenue from the sale of the call option. But if the stock value rises above its strike price, the owner of the stock can’t profit from its higher market value.

Nowak alleged that the strategy went sideways for him. He filed an arbitration claim on Aug. 17, 2021, citing negligence, breach of fiduciary duty and contract, failure to supervise, fraud, unauthorized trading and violations of Finra rules and Florida law.

In addition to the $11.5 million in compensatory damages, three Financial Industry Regulatory Authority Inc. arbitrators awarded Nowak $157,656.81 in costs and $400 in arbitration fees. The arbitrators referred to a court the decision on whether to award attorneys’ fees.

Morgan Stanley could fight the decision.

“The firm strongly disagrees with the award and is evaluating its options,“ Morgan Stanley spokesperson Christine Jockle said in a statement.

Attorneys representing Nowack did not respond to multiple requests for comment.

The decision is a major setback for Morgan Stanley, said Andrew Stoltmann, a Chicago securities attorney.

“It’s a massive award,” Stoltmann said. “It likely will be the biggest one against Morgan Stanley this year.”

Finra is increasing its scrutiny of complex products. This week, it posted an update about an exam sweep that is probing how options accounts are opened and supervised.

Options will come under increased pressure in Finra arbitration in a declining stock market, Stoltmann said.

The decision against Morgan Stanley “might be the canary in the coal mine,” he said. “I promise you will see additional large awards against major brokerage firms.”