Vested Interests

[Note: This post was co-published in the Chronicle of Philanthropy on March 3, 2020.]

Over the past few months, a fierce legislative battle has arisen  in California over the mildest of bills.

The incident serves as a reminder that, when it comes to the world of donor-advised funds, there are certain people and entities that benefit strongly from the current model. Whenever donor-advised funds come under examination, or when even the most common-sense idea for change is suggested, the DAF industry reacts vehemently, protecting its turf, its income, and its privileges.

So, what was the proposed California state bill about? Nothing dramatic, actually. It called for a bit of transparency in the operation of donor-advised funds.

For context, keep in mind that those of us who have been urging tighter regulation and legislation governing DAFs have repeated the criticism that many donor-advised funds sit idle or are barely used. We have suggested that it’s bad public policy for the federal government to provide a charitable tax deduction when donors put money into DAFs with no requirement that the funds ever be distributed to charitable organizations. We have urged a variety of remedies, including a requirement that funds in DAFs be distributed within a certain number of years of the donation or that donors receive a charitable deduction only when their DAFs finally distribute money to charity.

The proposed law in California, supported by the California Association of Nonprofits, did not require any sort of spending from DAFs or any major structural change. Rather, if enacted, the law would simply have required large DAFs based in California to report the asset size and grant distributions annually for each component fund. This fund-by-fund accounting of DAFs would be anonymous, and grants would not be itemized or identified with a particular fund. The California bill was hardly an intrusive proposal and, if anything, could have served the DAF industry’s purposes by proving its often-stated assertion that inactive donor-advised funds are few and far between.

But the DAF industry and its lobbyists have insisted that the bill would jeopardize donor privacy and discourage charitable giving. In the wake of the dust-up, the bill has been pulled from consideration.

The conflict over the California bill serves as a reminder that the DAF industry feels so strongly about maintaining donor-advised funds in their current state that it considers the imposition of any sort of oversight of this essentially unregulated industry as a threat to philanthropy and the American way.

Who are these people and institutions that feel so adamantly, and how do they benefit from the donor-advised fund status quo?

Donors’ financial advisers. Let’s be clear: Financial advisers make money from their clients’ donor-advised funds.

If a donor were to  contribute securities from her personal investment portfolio directly to an operating charity — the Boys & Girls Clubs, say — then the donor’s financial adviser would lose income. That’s because most financial advisers receive a fee based on funds under management. An outright gift to charity means reduced assets under management, which means less income for the financial adviser. But if, instead of giving the asset outright to the Boys & Girls Clubs, the donor were to transfer that security to a donor-advised fund within the financial adviser’s firm, then the financial adviser would continue to draw income, much as if the gift had never happened.

In fact, many financial advisers receive management fees for DAFs even if they are held at institutions other than those sponsored by their employers. Fidelity, Schwab, the American Endowment Foundation, and even some community foundations make provisions for providing donors’ financial advisers a management fee when their clients create DAFs.

Financial advisers therefore have a personal financial incentive a) to discourage clients from making outright gifts to charity, b) to encourage donors instead to create DAFs, and c) to encourage donors to keep their DAF funds accumulating, undistributed, for as long as possible. Money invested long-term in donor-advised funds equals ongoing income for financial advisers.

Do all financial advisers always put their personal financial benefit ahead of other considerations as they advise their clients? Certainly not. Does the personal financial incentive influence their behavior? Absolutely.

Wall Street firms. DAF accounts held more than $121 billion as of the end of 2018, according to the National Philanthropic Trust. Those funds earn significant fees for the financial-services industry.

Here, as with the individual financial advisers, the incentive for the financial-services firms is to keep the funds invested. If all the money in DAFs were distributed within a few years, the world would undoubtedly be a better place, thanks to the enormous injection of giving to charity. At the same time, it would hurt the bottom line of Fidelity Investments, Vanguard, Schwab, UBS, Goldman Sachs, and Morgan Stanley. And given the choice between making the world a better place and enhancing their bottom line, we can be pretty sure what the financial-services industry would choose.

Community foundations. First, a set of disclaimers: Unlike commercial donor-advised-fund sponsors, community foundations are genuine charities that care about their communities and do far more than simply sponsor donor-advised funds. Unlike financial advisers, community-foundation staff members do not get paid a fee for money going into and staying in donor-advised funds. And finally, there are hundreds of community foundations around the country, each one governed independently. I do not and would not ascribe a single set of motivations to all community foundations.

That said, one of the groups leading the charge against the California DAF legislation was the 32-member California League of Community Foundations, led by the enormous Silicon Valley Community Foundation. The fact that the Silicon Valley fund melted down in 2018 in a management scandal of epic proportions, fueled largely by its manic desire to attract new donor-advised funds, has not prodded the organization into circumspection about how DAFs can serve society better. Nationally, a consortium of community foundations contributed more than a million dollars last year to a national lobbying effort whose major purpose seems to have been to fight off even the mildest efforts to make DAFs send money to groups that can put them to work right away.

You would think that community foundations, which exist to strengthen their communities, would support efforts to grant out funds more rapidly. But community foundations, alas, also have a financial incentive to keep spending from donor-advised funds at modest levels.

That’s because community foundations draw a large portion of their operating funds from fees on DAFs under their management. If DAFs were required to spend all their assets, it would necessitate a significant shift in the business model for community foundations. Community foundations seem reluctant to tinker with the current model, despite encouragement from me and others. Sadly, in terms of the rules governing donor-advised funds, community foundations overall are throwing their lot in with commercial gift funds, paying their lobbyists to fight any sort of change in DAF rules, even the thin gruel of the California proposals.

Nonprofit associations, research groups, and journals. One would think that organizations representing operating nonprofits would support efforts to encourage DAFs to do more to drive additional funding to the charities that make up their membership. Certainly, that’s what inspired the California Association of Nonprofits to lead the way with this proposed legislation.

Unfortunately, associations representing nonprofits generally have yielded to the influence of grant makers and donors, either sitting on the sidelines or actively opposing DAF-regulation efforts. Why have nonprofit associations been more responsive to the interests of DAF sponsors than they have been to the much larger number of operating charitable organizations? Perhaps this is because of the inherent power imbalance. Grant-seeking organizations are in a vulnerable position, and they need to be careful about criticizing major grant makers, so they are muted in expressing their opinions. By contrast, DAF sponsors are unabashedly assertive in preserving their interests.

But there may be another factor influencing nonprofit associations’ approach to DAF reform: funding from the donor-advised-fund industry. I can’t help but notice that the Fidelity Charitable Trustees Initiative, an arm of Fidelity Charitable, has awarded grants in recent years to nonprofit associations, journalists covering the nonprofit world, and a group that does research on charitable giving. And Fidelity is not the only DAF sponsor making grants within the charitable world. Is there an explicit quid pro quo for these grants? I’m certain, no. But will organizations taking Fidelity’s money be less inclined to be critical of commercial DAFs? My skepticism is too ingrained for me to think otherwise.

There clearly is a need for legislation that would reveal more of what’s going on behind the curtain of DAFs. It makes perfect sense for the public to have an idea of the ins and outs of the nation’s fastest growing philanthropic vehicle. And it is crucial that more nonprofit and political leaders stand up, step forward, and join with the California Association of Nonprofits in finally starting to hold the donor-advised-fund industry accountable.