Free-riding violation

A free-riding violation happens in a cash account when an investor buys a security and then sells it before ever paying for the original purchase, using the sale proceeds to cover the cost instead of their own settled funds. Cash accounts require an investor to have enough settled cash on hand to pay for a purchase, so using money that has not actually arrived yet, effectively borrowing against a sale that has not been paid for, breaks that requirement.

The rule exists because a cash account, unlike a margin account, is not supposed to involve any borrowing or use of unsettled funds. If an investor buys a stock and sells it before the purchase settles, they have used the exchange's own settlement lag as a kind of free, unauthorized credit line. Under the current settlement cycle, purchases and sales generally settle within roughly one business day, but even that short window is enough for a pattern of buying and selling before paying to qualify as free-riding.

Brokers are required to detect this pattern and respond to it, typically by freezing the account for a period, often ninety days, during which the investor can still trade but only using cash that has already fully settled before each new purchase. Unlike a good faith violation, which involves selling a security before its own purchase settles but does not necessarily involve avoiding payment entirely, a free-riding violation specifically involves never having settled funds to pay for the position in the first place. Repeated violations can lead a broker to restrict the account further or close it to cash trading altogether.