“Community Art – Community,” Ronald Tanglao

As someone who is both a supporter of community foundations and an advocate for common-sense reform of donor-advised funds, I was disappointed by the defense of the DAF status quo put forth in the recent opinion piece by Douglas Kridler, Alicia Philipp, Lorie Slutsky, Steve Seleznow, and Max Williams—all CEOs of major community foundations.

Community foundations play a critical role in civil society. Community foundations identify key issues and worthy charitable priorities in their regions. They draw attention and support and build coalitions to attend to those issues, and they attract contributions of various types to fund these efforts now and in the future. Donor-advised funds have long been central to how community foundations have functioned. I understand why community foundations are disinclined to alter a vehicle that has fueled their growth, and why they are resistant to suggestions that DAFs need to be more strongly regulated.

But an ever-broader audience is beginning to raise serious questions about donor-advised funds. Rather than reflexively resisting any change, community foundations would do well to get ahead of the curve and lead the reform effort so that DAFs work for everyone. And the key may be to remember the way donor-advised funds functioned before Wall Street turned them into commodities. Done the right way, reforming DAFs would not only help working charities, but would also allow community foundations to grow in stature and do what they do best in a more effective way.

DAFs: The Good and the Bad

For several years, I have been writing about the problems associated with donor-advised funds, so some readers may be surprised to hear me say that I think DAFs play an important role in encouraging effective charitable giving. Particularly when individuals accumulate highly appreciated assets, creating a donor-advised fund is an attractive option for tax-smart philanthropy. And in many ways—most notably, cost, complexity, and tax advantages—DAFs are typically a much better choice than creating a private foundation.

That said, the current donor-advised fund structure is dysfunctional, and it’s hurting American charities. Understandably, much of the attention on DAFs has come about because of their extraordinary growth. When six of the 10 largest nonprofits in terms of money raised are DAF sponsors, according to the Chronicle of Philanthropy’s 2017 Philanthropy 400 Report, people take notice.

But the debate about DAFs is about much more than their size. The charitable world for at least the last decade has been increasingly frustrated not only by the growth of DAFs, but by their lack of transparency and the absence of a payout requirement of any sort. Because of the power imbalance—nonprofits seeking money do not advance their cause by criticizing their donors or DAF sponsors—nonprofit executives do not speak up publicly. But the DAF issue, particularly at a time of rising demand for services, increasing competition for dollars, and diminished tax incentives for charitable giving, has very much been gnawing at nonprofit leaders for years.

Moreover, from a larger public policy perspective, there is a growing awareness of the specter of “dark money,” and the role donor-advised funds play in what US Senator Sheldon Whitehouse has called “identity laundering.” Donors are passing charitable gifts to controversial and politically-charged groups through anonymous donations from donor-advised funds, a process that conservative funder Charles Koch, in Jane Mayer’s bestseller Dark Money, refers to as part of his strategy of “weaponized philanthropy.” Though details of this strategy have only begun bubbling to the surface, rest assured that for some donors—a tiny fraction, certainly, but a group with tremendous power and deep resources—the attraction of donor-advised funds rests not upon their charitable impact but their utter lack of transparency.

In the past few months, the media—both within the philanthropic world and the mainstream press—have taken notice. The community foundation CEOs’ opinion piece came in response to this essay by Dean Zerbe, who implored that the IRS and Congress create “DAFs that put working charities first,” and a companion article by Ray Madoff suggesting clear steps to ensure that DAFs work for everyone. I commend both essays. Zerbe cuts to the chase and asserts, I believe correctly, that commercial donor-advised funds such as Fidelity Charitable are essentially arms of financial institutions, indistinguishable in any real way from their for-profit partners. Zerbe hammers home the point that the incentives of these entities are to keep the funds invested (in the affiliated financial institutions, of course), rather than distributed to working charities. Madoff joins Zerbe in focusing on the imperative for dollars to flow from DAFs to charity and suggests reforms to incentivize distributions and curb evaluation abuses. Both Zerbe and Madoff support instituting a defined period of years from the date of gift to distribute the funds to working charities.

The Zerbe and Madoff pieces are only two of many widely-circulated DAF critiques in the last few months. DAFs have received particular attention this year because of the management meltdown at the Silicon Valley Community Foundation, the nation’s largest community foundation, reported in the Chronicle of Philanthropy, Forbes, the Atlantic, and elsewhere. An August 3rd New York Times article by David Gelles makes its stance on DAFs clear in its title: “How Tech Billionaires Hack Their Taxes With a Philanthropic Loophole.” In an August 22nd op-ed (“How I Helped Create the Donor-Advised Fund Monster—Inadvertently”) in the Chronicle of Philanthropy, Drummond Pike, the founder of the Tides Foundation, writes that he rues ever having helped to popularize DAFs. And a July report from the Institute of Policy Studies, “Warehousing Wealth,” places donor-advised funds within the context of widening wealth disparity, strongly asserting that DAFs serve to amplify inequality.

The donor-advised fund is no longer an obscure giving vehicle, known only to industry insiders. The growth and operations of DAFs have drawn attention and critiques in many of the most well-read and respected journals in the country. Community foundation leaders can no longer simply say, “Tut, tut. Everything will be fine. Don’t touch a thing!” Too many people are watching, and too many people are concerned.

Returning DAFs to Their Original Purpose

The value of a community foundation lies in the work it does, not simply in having the title, “community foundation.” This obvious truth came to mind when I read the sentiment expressed by the foundation heads in their NPQ piece about “the inherent value of community foundations.” Most community foundations in fact do excellent and important work. That said, it’s frankly hard to reconcile the stories spilling out of the Silicon Valley Community Foundation debacle—a scandal characterized by mismanagement, harassment of staff, and an obsession with growth for growth’s sake—with the notion of the inherent value of community foundations.

Meanwhile, most of the growth in donor-advised funds has been occurring not at community foundations, but at commercial DAF sponsors such as Fidelity Charitable and its dozens of financial services siblings. Community foundations find themselves uncomfortable partners and competitors with a set of institutions that hold vastly different values and incentives. It’s my view that, rather than adopt and assimilate those Wall Street values as their own, community foundations would do well to reassert their role as charitable leaders and recognize how reform of donor-advised funds would help community foundations gain additional credibility and impact.

In the NPQ article, the five community foundation CEOs vehemently defend the hands-off regulation governing today’s donor-advised funds. This is, from my point of view, the wrong approach, putting community foundations in an uncomfortable alignment with their competitors from the financial services industry and positioning community foundations as being dismissive of the very real concerns people have about donor-advised funds. No: Rather than pledge fealty to the DAF status quo, community foundations should go back to the original purpose of donor-advised funds. Community foundations should return DAFs to the way they were before Fidelity and its ilk got into the business of charity—or, perhaps more precisely, before Wall Street turned charity into a business.

DAFs started at the New York Community Trust in the 1930s as a way of engaging living donors. Before then, community foundations had relied almost exclusively on bequests to build their assets, and it made sense to try to get donors involved before their deaths. Donor-advised funds were the chosen way. For decades, the advisory nature of donor-advised funds was central to how they operated. Donors would make a significant commitment of capital for the good of the community. Donors would then suggest grants for the consideration by the community foundation, and the community foundation in turn would call donors to seek support for particular projects. This was a genuine dialogue. The collaboration effectively connected the foundations with their donors, encouraging major philanthropic commitments to the community.

This collaborative relationship at both community foundations and religious federations formed the basis of the IRS private letter ruling in 1969 (colorfully documented by Temple University historian Lila Corwin Berman) that decreed that donor-advised funds—a descriptor that had not yet come into common usage—were indeed to be considered part of their sponsoring organizations. This ruling gave DAF donors all the benefits of donating to a public charity, rather than to a private foundation. But as time passed, the “advisory” nature of the donors’ grant recommendations became little more than a legal fig leaf, particularly after the catastrophic ruling by the IRS in 1991 that the Fidelity Charitable Gift Fund qualified as a public charity.

With the entrance of Wall Street, DAFs became a commodity that provided donors the ability to receive all the tax benefits of a charitable gift without having to make a commitment to supporting any particular charitable purpose, even one as broad as a geographical area. The relationship between donor and sponsor is now, in most cases, purely transactional. The unique set of characteristics of DAFs—public charity tax status, absence of any payout requirement, lack of transparency, effective donor control—has led to manipulation, bloated accounts, and, by many measures, a net loss of income for working charities. DAFs clearly benefit the donors and the financial services industry; it’s not clear that they work at all for the Department of Treasury or the charitable sector; and it’s frankly not obvious that DAFs have benefitted community foundations, which are fighting an uphill battle to compete with the financial services industry in terms of fees and technology.

Taking a Stand for Smart Reform

So, in the face of this rising awareness of the problems of donor-advised funds, what are community foundations to do? Here are some suggestions.

• Community foundations should assert, correctly, that donor-advised funds are a very attractive vehicle for donors, particularly those with appreciated assets, and repeat the mantra that DAFs are far simpler and less expensive to establish and maintain than private foundations.

• Community foundations should acknowledge that private foundations have been following the letter of the law, but certainly not the spirit, by making grants to donor-advised funds, a workaround that allows foundations to hide or avoid their required annual charitable distributions. Community foundations consequently should support the effort to prohibit private foundation grants to DAFs from counting toward the five-percent charitable distribution requirement.

• Community foundations should recognize that payout from DAFs matter. As Dean Zerbe writes in his NPQ essay:

The whole rationale for the generous tax treatment of charitable deductions is that the money ends up in the hands of a charity that is actually helping those in need—providing the blankets, feeding the hungry—what I call “a working charity.” Having charitable donations go to banks (aka “warehouse charities”), with the wealthy getting their tax benefit today, the money managers getting their fees today, and the fiscal agent receiving fewer tax dollars today—while the poor see a benefit (maybe) tomorrow, or next year, or ten years from now—is nonsensical.

Community foundations should support legislation that requires the full distribution of principal and earnings within a set number of years. The Institute for Policy Studies report recommends a spend-down within three years from the date of the gift. In 2014 Congressman Dave Camp, then chair of the House Ways and Means Committee, suggested a deadline of five years. From my conversations with donors, spend-down requirements as short as that would discourage donations to DAFs and arguably reduce overall charitable giving. I instead suggest a spend-down of ten years, which seems acceptable to a large majority of donors with whom I’ve spoken. This enforces the common-sense notion that DAF funds—which, after all, receive the maximum tax benefit—are meant to go to working charities, and not to stay invested indefinitely. The community foundation leaders’ NPQ article acknowledges the importance of getting money out the door in grants. This rule would accelerate that process for the good of the community, and it would give community foundations that much more money to put toward important efforts.

• Community foundations should model transparency for the DAF industry by publishing an anonymous fund-by-fund record, showing the assets, number of grants, and total dollars distributed from each fund annually.

• Community foundations should recognize that, within the context of these new rules, they would have a significant competitive advantage over commercial DAF sponsors. If DAF donors indeed had to distribute their funds within ten years, community foundations—with their deep knowledge of the community—would be the entities that could make the donors vastly more effective and confident philanthropists. And the communities themselves, of course, would benefit greatly.

• Community foundations should support the idea that, if and when spend-down requirements are put into place, DAF sponsors would ask donors, at the time the funds are established, to indicate one or more default charitable beneficiaries. Should the donor die before the funds are distributed, or if the donor fails to get all the funds out the door in time, the funds would flow to designated charitable beneficiaries. One of the suggested default charities could well be the community foundation itself, for its unrestricted fund. Over time, this provision could provide community foundations with the flexible grantmaking dollars they crave the most.

…

I was once the young executive director of a small social service organization that worked with children from difficult socioeconomic backgrounds. The core of our program took place at a summer camp on an island in a New Hampshire lake. On a cold January night in 1990, the camp’s main lodge burned to the ground, throwing our organization into an existential crisis. Would we be able to rebuild by the summer? How could we possibly get the money to do so? Would the program survive? What would we tell the kids?

The first call I received the next Monday morning was from the lead grantmaker at our local community foundation. She said how distraught she and her colleagues were by the fire, and she asked what we needed. Two weeks later, the community foundation sent us the single biggest check we were to receive for the rebuilding campaign. In retrospect, I don’t know how much of those funds came from unrestricted assets and how much from donor-advised funds—it made no difference to me then, and I certainly didn’t ask. In fact, at the time, I didn’t even know that there was such a thing as a donor-advised fund. But I do know that it was the single most important source of funds for our campaign, and that our interaction with the community foundation was the single biggest boost to our morale and finances as we dug out from that crisis.

That exchange illustrates the singular impact that a community foundation can have on its region. No one else would have called me with the power to marshal support of our effort in such a hurry. No one else could have written a check that large. And, I’m happy to say, the rebuilding effort was a success, the program opened in time for the summer season, and the organization recently celebrated its fiftieth anniversary. Some 2,000 kids have benefitted in the 28 years since that fire. And it may never have happened without the leadership of our local community foundation.

I would argue that the suggested reforms to donor-advised funds would strengthen community foundations’ ability to respond to needs, whether crises like the one I lived through, or compelling, ongoing community demands. With reform of DAFs, there would be ever more focus on getting money out the door to good causes, stronger donor connection to the community, and a greater degree of collaboration between the donor and the community foundation.

Would DAF reform affect the business model of community foundations? Absolutely. But if, instead of doggedly defending the status quo, community foundations took the lead in helping donor-advised funds be more effective, more active, and less prone to manipulation, they would not only save DAFs from more draconian regulations, but also reinvent and reenergize the foundations themselves.

And if Congress doesn’t undertake reform of donor-advised funds? Community foundations should take it upon themselves to operate along the lines I recommend, thereby establishing themselves as institutions that focus on improving the lives and futures of those around them. This would distinguish community foundations from commercial donor-advised fund sponsors like Fidelity, which clearly are about growth, transactions, and profit for the financial services industry.

Should community foundations follow the path of supporting reform—and I hope that they do—their inherent value would be more than rhetorical. Community foundations’ value would be self-evident. And charitable organizations and the nation would benefit greatly in the process.

For more context on the issue of donor-advised funds, enjoy our series of articles from the summer 2018 issue of the Nonprofit Quarterly. You can start here.