Freeriding
Freeriding is the prohibited practice of buying securities and selling them the next day to pay for them before the settlement date. Typically if a customer freerides, the sell order will go through, but the account is then frozen to prevent further freeriding.
Example Question: An investor holds $20,000 of fully paid for and settled ABC stock in a cash account. The investor does not hold any additional cash or securities in the cash account. The investor sells all the ABC stock on Monday and buys $20,000 worth of XYZ stock on the same day. On Tuesday, the investor sells all of the XYZ stock without adding any additional cash to the account. Which of the following are true?
- I. The transaction involves freeriding
- II. The transaction is prohibited and the account will be frozen for 90 days
- III. The entire transaction is permissible
- IV. The transaction does not involve freeriding
- A. I and II
- B. III and IV
- C. I and III
- D. II and IV
Answer: A. Rationale: The settlement date on the sale of the ABC stock that the investor used to pay for the purchase of the XYZ stock would be Wednesday (two business days after the date of the sale). Since the investor used the proceeds from a sale of securities that has not settled yet to purchase the XYZ stock, the investor cannot sell the XYZ stock prior to Wednesday without adding additional cash to the account to cover the purch