If a security purchased in the customer’s cash account is sold prior to being paid for with settled funds in the account, a good faith violation has occurred. The reason it is referred to as a good faith violation is that trade activity is giving the appearance that sales proceeds are being used to cover buy orders when there is insufficient settled cash to cover these purchases. Basically, trade activity indicates that a good faith effort to deposit additional cash into the account will not happen.
Accounts with three good faith violations in a 12-month period will be restricted to purchasing securities with settled cash only for a period of 90 days.
Ms Sudha has a US brokerage account with $1,500 cash in it, fully settled.
On Monday afternoon, Ms. Sudha purchased $1,500 of X stock. She sells the X stock for $1,600. The funds from the sale are expected to settle on Wednesday. Up till now, this is not a ‘good faith violation’ as her account was fully funded to pay for the purchase of the X stock.
However, during the closing hours on Monday, Ms. Sudha purchases $1,600 of Y stock again. No Good faith Violation incurred yet.
The next day (Tuesday), she sells her entire holding of Y stock and thus suffers a GFV. This Tuesday trade is a violation as Ms. Sudha sold the stocks she bought with unsettled funds.
- Buying a stock with unsettled funds is not a violation but selling the same even before the said cash is settled leads to the violation. Violation can be avoided by selling the stocks that were bought with unsettled cash after the cash settlement.
- Settled funds means the amount is settled in your account and can be used to trade or withdraw whereas unsettled funds is the amount to be received from the Sales proceeds and is in the process of being settled for you to use the same.