Good Faith Violation: Why Unsettled Cash Gets Flagged

“Good faith violation recorded. Further violations may restrict this account.” The message usually lands the morning after a quick round trip, and it reads like an accusation. The flag records when money arrived, and the rule behind it is short.

What does the violation record?

A cash account must pay for every purchase in full. That comes from Regulation T, the Federal Reserve Board rule covering credit at brokers, and it is the line between a cash account and a margin account, where the broker lends you part of the price. When you sell a stock, the cash from the sale does not become yours on the spot. It is unsettled until settlement day.

The broker will often let you buy again with that unsettled cash. It extends this courtesy in good faith, trusting the sale will settle before the new purchase has to be paid for. The problem starts when you sell the new position before the money that bought it has settled, because then the purchase was never paid for with settled funds at all, and the second sale was financed by the first sale’s IOU.

How fast does a trade settle now?

One business day for most US stocks. The SEC amended its Rule 15c6-1 to move standard settlement from two business days to one, a change known as T+1, and it took effect on May 28, 2024.

A shorter cycle shrinks the window for a violation, and the window is still there. Any trade that buys with Monday’s proceeds and sells again on Monday still lands inside the gap.

A worked example

Take a hypothetical cash account holding $5,000 of stock A and no cash.

Same trades, one day apart. The calendar decides it.

The trap is common for swing traders who rotate quickly. They sell a laggard in the morning, buy a stock that looks better, and then the new position drops hard before lunch, and the urge to cut it right away runs straight into the settlement clock, which is why a stop order sitting on a fresh purchase in a cash account deserves a second look.

Can a chain of trades trip it a day later?

Easily. Settlement is tracked purchase by purchase, so a clean trade on Tuesday can feed a violation later that same Tuesday. Carry the hypothetical account forward.

Every trade in that chain looked fine on its own. The broker’s screen probably showed buying power the whole time. What tripped it was the last link, a sale of a position funded by proceeds one day short of settling.

The habit that prevents it is dull and reliable. Before you sell anything you bought this week, ask when the money that paid for it settled. If the answer is “tomorrow”, wait.

Does a new deposit count as settled cash?

That depends on the broker. An electronic transfer can show up as cash available to trade before it is available to withdraw, and firms treat a purchase made with a pending deposit in different ways. Some apply the same good faith logic to it. Others restrict selling until the deposit clears. The deposit terms in your account agreement say which applies to you.

Is free riding the same thing?

No, and it is treated more harshly. Free riding means buying a stock and paying for it only with the proceeds of selling that same stock. The purchase was never covered by money you put in.

Regulation T spells out the consequence. The account is frozen for 90 days. During the freeze you can still trade, but every purchase needs the full cash in the account before the order goes in.

What happens after a good faith violation?

Brokers write their own penalties for good faith violations. Federal rules leave the count to them. A common pattern is a warning for the first, then a restriction after several within 12 months: for a set period, often 90 days, the account can only buy with settled cash. The account stays open and your positions stay put.

The restriction mostly costs time. Every sale ties up its proceeds for a business day before you can use them, which is irritating for someone who trades often and barely noticeable for a long-term holder.

How do you avoid one?

Read the right balance. Most balance screens show at least two cash figures: one labeled something like “cash available to trade” and another labeled “settled cash” or “cash available to withdraw”. The first includes unsettled proceeds. The second does not.

Then follow a simple rule. Any position bought with money that isn’t in the settled line yet stays open until the next business day. If that is unacceptable for a given trade, buy it with settled cash or skip it.

Keep a small settled buffer if you trade actively. A cushion of settled cash that you never spend lets you act on a new idea without touching proceeds still in transit.

Consider the account type. A margin account removes the settlement problem because the broker lends against your holdings while a sale settles, but it adds interest, maintenance requirements and the possibility of a margin call, so the swap is only worth making if you understand those terms. Initial margin covers what borrowing at the broker requires to open a position. In a retirement account, many brokers offer limited margin in an IRA, which allows trading with unsettled proceeds without any loan at all.

Does the rule touch options in a cash account?

Yes. Option trades settle on a one-day cycle too, and buying calls or puts with unsettled proceeds, then closing them the same day, creates the same violation. Whether you need a margin account for a given strategy is a separate question, answered in do you need a margin account to trade options.

The rest of what sits behind a stock order, from short sales to IPO day, is in the stock trading section.