Shattered Trust: $21 Million DAF Lawsuit Threatens Donor Confidence

Donor-advised funds have soared in popularity in recent years, but a new lawsuit that shines light on what donors legally give up when they create a DAF could undermine trust in the accounts, say those watching the case.

“This is a fascinating case because it points out the tension between the real-world practice and the actual legal structures used,” says Russell James, a long-time fundraiser and attorney who now leads the charitable financial planning graduate program at Texas Tech University. 

DAFs are accounts held by sponsoring organizations in which donors deposit money that must be used for charitable purposes. Donors receive an immediate tax break and can decide later where to send the money.  

Once money is deposited in a DAF, the organization sponsoring the account becomes the legal owner of the funds. Donors can advise the sponsor how to disburse the money, and sponsors nearly always follow donor recommendations. 

“In practice, a DAF would almost never go against the reasonable advice of a funder because to do so would essentially shut down future gifting to the DAF were it to become known,” says James.

The Circumstances of the Case

Philip Peterson sued the Christian Community Foundation, which sponsors DAFs under the name WaterStone. He is identified in the lawsuit as the “successor adviser” to a DAF started by his father. Philip Peterson became an adviser in 2017 and continued making gifts from the DAF until 2023. The suit alleges that after Peterson had a disagreement with a WaterStone executive, the sponsoring organization failed to make a $1 million grant to a Christian charity as Peterson requested. Peterson also alleges that his access to the accounts was removed, and he now has no idea how much is in the account and can no longer grant money to charities from the account his father opened.

“I promised my father that if I was the remaining person on the fund, that I would direct this money to organizations that I knew that he felt strongly about and he wanted to support,” Peterson told the Chronicle. But Peterson hasn’t been able to keep that promise. 

He informed the charity to expect a $1 million gift in 2024. Since that time, he says, “They would check in with me because there were certain programs that money was going to be used for. That really put them in a huge bind.” 

WaterStone’s chief giving strategist, Rick von Gnechten, told the Chronicle by email before its court filing that “WaterStone has consistently carried out the articulated wishes of the donor since the donor-advised fund in question was established. The plaintiff in this case is not the donor. Because of the pending litigation, WaterStone declines to comment further on this matter. Any additional positions taken on this matter will be made through WaterStone’s filing in response to Mr. Peterson’s Complaint.”

WaterStone’s filing in court requested to dismiss the case. In its request, the DAF sponsor argues that Peterson has no standing to sue because he is not the legal owner of the funds. WaterStone’s filing states that the terms of the DAF do not “call for WaterStone to honor grant recommendations, provide accountings, follow particular guidelines, have particular controls, or engage in particular communications. To the contrary, the terms provide only that the donor’s ‘gift is irrevocable’ and that ‘ownership and custody … will be fully relinquished to the Christian Community Foundation.’”

‘What’s Legal’ Versus ‘What’s Ethical’

The legal structures of a DAF do not really give individual donors rights to control their accounts, says Philip Purcell, who teaches courses on nonprofit law and fundraising at the Lilly Family School of Philanthropy.

Instead of control, donors get advisory privileges. “It’s not legal control, it is advisory,” Purcell says. “A lot of people don’t realize that when the statute says advisory, it really means that. It’s not legal control. The legal control rests with the owner, the charity that is the sponsoring organization.”

The allegations that WaterStone stopped communicating with and ignored Peterson’s advisory privilege, James notes, could be problematic. “Although the adviser can’t legally control the funds, they do have a right to advise as to its usage,” he says. 

While the legal terms of DAFs clearly state that donor advice doesn’t have to be followed, there wouldn’t be $326 billion held in DAFs if sponsors were ignoring advisers, Purcell says.

“If the sponsoring organizations of donor advised funds were not trying to work collaboratively with their donors, donor advisers, and successor advisers, you would not see donor advised funds being as popular as they are,” he says,

Typically, when DAFs don’t follow donor recommendations, it’s for reasons related to the law or the sponsor’s mission, says Purcell. Legally, DAF funds must be given to certain types of nonprofits, so if an adviser recommends money be given to a political campaign, that request should be denied. Similarly, DAF law prohibits donors from benefiting from DAF funds, so they can’t be used to pay for gala tickets. Some DAF sponsors are religious nonprofits that might deny a recommendation to a charity they believe is at odds with their religious mission.

Usually, when sponsors deny a grant recommendation, they tell the adviser why and allow them to direct the gift to a qualified use, or sometimes they’ll transfer the entire fund to a different sponsoring organization that better aligns with the adviser’s needs, says Dan Hiest, co-founder of the DAF Research Collaborative. In the lawsuit, Peterson alleges he was given neither option.

For the sake of public trust, it’s important that sponsoring organizations act both legally and ethically, says Hiest. “For me, it’s a matter of what’s legal and what’s ethical,” he says. “Nonprofits need to go beyond just what the law requires and try to deal with their stakeholders in ethical ways.”

James adds that while DAFs legally own the funds, he’s never seen that given as a reason not to interact with donors. Instead, they generally heed donor advisers’ wishes. “If you stop following donor recommendations, donors will stop using your DAF for future gifting,” he says. “Publicizing the actions would essentially shut down future contributions to the DAF because the trust has been broken.” 

While all observers the Chronicle contacted say this is a highly atypical case, there could be some ramifications. In addition to the possible weakening of trust that Heist mentioned, this case could also negatively impact small DAF sponsors.

“If anything, this says don’t pick a tiny little DAF that might go rogue,” James says. “Use one that’s got too much at risk if it becomes known that it ignores donor advice.”

Mike Wang, a partner at the philanthropic advisory firm Building Impact Partners cautions that the number of DAF providers is growing quickly. “The bigger the business gets, the more funky things like this we’re going to see happen,” he says. “That doesn’t mean we shouldn’t be using DAFs. But I do think that this idea that DAFs are a panacea is really off-base.”

Fuel for DAF Critics

Critics of the DAF structure, who have long complained that DAFs lack transparency and don’t do enough to make sure money goes out to charities, may see this case as fuel to push for more regulation of DAFs.

The DAF at the heart of the lawsuit had $21 million in it when the plaintiff last had access, and those following the case say he does not legally have the right to find out what happened to the money. Laws governing DAF sponsors require only the release of aggregated data about accounts, says Heist. 

That doesn’t mean DAF sponsors “can act in violation of the law and get away with it,” adds Purcell. “It only means that their records are not as accessible.”

Purcell and Alexander Reid, a partner at the law firm BakerHostetler, note that under current legal structures, the attorneys general in the states where WaterStone or Peterson are located would be able to look into what has happened to assets in individual accounts at a DAF sponsor. Peterson is located in Kansas. A spokesman for the office of Phil Weiser, attorney general of Colorado, where WaterStone is located, told the Chronicle he could not comment on whether WaterStone is under investigation.

If a donor’s only choice under the current law is to get the attorney general to act, then requiring greater transparency would be good for DAFs, says Chuck Collins, program director at the Institute for Policy Studies, which last year issued a report recommending changes to improve DAFs.

“A higher level of transparency would be good for everybody: for the public and for the DAF account holders,” says Collins, who recommends that sponsors be required to report on an account-by-account basis, not simply in the aggregate.

Another criticism of DAFs is that money sits in them too long without going to charities. “Some of the DAF sponsors — it’s really not in their interest for the money to move very fast because that’s how they’re going to earn their operating income,” Collins says. He thinks DAFs should have some requirement to move money out.

Andrew Nussbaum, Peterson’s attorney for the lawsuit, notes that their ultimate goal is to move the money to a different DAF sponsor so Peterson can disburse it to charities that he knows need it.

“We hope the court will say donor-advised fund sponsoring organizations have to honor their representations and commitments to donor-advisers like Phil and his father,” he says. “We hope to settle. It’s time to move to a place where these funds can go to their intended purposes.”