Lawsuit over $21 million donor-advised fund highlights risks of DAF giving

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

With donor-advised funds gaining recognition as a automobile for the rich to offer again, risks 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 did not make charitable grants that he has really useful since early 2024. The go well with, filed in Colorado federal court docket, alleges the Christian nonprofit, referred to as WaterStone, minimize off his entry to details about the account and that he does not understand how the fund has fared for the reason that finish of 2023, when it had $21 million in property.

Counsel for WaterStone, based because the Christian Neighborhood Basis, stated in a press release that the Colorado Springs nonprofit has revered the needs 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 into one of probably the most dominant forces in philanthropy. People donated practically $90 billion to DAFs in 2024, per the newest annual report from the DAF Analysis Collaborative. In line with the newest information obtainable, DAFs held $326 billion mixed in property in 2024.

For People trying 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 an alternative of writing a examine to a nonprofit, donors contribute money and different property to a DAF. Whereas the tax deduction is fast, the funds could be allotted to charities later.  

DAFs, not like non-public foundations, aren’t required to distribute property inside a given timeframe, a typical criticism amongst opponents who say DAFs are wealth hoarding automobiles.

The Peterson case gives a cautionary story on the tradeoffs – particularly in relation to management. Whereas donors are capable of advocate 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 called sponsors, usually respect their donors’ needs, donors have little recourse if they don’t.

“It is bought to the general public as, ‘That is your account, and you may determine the place it goes, and you may transfer it, and also you keep full management.’ However in the event you do not hand over dominion and management, you do not get the tax advantages,” stated Ray Madoff, tax scholar and professor at Boston Faculty Regulation Faculty. “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 instructed 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 instructed 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 conform to the proposal as this might not permit 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 instructed Harrison over Zoom that he wished to maneuver the DAF to a different sponsor, Harrison instructed 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 court docket to compel WaterStone to switch the DAF to a different group so he can deliver 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 – had 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 might 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 court docket or transfer to dismiss it’s mid-March.

“WaterStone has constantly carried out the articulated needs of the donor for the reason that 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 isn’t 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 real successor-advisor. Previous to 2024, WaterStone granted Philip Peterson’s grant requests, Nussbaum stated.

Nussbaum stated the lawsuit may set a chilling precedent if the court docket upholds WaterStone’s argument that designated successors shouldn’t 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 a listing of authorised charities.

“I can let you know this: My dad would by no means have created a donor-advised fund if he knew that this was going to be the 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 try 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 Faculty 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 personal basis.” 

Dana Brakman Reiser, professor at Brooklyn Regulation Faculty, cautioned that Peterson’s story is a uncommon situation. She stated the most important DAF sponsors like Constancy Charitable and Schwab Charitable (now DAFgiving360) are affiliated with monetary establishments and customarily inclined to maintain donors glad.

“It is of their curiosity so long as honoring the donor’s request isn’t going to get the sponsor in bother,” she stated. Brakman Reiser added that the IRS prohibits utilizing DAF property to purchase gala tickets or pay school tuition.

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

Sponsors usually gather charges for managing DAF property, creating an inherent monetary incentive to disburse fewer property, in response to Chuck Collins, the director of the Program on Inequality and the Widespread 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.

“An increasing number of, they’re having to compete with the business DAFs like Constancy which have very low overhead and do not take a lot in the way in which of charges. And so what is the enterprise mannequin for a neighborhood basis the place, , 80% of the donations coming in are from individuals desirous to create DAFs?” he stated. “In actuality, their enterprise mannequin now depends upon 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 regularly and as a substitute bought off 1.93 million shares, a place initially value $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 referred to as the Nationwide Heritage Basis worn out 9,000 DAFs value $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 so far been largely unsuccessful in court docket.

Briefly, in response to Colinvaux, courts have upheld that donors have ceded any management so as to qualify for the tax break. If donors had the proper to manage property — versus the privilege to advise — they’d not be capable to declare a deduction, he stated.

Nussbaum stated Peterson’s case is completely different because it focuses on his rights to advise grants reasonably 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 court docket. Whereas he is aware of his go well with faces appreciable odds, he stated he felt he had no alternative.

“Folks put an unlimited quantity of belief in these corporations, and we’re hopefully going to search out out what these corporations can and might’t do,” he stated. “It might 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.”

Correction: This story has been up to date to right the IRS limitations on use of DAF property.