A virtual bench trial that began on October 19 may soon further define the contours of control issues surrounding donor-advised funds. The case, Fairbairn et al. v. Fidelity Investments Charitable Gift Fund, centers on a feud between donors Emily and Malcolm Fairbairn and Fidelity Investment’s Charitable Branch. The Fairbairns donated approximately $100 million (primarily of stock in publicly-traded Energous Corp.) to a donor-advised fund managed by Fidelity. The Fairbairns claim that Fidelity made several promises to the couple, including that they would not sell the stock before 2018, would not sell more than 10% of its trading volume, and would allow the Fairbairns to advise on its liquidation, along with utilizing other sophisticated methods of liquidation measures all calculated to avoid a sharp decline in share price. The Fairbairns said that Fidelity acted negligently when it ultimately proceeded to liquidate nearly 2 million Energous shares in December of 2017 over a 15 minute period; the company’s share price dropped by 30%. The Fairbairns say the price drop ultimately reduced their donation by $9.6 million and cost them $3.3 million in taxes.
The lesson to be learned from the Fairbairn’s spat with Fidelity Charitable? While donor-advised funds come with their advantages, donors should take steps to carefully vet and understand their chosen fund’s policies and practices. Here’s what you need to know.
What are Donor Advised Funds?
Donor-advised funds (DAFs) are a charitable vehicle in which donors give money or assets (like stocks, bonds, and real estate) to a nonprofit fund sponsor who disperses the donations over time to charitable causes. DAFs can offer a tax advantage to donors by allowing them to claim an immediate deduction for the full value of their donations while spreading out the disbursement of funds over many years. Likewise, DAFs can be used to minimize capital gains tax by permitting donors to directly transfer assets (like stock) without having to first liquidate them. DAFs are also appealing for their flexibility, ease of setup, the ability for anonymization, and typically low administrative costs.
Issues With Donor Advised Funds
With the number of DAFs tripling over the past five years, and corporate DAFs such as Fidelity’s and Schwab’s Charitable Gift Funds now taking top honors as the nation’s biggest charities, DAFs are coming under increasing scrutiny for certain flaws.
Control Issues. A key feature of DAFs is that the sponsoring organization owns and controls the fund, while the donor has non-binding advisory privileges in providing advice on the fund’s investment and distribution. So while the donor may retain a right to advise on investment decisions and grants made from the fund, the sponsor still retains the ultimate right to determine how funds are managed and used. As demonstrated in the Fidelity case, this can lead to later issues if the donor does not fully look over the internal policies and procedures of the sponsoring organization or a disagreement later arises as to the fund’s investment and distribution choices.
In light of the potential for such disputes, it is implicit upon donors to be diligent with their chosen fund. For example, most funds have a specified process, along with a standard diligence process, for responding to requests of donors to make a gift to a selected charity. In addition, donors should keep in mind that the sponsor’s fiduciary duty is owed to the fund, rather than the donor. In situations like the Fairbairns, the fund’s actions (like liquidating donated assets) can have an unintended negative impact on the donor’s non-fund assets. Donors should carefully consider the consequences of donating specific types of assets, such as stocks.
Distributions Are Disproportionate to Gains. Although a sponsoring organization may have its own specific policies, there are no laws or regulations that require a donor to ever instruct the fund to make a charitable distribution; the fund can literally exist in perpetuity without shelling out a single dollar to charity. In addition, large corporate financial firms, like Fidelity and Schwab, profit from investment and management fees. As a result, some argue that fund sponsors are disincentivized to make grants, preferring instead to rack up handsome fees generated by funds that continue to appreciate under their management.
However, others argue that because of the investment gains achieved through DAFs relative to their low overhead costs, they actually serve to increase the total amount that nonprofits receive in donations over time. Still, many DAFs maintain policies that require some sort of minimum distribution. If you are considering funding a DAF, you’ll want to carefully understand these requirements.
Intermediaries Disrupt Stewardship. Some also argue that because DAFs act as an intermediary between donors and charities, this disrupts the traditional stewardship process; nonprofits may increasingly focus on appealing to a limited number of corporate DAFs rather than appealing to a larger donor base. Likewise, because donations from DAFs can be harder to trace, this can make it more difficult for nonprofits to steward long-term relationships with targeted donors.
Some donors decide to set up their DAF with a local community foundation, rather than a larger investment firm, to ensure that funds are stewarded towards carefully diligenced local causes. This can help resolve some of the concerns for separation between the donors and the causes they seek to support.
Administrative Concerns. Because the donor receives a tax deduction at the time of their initial contribution to the donor-advised fund, gifts that are subsequently made to nonprofits by the fund are not considered a tax-deductible gift; this would result in double-counting the gift as a tax deduction. To avoid accounting confusion, any gift acknowledgment should clearly state that the gift came from a DAF and is not tax deductible.
Ellis Carter is a nonprofit lawyer with Caritas Law Group, P.C. licensed to practice in Washington and Arizona. Ellis advises nonprofit and socially responsible businesses on corporate, tax, and fundraising regulations nationwide. Ellis also advises donors with regard to major gifts. To schedule a consultation with Ellis, call 602-456-0071 or email us through our contact form.