In this article:
- Settlement dates
- What is a good faith violation?
- What happens when you have a good faith violation?
- What's a broker-dealer?
Before we explain good faith violations, it’s important to understand the basics of how securities (stocks or ETFs) are paid for. Our broker-dealer is DriveWealth, an unaffiliated entity, and they act as an intermediary (or go-between) facilitating trades between you and the buyer of the security. Since DriveWealth knows how much the security you sold is worth, they will generally allow you to access those funds immediately.
However, for most securities, the settlement date, or date when the actual transfer of cash and assets is completed, is actually two business days after the trade date. So, if you sell a security on a Monday, the broker-dealer won’t actually receive the funds from the sale until Wednesday – the settlement date. This is what the Pros call “T+2” or Trade Date plus two working days.
What is a good faith violation?
Generally, funds from selling a stock are reflected in your Cash to Invest account right away, but remember, until the trade settles in 2 additional business days (this is referred to as “T+2”), those funds are not actually back to the broker-dealer. The funds during this time are ‘unsettled’ and this is where things can get a little tricky.
The broker-dealer allows you to buy a new security with the unsettled funds from your recent sale, understanding that they will be paid when the trade settles (in T+2). A good faith violation occurs when you purchase a security with unsettled funds and sell it before the funds that you used to buy it have settled. In other words, the broker-dealer will spot you the money to purchase your next stock, but if you try and sell that second stock before they’ve been able to collect the money from the first stock sale, that’s a good faith violation.
Here’s an example:
Emily has $10 in her Cash to Invest account.
- On Monday morning she purchases $10 of X stock.
- On Monday afternoon she sells her X stock for $12
Now her Cash to Invest has $12 - even though the funds aren’t expected to settle until Wednesday.
- On Tuesday morning she buys $12 of Y stock
This is not a good faith violation, until...
- Tuesday afternoon she sells her Y stock for $13
The selling of her Y stock is a good faith violation, since the funds used to purchase the stock have not yet settled. If she waited to sell her Y stock until Wednesday, that would’ve been fine.
There may also be times where you have both settled and unsettled funds in your Cash to Invest account. As long as you’re purchasing securities with settled funds, there’s no concern about good faith violations.
Here’s another example:
Justin has $20 in his Cash to Invest account and $10 in Stock A.
- On Monday morning Justin sells his $10 of Stock A
His Cash to Invest account now shows $30, $10 of which is still unsettled.
- On Monday afternoon he buys $15 of Stock B
All $15 dollars of his purchase were covered by the settled funds he already had in his Cash to Invest account. This means that Justin is free to sell Stock B whenever he’d like without worrying about a good faith violation – although long term investments are usually more wise.
If Justin chose to buy $30 of Stock B instead, he would’ve had to wait until Wednesday to sell that stock in order to avoid a good faith violation. That’s because $10 of that purchase were still unsettled on Monday.
What happens when you have a good faith violation?
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. When you reach this threshold, you will not see your Cash to Invest increase from a recent sale until the funds have actually settled with our broker-dealer, two business days after the trade date (or T+2).
This is also true for any funds you move directly into your Cash to Invest account. Funds transferred into Cash to Invest will also need to 'settle' before they're made available for trading.
Remember, when investing in the stock market, there will inevitably be ups and downs. Historically, the value of starting early is the ability to keep funds invested over time, and watch as they trend upwards.
What is a broker-dealer?
A broker-dealer is a highly-regulated person or company that buys and sells stocks, ETFs and other securities for its own account or on behalf of its customers. Specifically for Greenlight, DriveWealth is the broker-dealer we partner with and they manage this process on behalf of our families.