When making trades in a cash account, you will need to be aware of the rules around Good Faith Violations and Freeriding violations. A cash account requires that you pay for all stock purchases in full by the settlement date. According to industry standards, most stocks have a settlement date that occurs on the trade date plus 1 business day (T+1). That means that if you buy or sell a stock on a Monday, the settlement date would be Tuesday.
Good Faith Violations
Good Faith Violations (“GFV”) occur when you purchase a stock via your cash account with not-yet-settled funds, and then sell the stock before the funds you bought it with have settled.
What are “settled funds”?
Settled funds are either cash or the sales proceeds of fully paid-for securities.
How does a Good Faith Violation happen?
Here’s an example:
The cash available to trade in your cash account is $0 on Monday morning. You sell ABC on Monday morning for $1,000. The settlement date for the ABC sale transaction and proceeds is Tuesday since the settlement for stocks is the trade date plus one business day (T+1).
If you then bought XYZ for $1,000 on Monday afternoon and then sold XYZ at any point prior to Tuesday (the settlement day for ABC sale), then this transaction would be deemed a good faith violation because XYZ was sold before your account had sufficient settled funds to fully pay for the purchase.
How does a Good Faith Violation impact my account?
Good Faith Violations are counted within a rolling 12-month period. Upon receiving a 4th Good Faith Violation in a rolling 12-month period, your cash account will first be restricted to buying with settled funds only. This means you will only be able to buy securities if you have sufficient settled cash in your cash account prior to placing a trade. This restriction will be effective for 90 calendar days. This helps to prevent a fifth violation and prevents future cash account violations.
You will receive a 4th Good Faith Violation if you had three Good Faith Violations in the rolling 12-month period.
After the fifth Good Faith Violation, your cash account will be restricted to “sell only” for 90 days. These are clearing house restrictions and we are not able to remove these restrictions during the 90-day period. To avoid this in the future, you can wait to make your buy until your sale has settled or add more funds to your account.
To sum up: If you incur 4 Good Faith Violations in a rolling 12-month period in a cash account, your account will be restricted to buying with settled funds only. This means you will only be able to buy securities if you have sufficient settled cash in the account prior to placing a trade. This restriction will be effective for 90 calendar days. A fifth GFV restricts your account to sell only.
Freeriding Violations
A freeriding violation occurs when you buy securities and then pay for that purchase by using the proceeds from a sale of the same securities. This practice violates Regulation T of the Federal Reserve Board concerning broker-dealer credit to customers.
In a cash account, an investor must pay for the purchase of a security before selling it. If an investor buys and sells a security before paying for it, the investor is “freeriding” which is not permitted under the Federal Reserve Board’s Regulation T and may require the investor’s broker to “freeze” the investor’s cash account for 90 days.
How does a freeriding violation happen?
Here’s an example:
The cash available to trade in your cash brokerage account is $0 on Monday morning. You buy ABC on Monday morning for $1,000. The Settlement date for the ABC purchase transaction is Tuesday since the settlement is always T+1. Your last deposit of $1,000 payment before Tuesday through an electronic funds transfer to cover the purchase was reversed, due to insufficient funds.
On Monday afternoon, you sell your ABC for $1,500 and decide it is no longer necessary to send the $1,000 payment or try your payment again.
A freeriding violation has occurred because the $1,000 purchase of ABC was paid for, in part, with proceeds from your subsequent sale of ABC stock.
What are the penalties around Freeride Violations?
If you incur 1 free riding violation in a 12-month period, we will restrict your account, and the profits from purchases in the account are not eligible for withdrawal, based on a lack of payment for the purchases by the investor.
If you have any questions, reach out to Member Support at support@public.com