Donor Does Not Have a "Right" to Decide Where Donor Advised Funds Are Donated

(Parker Tax Publishing October 2022)

A panel of the Ninth Circuit affirmed a district court's holding that a donor to a donor advised fund (DAF) did not have standing to sue the Schwab Charitable Fund in federal court for allegedly breaching its fiduciary duties by, among other things, deducting excessive fees from donor's DAF. The court further found that, because the donor has no right to control how Schwab Charitable invests or donates the funds he contributes, and because he did not allege that the right he does have - the right to provide nonbinding advice - was infringed, his property rights-based theory of standing failed as well. Pinkert v. Schwab Charitable Fund, 2022 PTC 282 (9th Cir. 2022).

Background

Philip Pinkert opened a donor-advised fund (DAF) at Schwab Charitable in 2007. In 2020, Pinkert filed a lawsuit against Schwab Charitable Fund, the Schwab Board of Directors, and the Schwab Charitable DAF (collectively Schwab). He filed the suit on behalf of himself and similarly situated individuals and on behalf of the general public.

According to Pinkert, Schwab breached its fiduciary duties with respect to its management of the Schwab DAF under both common law and California's Uniform Prudent Management of Institutional Funds Act to the detriment of Schwab DAF donors and the charitable organizations that are the ultimate recipients of its assets, all of whom suffer when excessive fees are deducted from those assets. As a result of these breaches and violations, Pinkert also argued that Schwab violated the California Business & Professional Code. Pinkert brought the suit, he said, to remedy this unlawful conduct, prevent further mismanagement of the Schwab DAF, recover the losses caused by Schwab's violations and fiduciary breaches, and obtain equitable and other relief as provided by California law.

Specifically, Pinkert argued that Schwab's conduct injured him in four ways. First, although Pinkert donates funds to Schwab for some purposes, he retained a property right to direct the funds to charities, and the excessive fees and Schwab's related mismanagement of the funds impaired his ability to exercise that property right. Second, because his DAF does not contain as much money as it would have absent the excessive fees and Schwab's allegedly imprudent management of his account, Pinkert argued that his reputation for charitable giving will not be enhanced as much as he intended. Third, having less funds available to direct means that Pinkert cannot express his values as strongly as he would have been able to otherwise. Fourth, Pinkert said he may need to contribute more funds to his DAF in the future to make up for the excessive fees and other mismanagement by Schwab.

Pinkert filed suit in the U.S. District Court for the Northern District of California. After Schwab moved to dismiss, the district court held in 2021 PTC 176 (N.D. Cal. 2021) that Pinkert lacked standing under Article III of the Constitution, as well as statutory standing under California law. Article III of the Constitution gives federal courts the power to adjudicate only genuine "cases" and "controversies." That power includes the requirement that litigants have standing. In DaimlerChrysler Corp. v. Cuno, 547 U.S. 332 (S. Ct. 2006), the Supreme Court held that a plaintiff has standing only if he or she can allege a personal injury that is fairly traceable to the defendant's allegedly unlawful conduct and likely to be redressed by the requested relief. The district court allowed Pinkert to amend his complaint, but he notified the district court that he did not intend to do so, and instead wished to appeal. The district court then entered judgment for Schwab and Pinkert appealed to the Ninth Circuit.

Donor Advised Funds

A DAF is a charitable giving vehicle that allows donors to take a present-year income tax deduction, while distributing the funds to charity at a later time. Under Code Sec. 4966(d)(2), a donor-advised fund is defined as (1) a fund or account owned and controlled by a sponsoring organization, (2) which is separately identified by reference to contributions of the donor or donors, and (3) where the donor has or reasonably expects to have advisory privileges over the distribution or investment of the assets by reason of the donor's status as a donor. Thus, although a DAF holds title to the money (in part, so that donors may claim the tax deduction), donors possess broad rights and continue to receive significant benefits after their initial contributions are made. DAFs let donors choose the investment options in which DAF asset are invested, and give them a robust right to "advise" how the funds will ultimately be distributed to existing public charities.

The IRS Guide Sheet on DAFs sets the baseline for donors' advisory rights as "the right of a donor to provide noncompulsory recommendations, suggestions or consultative advice" about the disposition or investment of funds in the donor's account. In practice, Schwab donors often control the disposition of account assets, subject only to Schwab's review to ensure donations are going to charitable organizations and will not provide personal benefit to the donor. Thus, the advisory rights granted to donors permit donors "to promote [their] own substantive, religious, or social goals" for many years after the DAF is first funded.

DAF accounts are generally charged two types of expenses. First, there is an administrative fee that covers the expense of operating the accounts and processing charitable donations. This fee is generally charged annually as a percentage of the assets in the account, with the percentage charged declining as the amount of account assets exceeds certain breakpoints (e.g., the administrative fee might be 0.75 percent on the first $100,000 donated, 0.50 percent on the next $900,000, 0.25 percent on the next $1,000,000, etc.). Second, DAF assets are then invested in one or more pooled investment vehicles, and these vehicles charge annual investment management fees as a percentage of the assets invested.

DAFs are maintained and operated by Code Sec. 501(c)(3) public charities, called sponsoring organizations. As such, operating a DAF cannot be a for-profit enterprise. A DAF organized in the State of California cannot be "organized or operated for profit," and "no part" of its net earnings may inure to the benefit of any private shareholder or individual. The assets of a nonprofit corporation cannot facilitate a third party's more advantageous pursuit of their business, meaning that the DAF cannot, through its dealings with a third party, provide the party a benefit better than a person might obtain through arm's length negotiation.

Analysis

A Ninth Circuit Panel affirmed the district court and held that Pinkert lacked standing under Article III. The court quickly dispensed with Pinkert's arguments regarding his purported need to contribute more to the DAF and the related impact on his reputation and his expressive rights. It found that it did not need to decide whether these theories of injury were cognizable in general because Pinkert did not allege that he had experienced or will experience any of these purported injuries. Pinkert, the court noted, did not allege that he has attempted to direct a donation of a particular amount and was unable to do so because Schwab's alleged mismanagement left less in the account than he expected. Nor, the court observed, did he allege that he has contributed more to the DAF to make up for the allegedly excessive fees and poor investment decisions. Because Pinkert did not allege that he has already been injured in these ways, the court understood him to be arguing that he is likely to be injured by the excessive fees in the future.

While an injury that has not yet materialized but will occur in the future can be a basis for Article III standing, the court stated, the injury must be "imminent," meaning that it must be "certainly impending." The court found that whether Pinkert's asserted injuries are certainly impending depends on whether he plans to make donations of particular amounts in the future and will be unable to do so because of the alleged mismanagement. But, the court noted, Pinkert did not allege that he has any such plans, nor did he allege the details necessary to show that any such plans are concrete.

The court also found Pinkert's property-rights argument unpersuasive because when Pinkert donated to his DAF, he did so subject to Schwab's "Program Policies." Those policies, the court observed, allow account holders to "recommend" funds in which Schwab may invest the assets, and charities to which it may issue grants, but Schwab retains final authority over the distribution of all grants and may decline or modify a grant recommendation that is inconsistent with the Program Policies, or for any other reason. Therefore, the court concluded that while Pinkert could advise where the funds should be invested, he did not retain any "right" to direct where the funds will be invested or donated.

For a discussion of the tax treatment of DAFs, see Parker Tax ¶63,560.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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