A Good Faith Violation (GFV) occurs when you have liquidated stocks that were bought on unsettled proceeds which have yet to settle.
Cash accounts have T+2 settlement period. When you sell stocks, the amount received from that sell is considered unsettled funds until two business days later.
Please note that when these funds are not settled, we allow our customers to use them for opening a new position, but if you close the new position before the unsettled funds settle, you incur a Good Faith Violation. Essentially, we allow you to buy a position on unsettled funds in good faith that you will wait for the funds to settle from the original sale before liquidating the newly acquired position on unsettled funds. Hence why it's called a good faith violation.
Additionally if you close a newly acquired position bought on unsettled funds with T+2, your buying power will only replenish on the next business day.
Here's an example.
On Monday Nick sells 100 settled shares of ABC, which generates cash sale proceeds of $100. The cash proceeds from this sale will settle on T+2, which is Wednesday. He then uses this unsettled cash of $100 to purchase shares of XYZ on the same day. On Tuesday Nick sells the shares of XYZ. Because the shares of XYZ were bought using unsettled funds from the sale of ABC and sold before the funds from the ABC sale settled on Wednesday, a GFV will be issued and funds will not be made available in buying power. To avoid a GFV, the customer would need to hold the XYZ shares until Wednesday (when the sale of original ABC trade settles), before selling. In the example above buying power will be replenished the following day once the funds settle.
Each GFV will stand in account for 12 months and automatically expire in the 13th month. No cash deposit or stock liquidation will alleviate the violation.
After the second GFV occurs, the account's buying power will be restricted to settled funds. Selling positions will no longer increase buying power until settled (T+2). After four violations, your account will be restricted for 90 days. After your fifth violation, your account will be closed for 90 days.
For more trading-related terms, please visit "Glossary-Trading" section