Managing the Strike Count: How to Avoid Good Faith Violations

Despite explicit rules from FINRA regarding good faith violations, clients are often confused about the when, why, and how. Here’s what you should know about cash balances, settled vs. unsettled funds, and how to avoid good faith violations.

https://tickertapecdn.tdameritrade.com/assets/images/pages/md/Strikes and Balls: Good Faith Violations
5 min read
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Key Takeaways

  • FINRA rules regarding good faith violations are explicit 

  • Three violations within a 12-month period will result in a 90-day restriction from using unsettled funds to initiate trades 

  • Check how much cash is available for withdrawal before initiating a transaction

If you follow baseball, you know the key to a good batting average is managing the strike count. One is generally not a big deal, but two is cause for concern—because that third one will earn you a trip back to the bench. And nobody wants that.

Managing the strike count—of so-called “good faith violations”—is particularly important if you trade at or near the limit of the available cash in your account, especially if you frequently close trades within two days of initiating them. Why? If you have three of these account violations within a 12-month period, a 90-day restriction will be placed on your account, which means you can only use settled cash to trade.

But it can be tough to figure out the “how” of avoiding these violations if you don’t know where to look.

According to Dan Merritt, manager of margin risk at TD Ameritrade, FINRA rules around good faith violations are explicit. “It’s not like there’s a lot of wiggle room for exceptions, so it’s best to know how to stay on the right side of the regulations,” he said.

In other words, it’s a bit like arguing balls and strikes with the umpire—futile at best.

Fortunately, there are a few ways to find out how much you have available in settled funds. Knowing where to go for this info will save you time and, more critically, will help keep you from accidentally triggering a violation.

What Is a Good Faith Violation?

A good faith violation occurs when you haven’t paid for purchases with settled funds. There are two types of settled funds. The first type is cash. The other type is proceeds from a sale of a security that’s been fully funded. It’s the second type of settled funds that can trip up traders. Exactly when a security sale settles depends on the product, but the standard for equities is the trade date plus two days (known as “T+2 settlement”).

Here’s an example of how a good faith violation happens:

  • On Monday, Janet holds $10,000 worth of XYZ stock.
  • On Tuesday, Janet sells her entire XYZ position for $10,500, which, according to T+2, will settle on Thursday.
  • On Wednesday morning, Janet buys $10,500 of FAHN on good faith that XYZ’s sale will settle.
  • On Wednesday afternoon, Janet sells FAHN for $11,000, making a $500 profit. However, FAHN’s original purchase wasn’t fully paid for because XYZ’s sale hadn’t yet settled.

That’s a violation. Strike one.

When a good faith violation happens, you’ll get an email pointing out that a violation occurred and explaining the consequences if it happens twice more (see figure 1). The email will also include information about how to avoid violations in the future.

A good faith violation will trigger an email
FIGURE 1: MESSAGE CENTER. You’ll receive an email if you incur a good faith violation. For illustrative purposes only.

Locating Settled-Funds Information in Your Account

Merritt explained there are two ways to find settled-funds information on the TD Ameritrade website.

Method One

  • In your account, under the Trade tab > Stocks & ETFs, you’ll see Buy & Sell data and information about your assets (see figure 2).
  • The heading Available for Withdrawal is where you can find your settled funds. In figure 2, that total is $1,190.22. You can buy securities using that amount and sell what you bought at any time without triggering a violation. In other words, initiating a trade with unsettled funds is okay—it’s the selling that actually triggers the strike.
  • The heading Cash & Cash Alternatives is the amount of cash in the account, but it may contain funds that haven’t settled yet. In figure 2, that amount is $1,729.12. If all funds are settled, you’ll see that Cash & Cash Alternatives equals the amount Available for Withdrawal
Find out how much settled cash you have available to trade to avoid a good faith violation
FIGURE 2: HOW MUCH SETTLED CASH? The amount “available for withdrawal” is settled. For illustrative purposes only. 

Method Two

  • Select the My Account tab (see figure 3). There you’ll see Balances information, including a chart of your balance history from weekly levels to inception and your total account value. Scroll down.
  • Under your total account value is a section called Cash Balances. The first line is the Cash & Cash Alternatives, which shows the total balance of $1,729.12. Beneath that is Cash Available for Withdrawal, where you can see the balance of $1,190.22.

No matter what platform or device you’re using to access your account—thinkorswim®, desktop, tablet, or phone—the keywords you need to look for are Available for Withdrawal. Check that data to ensure you have enough settled funds on hand to complete a transaction. 

Find out how much settled cash you have available to trade to avoid a good faith violation
FIGURE 3: ANOTHER WAY TO CHECK WHAT’S AVAILABLE FOR WITHDRAWAL. For illustrative purposes only. 

In this example, the difference between the cash “available for withdrawal” ($1,190.22) and the “cash” plus “cash alternatives” ($1,729.12) is a little over $538. You’d risk a good faith violation if you buy securities for more than $1,190.22, because you’d be using $538 from a trade where the money hasn’t settled yet. Still, you wouldn’t actually be in violation unless you sold the securities before that $538 settled.

Let’s trace the timeline in a little more detail:

  • Suppose that, on Monday, the account has $1,190.22 of settled cash and $538.90 of cash that will settle on Wednesday.
  • On Monday, you bought 100 shares of ABC stock for $17, or $1,700. You now have an open position with 100 shares of ABC stock. A portion of that purchase used unsettled cash.
  • On Tuesday, you want to sell a portion of that position. Because the position includes shares bought with unsettled funds, selling too many of the shares would create a good faith violation.
  • To avoid the violation and still sell shares, you’d need to know what the Available for Withdrawal balance was when you opened the position, which was about $1,190. Divide that total by the price paid for the shares, $17. Note: the Available for Withdrawal amount isn’t captured anywhere historically. So you need to know what it is before you place the trade.
  • You could safely sell up to 70 of the 100 ABC shares purchased on Monday and not incur a violation.
  •  In order to avoid a violation, the remaining shares would need to be held through the settlement of the $538 that was used to purchase them. So in this example, you could sell them on Thursday.

Understanding a Good Faith Violation Email

When it comes to good faith violations, you get three strikes in a 12-month period. Strikes are counted on a daily basis, rather than by individual transactions. So if you had violations on multiple securities last Monday, they would count as just one.

When an event occurs, it triggers an email that’s sent to your account the next day. The email will explain that you had a good faith violation, what it means, and how to avoid it next time. You’ll get two “strike warning” emails. If it happens a third time in a 12-month period, you’ll be notified that your account has been restricted to using only settled funds for 90 days.

Merritt remarked that in the beginning it may be confusing to figure out when you may or may not be in violation. If you look at your balances and still aren’t sure whether you might make a good faith violation with a trade, it’s better to call a client representative to ask before making the trade.

“If you call us after you do something, it’s harder for us to assist you, so calling us and asking what will happen in a situation is sometimes better. That way we can walk you through all of your choices at that point,” he said.

In trading—as in baseball—as opportunities come your way, it’s easier to swing with confidence if there are no strikes against you.

Print

Key Takeaways

  • FINRA rules regarding good faith violations are explicit 

  • Three violations within a 12-month period will result in a 90-day restriction from using unsettled funds to initiate trades 

  • Check how much cash is available for withdrawal before initiating a transaction

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