Hey everyone, welcome back to our blog. Today, I’m going to go over an email that I got from my broker. I got flagged for what’s called a good faith violation. I will explain what a good faith violation is, why I got it, and how I could have avoided it. Finally, I want to give you some basic information on what it is just in case it ever happens to you.
Table of Contents
5 Second Takeaway: Good Faith Violation
- A good faith violation happens when you sell a security that you had previously bought but still haven’t paid for the initial purchase of the stock with settled funds.
- The settlement date is typically two business days after the trade date. The Pros call this “T+2” or Trade Date plus two working days.
- If you incur three good faith violations in a rolling 12-month period in a cash account, your account will be restricted to settled cash only for 90 days.
- The best way to avoid good faith violations is trading only with settled funds.
- Good faith violations are not associated with margin accounts.
Did You Know?
The federal reserve board regulation T requires that a cash account have sufficient settled funds to purchase. Or, your brokerage accepts in good faith that you’ll make a full cash payment for the security or asset before selling it.
What Is A Good Faith Violation?
A good faith violation happens when you buy a security in a cash account and then sell it before you pay for the initial purchase in full with settled funds.
What is the settlement date for a good faith violation? The settlement date is when a trade settles. In other words, the day when the transfer of cash and assets completes.
If you sell a security on a Wednesday, your broker-dealer doesn’t receive the funds from the sale until Friday. In this case, Friday is the settlement date. You’ve likely heard the pros refer to this as the “T+2” (Trade Date plus two working days).
What Are The Consequences of a Good Faith Violation?
If you incur three good faith violations in a rolling 12-month period in a cash account, your account will be restricted to settled cash only. That means you can only buy securities if you have enough settled cash in the account before placing a trade. This restriction will be effective for 90 calendar days.
What does this mean? Whenever you own a security or stock and then you sell that stock, your account will say that you have a certain amount of money available for trades.
Let’s say you own a specific ticker symbol and decide to sell it. After the sale, your account says you have $1000 for trading. Even though you can still use the $1000 to buy and sell another stock, the money is still considered unsettled in a cash account by the regulations. In other words, you must wait two business days for the funds to settle in your account fully.
An Example Of A Good Faith Violation
I bought ticker ABC and held it thinking it would be a home run. However, in the interim, I heard some promising merger news about stock DEF. The merger was to be announced on December 18. Because of this, I wanted to have some money available to buy into DEF in case the merger date was confirmed.
Unfortunately, ABC wasn’t performing like I thought it would. So on December 18, I decided to cut my losses and run and sell ABC. Immediately after I sold ABC, my account showed that you had x amount of dollars available for trading.
Immediately, I bought DEF with unsettled funds right before the merger meeting. However, my broker accepted the purchase in good faith that I would pay full cash for the security before selling it.
However, after about 45 minutes, I decided to do some digging. I found out that DEF was not going forward with the merger due to the lack of votes by the shareholders. Because of this, I immediately sold the stock for a small profit of a few hundred dollars. I sold because I knew the sell-off was coming and wanted to protect myself.
So being that those funds weren’t settled and I did all of this on the same day, within 30 to 45 minutes, I triggered the good faith violation.
The Violation Was This
- I bought ABC and held it for a certain period
- I sold ABC at a loss on 12/18
- I bought DEF on 12/18
- I sold DEF on 12/18
To recap, the violation was because I sold the stock, bought stock then sold that stock all on the same day. And the funds that I had used were considered to be unsettled.
How Could I Have Avoided A Good Faith Violation?
Below are two ways I could’ve avoided a good faith violation. Firstly, I could have bought DEF and held my position for two or more business days before selling.
Another way to avoid the good faith violation was to wait two days before I bought. Even if I made a day trade on it, it wouldn’t have been a good faith violation because my funds had settled. But I wanted to buy it on that particular day and not wait because if there was a wave up, I wanted to ride it.
Remember, if you sell a stock, wait two business days if you’re going to do anything. Or, if you’re going to buy into another stock on the same day that you sold another one with those same funds, make sure that you’ll hold that stock for more than two days, and you won’t get the red flag.