Good Faith Violations: What Are Unsettled Funds?

By ATGL

Updated May 31, 2024

Table of Contents

Understanding good faith violations and the concept of unsettled funds is crucial, as these can impact an investor’s ability to trade and result in significant penalties. Unsettled funds refer to the money from a sale transaction that has not yet completed the settlement process. Good faith violations occur when a trader purchases securities using unsettled funds from a previous sale.

These violations can lead to significant consequences, including account restrictions and other penalties. Being aware of how unsettled funds and good faith violations interact is essential for maintaining compliance with trading rules and facilitating efficient trading activities.

How Good Faith Violations Occur

Good faith violations arise when traders buy a security with the expectation that the proceeds from a recent sale will settle before the payment for the new purchase is due. In stock trading, the settlement period is typically two business days (T+2) after the trade date. However, if the sale proceeds do not settle in time, then the trader has effectively used unsettled funds, resulting in a violation.

For instance, suppose an investor sells shares of Company A on Monday. The settlement period for this sale is T+2, meaning the funds will not be available until Wednesday. If the investor then uses the anticipated proceeds from this sale to buy shares of Company B on Tuesday, they are relying on unsettled funds. Should the investor sell the shares of Company B before the original sale settles on Wednesday, a good faith violation has occurred because they did not actually have the settled funds to pay for the new purchase at the time of the transaction.

Traders should adhere to settlement rules and confirm that their account has enough settled funds to cover any new purchases. Brokerage firms and regulatory bodies take good faith violations very seriously, as they reflect an inconsistency in maintaining sufficient funds in an account for trading activities.

What Are Unsettled and Settled Funds?

In the context of trading, unsettled funds refer to the money from a sale transaction that is still within the settlement period. During this period, typically two business days (T+2) after the trade date, the funds are not yet available for use. These funds are in transit and cannot be used for new purchases or withdrawals until the settlement process is complete.

Settled funds are precisely the opposite — money that has completed the settlement process and is fully available in the account. These funds can be used for trading or withdrawn without any restrictions.

Implications of Good Faith Violations

Good faith violations carry several implications that can affect a trading account and overall trading strategy.

Account Restrictions

Brokerage firms may restrict an account, limiting trading privileges to prevent further violations. Three good faith violations per 12-month period typically result in 90-day restrictions. Common restrictions include prohibiting the use of unsettled funds for new trades and requiring maintenance of a settled cash balance to make future purchases.

Potential Penalties

Brokerage firms may impose fees or fines for each violation. These penalties prevent traders from using unsettled funds and encourage adherence to settlement rules. Repeated violations may result in more severe penalties, including the temporary or permanent suspension of the trading account.

Impact on Trading Activities

Traders might find themselves unable to capitalize on timely trades due to the unavailability of settled funds or the imposition of restrictions. This limitation can lead to missed opportunities and potentially lower returns on investments. Additionally, a history of violations can damage a trader’s reputation with the brokerage firm, leading to reduced trust and less favorable terms for future trading activities.

How To Avoid Potential Violations

While attempting to follow all applicable rules and regulations, investors can sometimes inadvertently stray into noncompliant territory. By maintaining vigilance and adopting preventative measures, individuals can equip themselves to circumvent potential violations before they occur.

Understand Settlement Rules

Traders should thoroughly understand the settlement rules that govern trading activities, such as the settlement period required for a trade to be finalized and for funds or securities to be transferred to the appropriate account. Traders should familiarize themselves with the specific rules and regulations of the brokerage firm, as it may have additional guidelines regarding the use of unsettled funds.

Maintain Sufficient Funds

By maintaining an adequate cash balance in the account, traders can cover new purchases without relying on the proceeds from recent sales. This practice helps them stay compliant with settlement rules and also provides flexibility to take advantage of trading opportunities. Traders should regularly review their account balance and adjust their trading strategy to avoid situations that might inadvertently result in using unsettled funds.

Monitor Trade Settlements

Closely monitoring the settlement status of trades is key to avoiding good faith violations. Traders should keep track of the settlement dates for all their transactions and make a note of when funds will be available for use. Many brokerage platforms provide tools and notifications to help monitor trade settlements. Traders can use these features to stay informed about the status of their funds. By tracking transactions and understanding when the proceeds from sales become settled, traders can plan trades more effectively and avoid violations.

Learn To Keep Your Trading Compliant and Profitable

Maintaining compliance in trading is crucial for an investor’s long-term profitability and avoiding regulatory issues. Adhering to settlement rules, keeping an adequate cash balance, and monitoring trade settlements allow individuals to trade with confidence and efficiency.

Traders should regularly review updates from regulatory bodies and their brokerage firms to stay current and avoid inadvertent violations. Maintaining a sufficient cash balance in their account allows them to execute trades without relying on unsettled funds, minimizing the risk of good faith violations. This practice also lets the individual seize market opportunities without delay.

Monitoring trade settlements is key for the trader to plan effectively. They should use the tools and notifications from their brokerage platform to track when funds from sales will be available. This awareness helps them time trades accurately and avoid potential violations.

Continuous education is vital for compliance and profitability. Explore resources such as ETF strategies, hedge funds, and mutual funds to broaden your understanding of different investment products and strategies. For advanced strategies and personalized guidance, consider a membership with Above The Green Line for exclusive resources and expert insights.