Monday Nov 19

How I Helped Create the Donor-Advised Fund Monster — Inadvertently

The IRS’s decision in 1991 to grant charity status to Fidelity’s donor-advised fund was a highly damaging mistake that has undermined the entire nonprofit world. With that move, the IRS sanctioned the creation of “captive” charities — created by, and contractually tied to, banks and financial-management companies — that are now associated with nearly every major financial-services company across the United States. It should be clear to even the most cursory reader that these “commercial” funds — tied contractually to the likes of Fidelity, Vanguard, Schwab, Goldman Sachs, JPMorgan, and every bank you can think of — are essentially an asset-accumulation strategy dressed up as charities.

Anyone who thinks any of these institutions decided to start offering donor-advised funds purely from a desire to prompt more giving to nonprofits needs a lesson in altruism.

I’ll never know for sure, but I think my colleagues and I at the Tides Foundation should share some of the blame. We helped invent the idea of a charity solely intended to support donor-advised funds. (DAF).

Rapid Growth

In 1976, I formed the Tides Foundation as the first DAF-centric, mission-driven charity in the United States. We borrowed a sleepy device deployed by community foundations to attract donors. Instead of focusing on geography as such funds do, we sought to channel money to groups with progressive values nationally and internationally.

The IRS, perhaps confused by our effort, ended up conducting a field audit before it issued permanent public charity status to Tides.

This status, of course, bestows many benefits over private foundations. Most important: When donors make gifts of appreciated stock, they can deduct a bigger percentage of their adjusted gross income than they would be eligible for if they gave to a private foundation. Even sweeter, if they exceed the limit in the gift year, they can carry over excess and deduct it for up to four more years until it’s used up.

And, unlike with gifts to private foundations, most donors can remain anonymous.

Throughout the 1980s, donor-advised funds gained acceptance as a tool that encouraged more giving. Tides grew rapidly at times, and many community foundations added emphasis to donor-advised-funds development as well as bequests. Then in the early ’90s, Fidelity arrived on the scene.

I couldn’t understand why the IRS decided the Fidelity Gift Fund was providing charitable benefits at the same level as that of a community foundation or other active charities. I served on the Legislation and Regulations Committee of the Council on Foundations during this period. As Fidelity sought membership, I strenuously objected to letting an organization become a member unless there was an arms-length relationship between a charity and the manager of its money. Fidelity made no bones about the fact that funds parked in its gift fund could only be invested in Fidelity products — and a limited number of those.

From a crass point of view, this looked to me like an asset-accumulation strategy with a thin veneer of charitable purpose neatly laid on top. And it has worked marvelously not just for Fidelity but for Schwab, Vanguard, and other commercial sponsors of donor-advised funds that have jumped into the fray. For the most part, these commercial funds are now eating the lunch of community foundations and other charities that offer donor-advised funds to advance a mission.

Booming Business

Looking back, I suspect the reason community foundations and their primary trade association, the Council on Foundations, acquiesced to Fidelity was because community foundations had for years used sole trusteeships and other sweetheart deals with local banks and trust departments. Though few knew about these arrangements, perhaps community foundations were concerned that scrutiny of Fidelity could lead to a law or regulation that would jeopardize that status quo.

We depend on the IRS and various state attorneys general to enforce the idea that a charity’s assets should be prudently managed and reflect the highest fiduciary standards. How can this coexist with contractual, joined-at-the-hip arrangements where even the commercial name is shared? Can the Schwab Charitable board really decide, based on risk and return analysis, that another company’s financial product is a better investment for funds they oversee? I don’t think so, but for a charity, that is what fiduciary obligations should lead to.

But now, it turns out it’s not just financial institutions that are benefiting. Some donors are also reaping far more substantial benefits from gifts to advised finds that they would with gifts to private foundations.

People with large amounts of highly valued stock available to founders and others ahead of an initial public offering have been able to dump them into donor-advised funds. Donors can then take deductions for the full value of the stock at the time of their donation and can spread the tax break over five years, even if during that time the stock drops substantially in value, as often happens in the months and years after an IPO. Blend in the opportunity for anonymity, easier ways of granting money to foreign charities, and generally looser regulation of grant making, and opting for a donor-advised fund becomes more and more attractive.

Taken together, these observations explain why donor-advised funds have become a booming business — outstripping traditional private foundations as the dominant way wealthy Americans give.

Mini-Private Foundations

Truth be told, donor-advised funds function essentially as mini-private foundations. No grant is made that doesn’t start with the initiative or support of the donor; the idea that the donor is simply giving advice isn’t the reality. Private foundations also make grants at the behest of a donor or for the purposes he or she set out in starting the fund. Yet private foundations do this out in the open with appropriate disclosure and accountability, as required under federal tax law. What is the additional public benefit provided by DAFs that justifies their enhanced tax deductibility, anonymity, and flexible rules? Simply put: There is none.

Sponsors do not report on DAFs at the individual-fund level. When they do disclose information, groups like Fidelity or community foundations aggregate the numbers. One donor-advised fund that distributes a big sum in a year masks the many that give away little or nothing. Why is this OK?

One reason commercial funds and large DAF sponsors resist change is because many define success not on the basis of annual grants made but rather the total assets under management — the same marker of success used throughout the financial world. A charity should be judged by what it does, the programs it supports, and the grants it makes, not by how much it manages.

It is long past time for reform to corral these practices, however unlikely Washington gridlock makes such an action. DAFs should be treated with rules mirroring those applied to private foundations: donor disclosure, the same limits on deductions for gifts of stock, and minimum annual payouts calculated on a fund-by-fund basis.

Perhaps even more crucial, financial management of donor-advised-fund assets should meet the highest fiduciary standards. The law should prohibit contractual, self-serving, or profit-based arrangements. No charity should be tied to the provider of a financial or asset-management
service. Instead, charities should be expected to use objective, transparent standards and commitment to the public good in the management of their assets.

Greed should be relegated to its more familiar environs exclusively within the financial world. It has no place in philanthropy.

Drummond Pike is the founder and former chief executive of the Tides Foundation. He is also a member of the board of the parent organization that publishes Social Policy. This article is reprinted with permission from the Chronicle of Philanthropy – August 22, 2018

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