9.2 Cash Accounts

The Cash Account Defined

A cash account is the default brokerage account: the customer must pay in full for every purchase, with no borrowing. Because there is no credit, the rules that matter are Regulation T payment timing and the three cash-account trading violations the exam loves to test.

Regulation T and Settlement

Regulation T, issued by the Federal Reserve Board, governs the extension of credit by broker-dealers. For a cash account it requires full payment promptly after the trade. Regular-way equity settlement is T+1 (trade date plus one business day), which became effective May 28, 2024, replacing the old T+2 standard. Reg T allows a firm to obtain an extension if a customer needs a little more time; an unmet purchase that is not extended must be canceled or liquidated.

Key idea: to trade cleanly, the customer should have settled funds available. Trouble starts when a customer trades against money that has not yet settled.

The Three Cash-Account Violations

Good Faith Violation (GFV)

A good faith violation occurs when a customer buys a security using unsettled proceeds from a recent sale, then sells the newly bought security before those proceeds settle. The customer acted in "good faith" — funds are coming — but sold before settlement.

• Example: Monday a customer sells Stock A (proceeds settle Tuesday). The customer uses those unsettled proceeds to buy Stock B on Monday and then sells Stock B that same Monday. Selling B before A's proceeds settled is a GFV.
• Penalty: the first violations typically draw warnings; three GFVs within 12 months lead to a roughly 90-day restriction requiring settled cash before any purchase.

Freeriding Violation

Freeriding is the serious one: the customer buys a security and then pays for it by selling that same security (or never deposits payment at all). No real money was ever committed.

• Example: Monday buy $3,000 of ABC with no funds in the account; Tuesday sell ABC for $3,500 and never deposit the $3,000 — the sale itself "pays" for the buy.
• Penalty: even one freeriding violation triggers a mandatory 90-day account freeze under Reg T. There is no warning.

Liquidation Violation

A liquidation violation (sometimes called a free-riding cousin) happens when the customer fails to pay for a purchase and the firm must sell other positions to cover the unpaid trade. The customer keeps any loss and surrenders any gain on the forced sale, and a 90-day freeze applies.

The 90-Day Freeze

During a freeze the account is not closed — the customer may still place orders, but only if fully settled cash is on deposit before the order is entered. No buying against pending sales. The firm's designated examining authority (typically FINRA) can waive a freeze only for genuine, documented exceptional circumstances.

Exempt Securities

Certain securities sit outside Regulation T's payment timeline:

• U.S. government securities — Treasury bills, notes, and bonds
• Municipal securities — general obligation and revenue bonds

These are exempt because they are highly liquid and low credit risk. Note this exemption is about Reg T credit/payment timing — it does not exempt the trade from settlement or recordkeeping.

Best-Practice Advice for Customers

1. Trade with settled funds whenever possible.
2. Track when sale proceeds actually settle (T+1) before reinvesting them.
3. Deposit cash in advance if the account balance is thin.
4. Treat unsettled proceeds as unavailable — do not "round-trip" them.

Cash Account Versus Margin Account

It helps to frame the cash account against the margin account that follows. A cash account extends no credit, so there is no debit balance, no interest charge, and no maintenance requirement — the only timing risk is the violations above. Customers who cannot or should not borrow (retirement accounts, custodial accounts, conservative investors) use cash accounts exclusively. A customer can hold both a cash account and a margin account at the same firm; the firm tracks them under separate account numbers because the rules differ.

Settling Different Instruments

Not every product settles T+1. Knowing the variations prevents accidental good faith violations:

• Equities, corporate bonds, municipal bonds — regular way is T+1.
• U.S. government securities and options — settle next business day, T+1.
• Cash settlement (by agreement) — same day, T+0, used when a customer needs immediate proceeds.
• Mutual funds — typically T+1, processed through the fund.

A customer who sells a position and immediately reinvests should confirm the sale's settlement date, because reinvesting unsettled proceeds and then selling the new position before the original settles is the textbook good faith violation.

Frozen-Account Mechanics, Step by Step

1. A violation is identified by the firm's operations or compliance group.
2. The account is coded so the order system blocks any purchase lacking settled cash.
3. The 90-day clock runs in calendar days, not trading days.
4. The customer may continue to sell existing positions during the freeze.
5. To buy, the customer must wire or deposit settled funds that clear before the order is entered.
6. The freeze lifts automatically at day 91 unless additional violations restart it.

On the Exam

The distinction tested most is GFV vs. freeriding: a good faith violation customer eventually pays but sold too early; a freeriding customer never deposits payment and lets the sale fund the buy. Remember freeriding equals a mandatory 90-day freeze on the first offense, that the freeze permits only settled-cash purchases, and that U.S. government and municipal securities are exempt from Regulation T payment timing.