Stock trading rules in cash accounts: Understanding good faith and freeride violations

There are rules you should be aware of when trading in cash accounts. One rule of cash accounts is when you buy securities, you must fully pay for the securities on or before the settlement date.

A GFV is issued when a position is opened using unsettled funds and then the position is subsequently closed before the funds used to make the opening trade have settled. For reference, the current settlement period on a stock trade is trade date plus one business day (T+1), and the settlement period on an options trade is the trade date plus one business day (T+1).

If you are issued a GFV, it will remain on that account for a 12-month rolling period. If an account is issued its third GFV within a 12-month rolling period, then the account will be restricted to settled-cash status for 90 days from the due date of the third GFV. This means you will be required to have settled cash in that account before placing an opening trade for 90 days.

Here’s an example of how a GFV works:

On Tuesday, February 3, a customer sells 100 settled shares of ABC, which generates proceeds of $5,000. This trade will settle on T+1, which is Wednesday, February 4. He then uses the funds to purchase shares of XYZ on the same day.

On Tuesday, February 3, the customer sells the shares of XYZ. Because the shares of XYZ were bought and then sold using unsettled funds from the ABC sale, a GFV will be issued. To avoid a GFV, the customer would need to hold the XYZ shares until Wednesday, February 4 (when the sale of ABC settles), before selling them.

A freeride violation is issued when a position is opened without sufficient funds and then subsequently closed before funds are deposited into the account. Freeride violations can only be met by depositing funds into the account in the amount of the call within three business days (T+3).

If an account is issued a freeride violation, the account will be restricted to settled-cash status for 90 days from the due date of the freeride violation. This means you will have to have settled cash in that account before placing an opening trade for 90 days.

For reference, ACH and check deposits typically become available for trading on the third business day after having been received. The freeride violation is not removed until the deposited funds are posted to the account.

Here’s an example of how a freeride violation works:

On Monday, June 2, a customer buys 100 shares of ABC without sufficient funds in the account to purchase the shares. He then sells some or all of the shares without depositing funds in the account to cover the purchase. The only way to avoid a freeride violation is to deposit the necessary funds into the account. He cannot sell other securities to cover that purchase after the fact.

The good faith and freeride violations are rules that apply to cash accounts. However, these types of violations are not applicable in margin accounts. Margin accounts have other rules regarding day trading, which many investors may use to avoid these violations. Trading on margin involves specific risks, including the possible loss of more money than you have deposited. Please read more information regarding the risks of trading on margin.