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What is a good faith violation (GFV)?
A GFV occurs when an investor buys a security using unsettled cash and sells the security before said cash is settled in a cash account. In the US, trades settle in T+1 days (one business day). However, the investor receives the proceeds of the sale immediately after the sale, even before the trade settles. This cash is provided to you by the broker “in good faith,” so you can continue investing without waiting for the trade to settle. A good faith violation occurs if you buy new securities using this unsettled cash, then selling said securities before the initial cash settles.
How does an investor commit a GFV?
An investor commits a GFV if the following scenarios happen:
Scenario 1:
- Funds available in your account: $0
- You sell $5,000 of stock A on Monday. While this trade will settle on Tuesday, you get the proceeds of the sale immediately as unsettled funds
- On the same day, you buy $5,000 of stock B with these unsettled funds.
- You sell stock B on Monday. This is a good faith violation because stock B, which was purchased with unsettled funds, was sold before cash from selling stock A settles (which will happen on Tuesday)
Scenario 2:
- Funds available in your account: $5,000 (settled)
- You sell $2,500 of stock A on Monday. This trade will settle on Tuesday. After this sale, you have $5,000 of settled cash and $2,500 of unsettled cash
- On that same day, you buy $7,500 of stock B
- You sell all of stock B on Monday. This is a good faith violation because stock B, which was partially purchased with unsettled fund, was sold before cash from selling stock A settles (which will happen on Tuesday)
- If you only sell $5,000 of stock B on Monday, then it won’t be a good faith violation, because the portion that is sold was purchased with settled cash
What happens when an investor commits a GFV?
Typically, when an investor commits a GFV, the violation is recorded. After multiple GFV violations, the broker’s account is restricted from buying securities with unsettled funds. Note that different brokerage firms may have different policies regarding GFV violations.
At present, Vested displays a warning to an investor when the system shows they are about to incur a GFV (i.e. the final leg of the sell-buy-sell process needed to incur a GFV). If the investor commits three violations within a one year period, their account gets restricted.
This restriction lasts for 90 days. Vested will display this restricted status in the Profile section of the investor’s account. After 90 days, the GFV counter will automatically reset, and the investor’s account reverts to its original, unrestricted status.
Avoiding good faith violations
Now that you know what a good faith violation is, how do you avoid it?
#1 Understand the settlement period. In general, the settlement period in the US works in a “T+1” format. More specifically, the “T” is the date you executed the trade and the “1” refers to the one business day to complete the settlement period. In other words, if you sell a stock on a Wednesday, the funds will settle on Thursday.
What is a settlement period? A settlement period is the time taken for financial transactions to be processed between all parties involved. This process comprises review and verification of payments, and confirmation of transfer of securities. Altogether, the settlement period helps maintain the integrity of the financial system.
#2 Keep track of your funds! Be mindful of the amount of settled funds available in your account. On the Vested app, you can easily track the amount of settled cash – shown on the dashboard – in your account.
#3 Consult with your broker. Before making any decisions on investments in US stocks, consult your broker to understand the financial regulations.
