Cash Accounts

A cash account is the most basic type of brokerage account where customers must pay for securities purchases in full by the settlement date. Understanding Regulation T requirements and cash account violations is essential for the Series 7 exam.

Regulation T Overview

Regulation T, established by the Federal Reserve Board, governs the extension of credit by broker-dealers to customers. For cash accounts, Reg T requires:

• Full payment for purchases by settlement date
• Settlement occurs on T+1 (trade date plus one business day)
• Payment deadline is technically S+2 (settlement plus two business days) for extensions

Payment Requirements

Key Point: While settlement is T+1, cash must be available in the account or paid by settlement to avoid violations.

Cash Account Violations

Three types of violations can occur in cash accounts, each with serious consequences.

Good Faith Violation (GFV)

A good faith violation occurs when you buy a security and sell it before paying for the initial purchase with settled funds.

Example:

• Monday: Buy 100 shares of XYZ for $5,000 using unsettled sale proceeds
• Tuesday (before settlement): Sell the 100 shares of XYZ
• Violation: Sold XYZ before paying for it with settled funds

Consequences:

• First two violations: Warning from the broker
• Third violation in 12 months: 90-day restriction requiring settled cash before trading

Freeriding Violation

Freeriding is a more serious violation that occurs when you buy securities and sell them before ever depositing funds to pay for the purchase.

Example:

• Monday: Buy 100 shares of ABC for $3,000
• Tuesday: Sell ABC for $3,500 before depositing any funds
• Never deposit the $3,000 purchase price
• Violation: Profited from shares never paid for

Consequences:

• First violation: 90-day account freeze (mandatory under Reg T)
• Account restricted to "settled cash upfront" trading
• After 5+ violations: Permanent restriction

Key Difference from GFV: In freeriding, the customer never deposits funds to pay for the purchase. In a good faith violation, the customer does eventually pay but trades the security before settlement.

Liquidation Violation

A liquidation violation occurs when a firm must sell securities to satisfy an unpaid purchase because the customer failed to pay.

Example:

• Customer buys $10,000 in securities
• Customer fails to pay by settlement
• Firm sells the securities to cover the unpaid balance

Consequences:

• 90-day account freeze
• Customer bears any losses from the forced sale
• Customer cannot recoup any gains from the forced sale

The 90-Day Freeze

When an account is "frozen" due to violations:

During a freeze, customers can still trade, but only with fully settled cash available at the time the order is placed.

Extension Requests

If a customer cannot pay by settlement, the firm may request an extension from a self-regulatory organization (SRO) or designated examining authority:

• Automatic extensions: Not available; must request
• Duration: Typically 1-2 additional business days
• Purpose: Allow time for payment or fund transfer issues
• Limits: Extensions are not guaranteed and cannot be routine

Important: Repeated extension requests may result in account restrictions or the firm refusing future extensions.

Exempt Securities

Certain securities are exempt from Regulation T payment requirements:

• U.S. Government securities (Treasury bills, notes, bonds)
• Municipal securities
• Other exempted securities as defined by the SEC

These securities are considered highly liquid and lower risk, so the same strict payment timelines don't apply.

Cash Account Best Practices

To avoid violations, representatives should advise customers to:

1. Only trade with settled funds when possible
2. Understand settlement timing (T+1 for most securities)
3. Deposit funds before trading if account balance is low
4. Track pending settlements to know available buying power
5. Don't rely on sale proceeds until they settle

On the Exam

The Series 7 exam frequently tests:

• Distinguishing between good faith violations and freeriding
• Understanding the consequences of each violation type
• Knowing the 90-day freeze requirement for freeriding
• Recognizing that T+1 is the settlement standard for equities
• Identifying exempt securities not subject to Reg T