Thursday, June 30, 2016

The Undermining of American Charity

Most Americans have never heard of donor-advised funds and would be surprised to learn that, measured in donated dollars, the second-most-popular “charity” in 2015 (just behind the United Way) was not the Red Cross, the Salvation Army, or Harvard or other universities. It was Fidelity Charitable, an organization created and serviced by Fidelity Investments for the purpose of holding charitable donations. Fidelity Charitable acts as a middleman, attracting its customers’ charitable donations and managing them in separate client accounts. Money in such donor-advised funds is invested and held until the clients give instructions (“advise”) about distributions to operating charities.

Because of a 1991 IRS ruling obtained by Fidelity (and similar rulings obtained by other commercially sponsored DAFs), clients get the same tax benefits when they transfer property to their donor-advised funds that they would get by making outright contributions to a museum, soup kitchen, university, or any other federally recognized charity. But no deadline is imposed for the eventual distribution of these funds to an operating charity. If a donor fails to distribute the account during her lifetime, she can pass on the privilege of making distributions to her children or grandchildren or anyone else she chooses. The effect of these rules is that assets that have been given the tax benefits of charitable donations can be held in a DAF for decades or even centuries, all the while earning management fees for the financial institutions managing the funds, and producing no social value.

Although Fidelity was the first financial institution to create this type of charitable middleman, Schwab and Vanguard soon thereafter created Schwab Charitable and Vanguard Charitable—and together these organizations have all made it to The Chronicle of Philanthropy’s annual top ten charities in overall donations (squeezing out more traditional charities like the American Cancer Society). Goldman Sachs, T. Rowe Price, Raymond James, and many others have also created donor-advised funds, making charitable giving a growing part of the financial world’s business model for attracting and servicing its clientele.

This business plan has been highly successful. Many billions of dollars have been drawn into the orbit of charitable middlemen, and there is no end to their growth in sight. According to the National Philanthropic Trust, annual contributions to DAFs hit an all-time high of $19.66 billion in 2014. The increase in contributions, combined with a rising stock market, “drove total donor-advised fund assets above $70 billion for the first time.” The leader, Fidelity Charitable, has had particularly strong growth and it is widely expected that in 2016 it will surpass the United Way and receive more donations than any other charity in the country.

One of the most surprising aspects of the rise of DAFs is that donors participate in this $70 billion industry without any legal protections regarding their control over the distribution of the assets held in DAFs. When donors open donor-advised fund accounts they do so because they expect to have continuing control over their donations. This expectation is reinforced by marketing materials that allude to control. For example, one leading DAF sponsor, National Philanthropic Trust, describes DAFs as follows:

An easy way to think about a donor-advised fund is like a charitable savings account: a donor contributes to the fund as frequently as they like and then recommends grants to their favorite charity when they are ready.

Despite such references to control, legal agreements between donors and DAF sponsors in fact provide that the donor cedes all legal control over donated funds. Although a donor is given the right to make recommendations (sometimes referred to as “advisory privileges”), this is not much of a “right.” DAF sponsors are legally allowed to ignore donors’ advice about the disposition of their DAF funds.

For most donors, this will have little practical effect; donors will advise and the DAFsponsor will follow the donor’s advice. This is because the business model of commercial DAF sponsors is to profit from the fees they secure and not from appropriating donor funds. However, not all donors have been so lucky. In one case, aDAF sponsor went bankrupt and the donated funds were seized to pay its creditors. In another case, the DAF sponsor used donated funds to pay its employees large salaries, hold a celebrity golf tournament, and reimburse the cost of litigation when a dissatisfied donor sued. In both cases, courts ruled against the donors and upheld the rights of the fund sponsor to exert full legal control over DAF funds.

The larger question raised by this arrangement is, why would donors and DAFsponsors enter into legal agreements that fail to reflect their expectations? Who benefits? Who is harmed?

by Lewis B. Cullman and Ray Madoff, NYRB | Read more:
Image: New York City, 1977; by Susan Meiselas