Who is Blocking DAF Reform?

Who is Blocking DAF Reform?

BY ALAN CANTOR

Given the outcry over donor-advised funds on both the right and left, why aren't even simple reforms going through? The insightful philanthropy critic Alan Cantor points his finger at the culprits.

The walls are caving in on American nonprofits.

The White House has ordered a vast rescinding of grants, current and future, to the nonprofit sector, with no concern for the lives damaged, programs destroyed, or critical research halted. The Trump Administration is threatening to order the withdrawal of 501(c)(3) status – a previously unimaginable and existential threat – from nonprofits ranging from small agencies to Harvard University. And nonprofits are frantically scrubbing their websites of what the Administration deems to be offensive words and phrases.

This is a frankly terrifying time to be in the nonprofit sector.

In the midst of so much trauma, it might seem incidental or even irrelevant to dredge up the topic of donor-advised funds and the crying need for DAF reform. As my mother used to say, "When the house is on fire, you don’t worry about the curtains!" But at a time when government grants and contracts are disappearing, the financial resources warehoused in DAFs could serve as a lifeline to nonprofits. Moreover, the political crisis has actually been underwritten by the DAF status quo: donor-advised fund grants have been an important revenue stream for the creation and execution of the Trump vendetta against nonprofits.

A Philanthropic Disaster

First, some context, which is painfully familiar to observers of the charitable sector:

• Donor-advised funds live in a grey zone of tax law. DAFs provide donors with all the tax advantages of an outright gift to an operating charity, but function much like private foundations, only without the oversight, transparency, and requirements for annual charitable distributions required of foundations.
• DAFs have grown wildly in recent decades. As The Independent Report on DAFs from Inequality.org notes, donor-advised funds now take in a sixth of all individual giving each year, and nine of the top 20 recipients in the country, including the top three, are DAF sponsors. Total DAF assets reached $254 billion in 2023, a 67 percent jump in only four years. That’s a lot of money that could do a lot of good.
• Notably, a significant portion of the "charitable giving" credited to donor-advised funds is actually in the form of grants to other DAFs. These DAF-to-DAF transfers, which the Inequality.org report estimates to have been $4.4 billion in 2023, inflates DAF grantmaking dollars (and implied impact) considerably.
  Moreover, and critically, DAFs offer virtually no transparency. The public has no access to the activities of particular DAFs, including controversial and politically potent grants.

A simple solution, blocked

In the 2021, a reform effort called the Accelerating Charitable Efforts (ACE) Act received bipartisan sponsorship in both houses of Congress, but the bill never came to a vote. Among many other provisions, the ACE Act would have required most – though not all – DAFs to grant out their assets within fifteen years. The ACE Act was an important – if modest and pragmatic – effort to rein in the unregulated world of donor-advised funds. Its goal was curbing bad practices and getting money to good causes. But it never had a chance.

Why not? And who are the forces blocking common-sense reform efforts?

The list of culprits

The first set of culprits protecting the DAF status quo are the financial services firms. We’re talking about Fidelity Investments, Schwab, Vanguard, UBS, Morgan Stanley, Goldman Sachs, and the others. Virtually every financial services firm has an associated “charitable” 501(c)(3) donor-advised fund operation.

This is a lucrative enterprise for the financial services industry. How do the firms make money from DAFs? Well, most dollars held by these affiliated (though technically independent) nonprofit donor-advised fund shops are invested in mutual funds managed by their parent investment companies. Those dollars add up. I laugh (grimly) when people from the commercial DAF world assert that profit has nothing to do with their motivation, that these companies are simply trying to help their clients be philanthropic. Sure.

Fidelity Charitable had assets of $55 billion as of June 2023. Assuming an average fee of 50 basis points (that is, ½ of 1%) for investment management, that’s a haul of $275 million a year for Fidelity Investments. And the longer the money stays in the DAFs, the more Fidelity and its fellow financial firms earn in fees.

Now, some in the financial services world might claim that I’m overstating the income. My response? I’m simply making my best guess, because there is no transparency into the financial arrangements between the investment firms and their closely held "charitable funds." If it turns out I have overestimated the haul by a few million dollars, my point remains: Wall Street firms make money off of DAFs – and the longer the funds remain undistributed, the more money they make.

And, of course, the financial services industry’s lobbyists have an enormous influence in Washington.

The second set of culprits are financial advisors. These are the folks who interact with individual clients and advise them on their investments. In the old days, we called them stockbrokers.

Brokers largely earn their income by taking a fee on assets under management. Back in 1990, if, say, a donor asked her broker to transfer $100,000 worth of IBM stock to the local Boys & Girls Club, that reduced the broker’s funds under management, and the broker would have earned less income in the future. But the broker would have had no options other than to follow the donor's instructions.

Today, it is often financial advisors, rather than the potential donors, who raise the issue of contributing stock to DAF – either within their company or even to Fidelity or another DAF sponsor, which will pay management fees to financial advisors for large donor-advised funds. So long as the assets remain in the DAF account, the management fees continue to flow into the financial advisor’s pocket as if the funds still belonged to the client, rather than to the client’s DAF.

In short? DAFs are a cash cow for financial advisors, and the bigger the cow, the better.

The third set of culprits are community foundations. This breaks my heart, because community foundations are core institutions supporting and often leading their communities. Community foundation staff members by and large are great people who care about helping local charitable causes. But the assets of many community foundations, particularly the younger foundations that don’t have generations of unrestricted assets, are largely comprised of donor-advised funds, and most new contributions go into DAFs. This focus on DAFs causes challenges.

Community foundations draw fees from their assets to fund their operations, a business model that drives some unhelpful behaviors. The community foundation business model relies on most constituent funds being invested in perpetuity, or at least for a long time.

Consequently, many community foundations speak to their donors about creating family legacies, multi-generational funds, and "endowed DAFs." This perhaps explains why grant distributions from community foundations in 2023, according to the Inequality.org report, were only 9.0%, compared with 16.3% from commercial gift funds.

This focus on long-term funds may explain why community foundations fought vociferously against the ACE Act, even though its provisions specifically excluded community foundation DAFs under a million dollars from having to spend down their assets.

The fourth set of culprits are the associations purporting to represent the nonprofit sector. When the Accelerating Charitable Efforts (ACE) Act was proposed in the 117th Congress, virtually no nonprofit associations spoke out in favor of it, even though, if passed, a huge amount of money would have been flushed out of donor-advised funds to support operating charities.

The usual opponents of DAF reform – the libertarian Philanthropy Roundtable, the Council on Foundations, and the Community Foundation Public Awareness Initiative – actively worked to torpedo the ACE Act. Two other opponents:

• Independent Sector, which has both foundations and operating nonprofits as members, embraced the priorities of the foundation world. Foundations are generally supportive of the DAF status quo.
• Meanwhile, the National Council of Nonprofits chose “to study” the issue until it died. As I’ve written before, the National Council of Nonprofits receives what seems to be significant support from the Fidelity Charitable Trustees’ Initiative, as do Independent Sector, Giving USA, and many other influencers within the field. (My hope is that the National Council, under the impressive new leadership of Diane Yentel, will shift its stance and sever ties with Fidelity.)

While all of this was going on, the commercial DAF funds – the behemoths like Fidelity – stood by, smiling while the nonprofit associations and community foundations did all their lobbying work for them.

The fifth set of culprits are the private foundations who use DAFs to hide their activities and avoid distributing any funds at all. This is a neat and unconscionable trick.

Since 1969, private foundations have been required to use five percent of their assets each year for charitable purposes. These charitable distributions are part of the public record. But when a private foundation makes a grant to a DAF, the accountability trail goes cold, and the foundation (which presumably controls the DAF) can do whatever it wants with the money, without anyone knowing.

I drew attention to this scam thirteen years ago in one of my first blog posts. More than a decade later, some of the wealthiest people in America, including Elon Musk and Larry Page, have buried hundreds of millions of putatively charitable dollars in this paper-shuffling scheme. It’s great for the privacy and influence of billionaires. It’s bad for the federal government (so much lost tax revenue!). And it's disastrous for working nonprofits.

The sixth set of culprits are nonprofit leaders themselves. The nonprofit sector is filled with idealistic, visionary, and hard-working individuals. I consistently stand in awe of the creativity and devotion demonstrated by so many nonprofit leaders. But when it comes to challenging donors and funders, these same folks are silent.

It’s generally not a wise idea to bite the hand that feeds you, and nonprofits do not want to offend their local community foundations or any of their DAF-holding donors by implying that the DAF model encourages the hoarding of charitable assets that are needed today. Ideally, nonprofit associations would be speaking up for these vulnerable nonprofits – but, as I explain above, most don’t. As a result, nonprofits need to speak up for themselves – and pressure their associations to do the right thing.

The seventh set of culprits are wealthy donors. For wealthy donors, there’s nothing not to like about DAFs. Donors get a full charitable deduction up front, just as if they were donating the money to a food pantry or a Boys & Girls Club; they avoid capital gains taxes on appreciated assets; they retain practical control of the distribution of grants, without any spending requirement, ever; and there’s complete privacy and zero transparency.

And when donors then leave DAFs to their children, they are perpetuating their power. They are passing along to their kids the prestige and influence to give (or not give) to charitable causes, on into the future.

Few people ever suggest to donors with DAFs that they are effectively hoarding both money and power. We talk about their generosity – and, indeed, there’s often a great deal of genuine charitable intent. But the fact is, undistributed charitable assets that remain in DAFs are not working to solve the significant problems facing the world. Few donors think in these terms, because those of us in the nonprofit world (as well as their professional advisors – the attorneys, accountants, and investment advisors whom writer and activist Chuck Collins calls “the wealth-defense industry”) are trained to fawn on them.

The final set of culprits are the donors and organizations providing support to the Trump Administration – and who use DAFs to do so.

Most of us are aware of Project 2025, the blueprint from the Heritage Foundation that has driven Trump’s second-term agenda. Since 2020, Project 2025 and aligned politically-driven nonprofits have received some $171 million from Fidelity, Schwab, and Vanguard DAFs alone. Meanwhile, the right-wing donor-advised fund sponsor DonorsTrust, dubbed "the dark-money ATM of the conservative movement" by Mother Jones in 2013, pours money from untraceable donors into the Heritage Foundation, the America First Policy Institute, the Federalist Society, and dozens of other groups working to further deeply conservative political agendas.

In her remarkable 2016 book, Dark Money, New Yorker journalist Jane Mayer quotes conservative megadonor Charles Koch talking about the need to “weaponize philanthropy” to further conservative causes. Part of this plan has been to create rabidly conservative organizations, such as the Heritage Foundation and the Federalist Society, that despite their partisan, political agendas earn designation as 501( c)(3) public charities. Central to those organizations’ ongoing effectiveness and power are anonymous contributions from donor-advised funds. Koch and his colleagues have accomplished this manipulation of the charitable tax laws with stunning success.

Changing the culprits into allies

The people and institutions behind the unregulated and frankly terrifying growth of DAFs need to be called out. But some of them can also help turn things around.

Let’s ignore the first two groups I list above: the financial services firms and the financial advisors. They’re never going to subvert their core drive for profit and do what’s right for the community. As Upton Sinclair noted a century ago (and forgive the gendered nature of the quotation), “It is difficult to get a man to understand something, when his salary depends on his not understanding it.” So too, the billionaire donors behind the right-wing “nonprofits” like the Heritage Foundation and the America First Policy Institute.

But community foundations can adjust their business models to be less dependent on drawing fees from assets in place. They should urge their DAF holders to spend down their assets for the good of the community. They can and should embrace the realization that passing through as much money as possible to meet current, crying needs strengthens their communities – and when community foundations show this kind of strategic generosity, new donations are sure to follow.

Nonprofits, for their part, should extoll donors who spend down their DAFs, or who leave DAFs to charity at death. Nonprofits should go on the record supporting DAF reform, and they should pressure their nonprofit associations to do the same. And those nonprofit associations should remember whose interests they were created to support — operating nonprofits and their missions — and speak out in favor of DAF reform, even if they offend some of their donors.

Those private foundations that are meeting their charitable distribution requirement by dumping money into DAFs will keep on doing just that, so long as it’s legal. It would be a relatively simple act for legislators to close the DAF loophole — but we all have to apply pressure on political leaders and regulators to make that happen. (This common-sense provision was part of the unsuccessful ACE Act.)

Meanwhile, donors – most of whom very much want to do the right thing – can be persuaded to change their behaviors. Many donors simply haven’t been told how counterproductive their perpetual DAFs have become. I have some hope that, if the situation is explained to them, donors in larger numbers will come to realize that to have real impact — and to derive the satisfaction that comes with making a difference — they need to spend down their DAFs, or transfer them to charities at their death, and not leave them to their kids.

* * *

It’s imperative to change how DAFs operate.

I’m the grandfather of three little boys. They, and hundreds of millions of other children around the world, will inherit this terribly fragile and damaged world of ours. On their behalf, we have to invest in saving the planet from climate disaster now. We need to provide opportunity, healthcare, and education to the least powerful and most vulnerable people now. We need to defend democracy now. We need to tear down structural racism and sexism and bias of all kinds now. And we have to recognize that a quarter-trillion dollars sitting in "charitable" investment accounts is a tragic waste. Money percolating in DAF accounts doesn’t fix a damned thing.

ABOUT THE AUTHOR: Alan Cantor has been working with nonprofit organizations since 1982, as a staff member, executive, board leader, and consultant. You can read more of Alan Cantor's writing here, where you can also reach him.

by Philanthropy Project