Tuesday, June 4, 2019

Controlling a Donor-Advised Fund

A couple months ago, I presented a work-in-progress on donor-advised funds to my colleagues at Loyola (a work-in-progress I hope to finish and post on SSRN soon). That evening, I got an email from one of those colleagues. It turned out that that same night, some donor-advised fund sponsored a bunch of the programming on WBEZ, our local NPR station, and the words donor-advised fund now meant something to my colleague.

Fast-forward to last Friday. A New York Times story popped up on my phone which, serendipitously, was about donor-advised funds. More specifically, it was about a lawsuit that, according to the Times, may cool donor enthusiasm for DAFs.

As a quick summary: commercial DAFs are essentially low-cost replacements for private foundations. They're often run by big mutual fund companies, which established a public charity. Donors donate to the charity, and the charity keeps their donations in separate accounts. The donor has given up ownership and control over the donation (and thus gets a deduction), but can advise the sponsoring organization about how to invest and distribute her donation.

And, as a legal matter, it's clear that the donor has given up the ownership and control. As a practical matter, though, I assume that donors have a lot of influence over their donations. If the sponsoring organization were to start going rogue, it's probably fair to assume that donors would be less excited to give their money to that particular sponsoring organization.

Tick-1271763_960_720But, again, as a legal matter, the sponsoring organization, not the donor, has control. And that's where the lawsuit the Times mentions comes in. According to the Fairbairns' complaint, in 2017, they donated 1.93 million shares of Energous stock--which is publicly traded on the NASDAQ--to Fidelity Charitable. They wanted Fidelity to eventually distribute their donation to charities that combat Lyme disease.

The Fairbairns allege that Fidelity promised them four things to induce the donation:

  1. Fidelity would use state-of-the-art methods for liquidating large blocks of the stock;
  2. It wouldn't trade more than 10% of the daily trading volume of Energous shares;
  3. It would allow the Fairbairns to set a floor on the price it would accept; and
  4. It wouldn't start selling Energous shares until 2018.

Fidelity didn't do, well, any of those things. According to the complaint (which Fidelity admits is true), it sold all of the shares on December 29, 2017. The Fairbairns claim that the sale drove the value of the stock down by 30%. And why do they care?

The complaint gives two reasons:

Catastrophic

It turns out, according to the complaint, that the 2017 changes to the tax law meant that the Fairbairns couldn't defer a sizeable tax hit any longer. Moreover, a couple days before the donation, the value of Energous stock jumped 39%. By making this donation, they managed to avoid paying taxes on the appreciation, and could, at the same time, offset their deferred income.

Now here's the thing about the lawsuit: by donating to Fidelity (rather than donating directly to their Lyme disease charity or donating to a private foundation), the Fairbairns had given up their legal right to control both the investment decisions and the distribution decisions. So instead, the complaint alleges that Fidelity misrepresented what they would do to induce the Fairnairns' investment, that it breached an enforceable agreement about how it would deal with their donation, that it was estopped from doing what it did, and that it was negligent in the manner it liquidated the stock.

Will this affect donors' willingness to provide charity through donor-advised funds? I honestly don't know. Frankly, investors should be aware that their right to advise is limited. On the other hand, large donors prefer to have control and, while a private foundation is more costly and provides a lower ceiling on deductibility, if they really want the control, perhaps they should give through foundations (or, heaven forbid, directly to active charities).

Samuel D. Brunson

 

https://lawprofessors.typepad.com/nonprofit/2019/06/controlling-a-donor-advised-fund.html

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