How does this work? Let's say you had a cash account and owned $10,000 worth of Microsoft stock. Ready to take your profits, you decide to sell the entire $10,000 and use the cash to buy $10,000 worth of Coca-Cola shares that day.
That's perfectly legal, but if you sell the Coca-Cola shares in the three days before the Microsoft trade clears, you could be breaking the law. In a cash account, you'd need $10,000 in cash to cover the second trade; that, or a "good faith" agreement with your broker to deposit the $10,000 before the trade officially clears. That rule is either obscure or restrictive enough that many brokers simply look the other way and let clients slide when it comes to good faith; hence, the "free ride."
