Lawsuit over $21 million donor-advised fund highlights dangers of DAFs

A model of this text first appeared in CNBC’s Inside Wealth publication with Robert Frank, a weekly information to the high-net-worth investor and shopper. Enroll to obtain future editions, straight to your inbox.

With donor-advised funds gaining reputation as a automobile for the rich to offer again, dangers and potential conflicts of pursuits are rising — and being placed on show in a lawsuit over a household’s $21 million charitable fund.

Philip Peterson, a 63-year-old Kansas resident, filed go well with in January alleging that the nonprofit that administers his household’s donor-advised fund has refused to speak with him and has didn’t make charitable grants that he has really useful since early 2024. The go well with, filed in Colorado federal courtroom, alleges the Christian nonprofit, known as WaterStone, reduce off his entry to details about the account and that he does not understand how the fund has fared because the finish of 2023, when it had $21 million in property.

Counsel for WaterStone, based because the Christian Group Basis, stated in a press release that the Colorado Springs nonprofit has revered the desires of Peterson’s late father, who initially created the fund in 2005 and died in 2019.

The case sheds mild on the rising uptake, and risks, of donor-advised funds, or DAFs, which have shortly turn out to be one of the vital dominant forces in philanthropy. Individuals donated almost $90 billion to DAFs in 2024, per the newest annual report from the DAF Analysis Collaborative. In response to the newest information out there, DAFs held $326 billion mixed in property in 2024.

For Individuals seeking to give again and save on taxes, DAFs are marketed as a versatile and easy manner to take action, usually described as charitable saving accounts or bank cards. As a substitute of writing a test to a nonprofit, donors contribute money and different property to a DAF. Whereas the tax deduction is speedy, the funds may be allotted to charities later.  

DAFs, in contrast to non-public foundations, will not be required to distribute property inside a given timeframe, a standard criticism amongst opponents who say DAFs are wealth hoarding autos.

The Peterson case affords a cautionary story on the tradeoffs – particularly in terms of management. Whereas donors are capable of suggest how the funds are distributed to charity, the property are legally managed by the organizations that administer the DAF on their behalf. Although these organizations, also referred to as sponsors, sometimes respect their donors’ needs, donors have little recourse if they don’t.

“It is offered to the general public as, ‘That is your account, and you’ll determine the place it goes, and you’ll transfer it, and also you preserve full management.’ However in case you do not surrender dominion and management, you aren’t getting the tax advantages,” stated Ray Madoff, tax scholar and professor at Boston Faculty Regulation College. “There is a disconnect between the authorized guidelines that govern it and the understanding of the events. And this case is an ideal instance of it.”

Peterson informed Inside Wealth that the rift with WaterStone began with a disagreement over how a lot to distribute.

In early 2024, Peterson alleges, WaterStone CEO Ken Harrison informed him that the group was going to maintain the fund’s principal in perpetuity and solely make grants from funding revenue. Peterson stated he didn’t comply with the proposal as this might not enable the fund to make its customary annual grants of between $2.3 million and $2.5 million.

He additional alleges that in March 2024, after he informed Harrison over Zoom that he wished to maneuver the DAF to a different sponsor, Harrison informed him by no means to contact WaterStone once more and abruptly ended the decision.

Now Peterson is suing to claim his advisory privileges and regain entry to the DAF, which was began by his late father, Gordon Peterson, an actual property investor and religious Christian, to help evangelical Christian causes. Peterson in the end seeks the courtroom to compel WaterStone to switch the DAF to a different group so he can carry the fund’s giving again up to the mark.

He stated he requested WaterStone make a $1 million grant in 2024 however doesn’t know if that grant – or if any grants – have been issued that yr. In 2025, WaterStone notified Peterson it will allow a $400,000 distribution from the fund, he stated.

“I made a promise to my father. I promised him that if I used to be the remaining individual on the account that I’d direct the funds as I knew that he would 100% approve,” he stated. “I need to be a person of my phrase.”

WaterStone declined to touch upon specifics of Peterson’s allegations. The deadline for WaterStone to reply the criticism in courtroom or transfer to dismiss it’s mid-March.

“WaterStone has persistently carried out the articulated needs of the donor because the donor suggested fund in query was established,” WaterStone’s authorized counsel stated in a written assertion, referring to Peterson’s father. “The plaintiff on this case is just not the donor.”

Andrew Nussbaum, Peterson’s lawyer, stated that WaterStone helped Gordon Peterson appoint his spouse, Ruth, and son Philip as co-advisors to the DAF earlier than he died. Ruth Peterson died in 2021, leaving Philip Peterson as the only successor-advisor. Previous to 2024, WaterStone granted Philip Peterson’s grant requests, Nussbaum stated.

Nussbaum stated the lawsuit might set a chilling precedent if the courtroom upholds WaterStone’s argument that designated successors would not have advisory privileges.

“If WaterStone is true, you are speaking about billions of {dollars} being past any form of authorized attain of the unique donor-advisors or their successors to have any oversight associated to the funds,” Nussbaum stated.

Furthermore, Peterson stated he believes WaterStone has not honored his father’s needs. He alleges that WaterStone has delayed or denied his grant suggestions though they met the mission assertion written by his father, which included an inventory of accepted charities.

“I can inform you this: My dad would by no means have created a donor-advised fund if he knew that this was going to be the end result. He felt very passionately about this,” he stated.

Regulation professor and DAF critic Roger Colinvaux stated in his view, donors who need management of DAF property are attempting to have their cake and eat it too. 

“Whether or not you want DAFs or not, the DAF sponsor is an unbiased charity. It is an unbiased entity, and its duties are to not the donor,” stated Colinvaux, professor on the Columbus College of Regulation on the Catholic College of America. “If the plaintiff wished the kind of management that the plaintiff appears to need, as evidenced within the criticism, there is a construction for that, and that is a non-public basis.” 

Dana Brakman Reiser, professor at Brooklyn Regulation College, cautioned that Peterson’s story is a uncommon state of affairs. She stated the largest DAF sponsors like Constancy Charitable and Schwab Charitable (now DAFgiving360) are affiliated with monetary establishments and customarily inclined to maintain donors pleased.

“It is of their curiosity so long as honoring the donor’s request is just not going to get the sponsor in bother,” she stated. Brakman Reiser added that the IRS prohibits utilizing DAF property to purchase gala tickets or help non-public foundations or non-501(c)(3) organizations.

Nonetheless, the pursuits of sponsors and donor-advisors are hardly ever completely aligned.

Sponsors sometimes gather charges for managing DAF property, creating an inherent monetary incentive to disburse fewer property, in line with Chuck Collins, the director of the Program on Inequality and the Frequent Good on the Institute for Coverage Research, a progressive suppose tank. Whereas neighborhood foundations pioneered the DAF mannequin, they’re now competing with bigger commercially-affiliated sponsors for donors’ {dollars}, he added.

“Increasingly, they’re having to compete with the business DAFs like Constancy which have very low overhead and do not take a lot in the best way of charges. And so what is the enterprise mannequin for a neighborhood basis the place, you recognize, 80% of the donations coming in are from individuals desirous to create DAFs?” he stated. “In actuality, their enterprise mannequin now will depend on individuals parking their property for longer intervals of time.”

Whereas Peterson’s case is uncommon, it isn’t the primary authorized problem surrounding DAFs.

In 2018, a hedge fund couple sued Constancy Charitable, contending the sponsor broke an settlement to liquidate their donated shares steadily and as a substitute offered off 1.93 million shares, a place initially price $100 million, in a matter of hours. Constancy Charitable argued that it had adopted the legislation and the case was dominated of their favor.

In one other noteworthy debacle, in 2009, a Virginia-based charity known as the Nationwide Heritage Basis worn out 9,000 DAFs price $25 million mixed to pay out collectors after it filed for chapter. 

Giving on to charity does not essentially assure the property can be used to the donor’s intent. However including an middleman into the equation provides one other layer of complexity. 

The handful of lawsuits filed by donor-advisors over how DAF property are spent or invested have up to now been largely unsuccessful in courtroom.

Briefly, in line with Colinvaux, courts have upheld that donors have ceded any management to be able to qualify for the tax break. If donors had the proper to manage property — versus the privilege to advise — they might not be capable of declare a deduction, he stated.

Nussbaum stated Peterson’s case is completely different because it focuses on his rights to advise grants moderately than management over how the property are investments. 

Peterson stated he tried to resolve the dispute with Waterstone for about two years earlier than going to courtroom. Whereas he is aware of his go well with faces appreciable odds, he stated he felt he had no selection.

“Individuals put an infinite quantity of belief in these corporations, and we’re hopefully going to seek out out what these corporations can and may’t do,” he stated. “It could have a giant impact on the business, and I do not need to be that man. All I need to do is to have the ability to proceed my father’s legacy.”