DAF Proposed Regulations: Should Personal Investment Advisors Be Subject to the Per Se Excess Benefit Prohibition?

I am working my way through the comments submitted in response to the proposed 4966 regulations.  I am about halfway through and although I am reading the comments, not just skimming them, I doubt that I am reading them as closely as Ward Thomas and the folks in Chief Counsel’s office.  Suffice it to say, they have a whole lotta work yet based on my reading of the comments.  The treatment of a donor’s personal investment advisor (PIA) in the proposed regs will likely get the lion’s share of further study and attention.  Here is the gist of the concerns:

1. IRC 4958(c)(2) defines DAF excess benefit transactions as “any grant, loan, compensation, or other similar payment” (apparently any payment like any one of those dissimilar transfers) from the fund to a donor or donor advisor if the donor or donor-advisor has advisory privileges.  Thus, practically any transaction between a DAF and the donor or “donor advisor” is automatically taxed as an EBT, regardless of whether the payment is no more than FMV for goods or services rendered to the DAF.  The whole grant, loan, or compensation is the excess benefit.

2. IRC 4966(d)(2)(iii) indirectly defines what the regs call a “donor-advisor” as a person appointed or designated by a donor to provide advice to the DAF. Prop. Reg. 53.4966-1(h)(1).  As a practical matter, neither donors nor their appointees or designees may transact with the DAF because excess benefit transactions are defined so broadly.

3. Proposed Regulation 53.4966-1(h)(2) states that a donor’s personal investment advisor who also advises a donor regarding the donor’s DAF is an automatic [“deemed”] donor-advisor even without an explicit designation or appointment to that effect by the donor. There is an exception for a donor’s personal investment advisor who advises the sponsor “as a whole” rather than just the DAF.  Prop. Treas. Reg. 53.4966-1(h)(3). Even so, that investment advisor is prohibited from more than incidental private benefit by IRC 4967.

4. Thus, a donor’s personal investment advisor is effectively prohibited from accepting even FMV compensation from the donor’s DAF.

All that seems reasonable, but perhaps only if (like me) you are relatively ignorant about the industry.  The commenters who know a thing or two more hate the proposal. Here are the common assertions:

a.  Whatever conflict of interest might exist when a PIA also advises a donor regarding her DAF is adequately policed by laws and licensure standards pertaining to investment advisors. There is no need for a per se rule prohibiting a donor’s personal advisor from transacting with the donor’s DAFs when the advisor is not designated or appointed by a donor as having advisory privileges.

b.  The proposal would provide an advantage to the big investment advisory firms that set up their own charities to sponsor DAFs.  The Morgan Stanleys, Goldman Sachs, and JP Morgan Chases, according to the Kansas City Community Foundation.  These big investment firms create sponsors, and then serve as the exclusive investment advisor for those sponsors while also sometimes providing personal investment advice to individual donors.  Since the big firm advises the sponsors regarding its entire operations, the PIA will not be a donor-advisor subject to IRC 4958 according to 53.4966-1(h)(3)(ii).  Funds established by community foundations and other non-commercial industry groups will not enjoy the same natural advantage since they will not have in-house advisors serving their entire operations. Instead, donors will more often want to retain their own advisor for their DAF and their personal assets. But those advisors will be subject to 4958.  Thus, the proposal creates an incentive for sponsors (whose managers are subject to an excise tax for approving transactions) to affiliate or remain with the larger firms that serve and advise sponsors generally, rather than accept advice or services from a donor’s personal investment advisor.  A sponsor would rather work with the larger firm because doing so provides greater assurance that managers will not get hit with the excise tax.  IRC 4958(a)(2). 

c.  Investment Advisors are thoroughly regulated by IRC 4967, which imposes a 125% tax on a designated advisor whose advice to a sponsoring organization regarding a DAF leads to the advisor’s receipt of “more than incidental benefit.” But even that provision applies to an investment advisor designated by a donor (not treated as a donor-advisor by virtue of a “deemed” rule.)  IRC 4966 incorporates IRC 4958(f)(7)’s definition of donor-advisor and the latter provision incorporates the definition in 4966(d)(2)(A)(iii).  That provision refers to a specific designation or appointment by the donor.  The Kansas City Community Foundation threatens that if the proposed rule is adopted, we should probably expect some “post Chevron deference” litigation about it. 

1.  The counter-argument.  It depends on what the definition of “is” is.  A personal investment advisor who advises the donor regarding her personal assets is necessarily “appointed or designated” to advise the donor (even if the exact magic words — designate or appoint — are never spoken), and thus the DAF, regarding investment or distributions from the DAF.  I think this is an indisputable truth, but that doesn’t mean PIAs should be treated with suspicion, given the laws and licensure standards to which they are subject.

2.  Has Congress already settled this question?  Are the proposed regulations an administrative attempt to change Congress’s mind?

e.  Nothing in IRC 4958, 4966, or 4967 explicitly authorizes the treatment of a donor’s personal investment advisor as a “donor advisor” for purposes of the excess benefit or taxable distribution tax without a donor’s designation of the IA as a person having advisory privileges.  

f.  Congress did not make investment advisors automatic donor-advisors when it amended 4958 to deal with DAFs. Nor did it intend to automatically prohibit personal investment advisors from transacting with a donor’s DAF.  It addressed investment advisors in 4958(f)(1)(F), and 4958(f)(8)(A) and neither provision imposes an automatic and complete ban on a donor’s personal investment advisor transacting with the donor’s DAF in the absence of a designation or appointment. 

g.  Prohibiting personal investment advisors from working with a DAF when the investment advisor also works with a donor’s personal investments will end up diverting assets from charities altogether, or perhaps to private foundations where no such blanket rule exists.

One supposes that a personal investment advisor invariably has advisory privileges regarding a donor’s assets whether transferred to a DAF or not.  The proposed regs sensibly note that no specific language is necessary to “appoint or designate” an advisor.  So there is a practical justification for treating an otherwise undesignated personal investment advisor in the same manner as an explicitly designated or appointed donor-advisor. 

But if the concern is only that a personal investment advisor will coordinate a donor’s personal and charitable investments, at least one commenter suggests the concern is overblown.  Don’t donors do that anyway?  There is nothing wrong with a donor’s investment in renewable energy, for example, being coordinated with the donor’s contribution to an environmental nonprofit pursuing similar goals.  It’s only a problem if the donor derives a private benefit.  IRC 4967 seems to cover that sufficiently.  Except that by its language IRC 4967 does not apply to undesignated or un-appointed advisers.  Perhaps the “deemed designation” rule works better as a regulation under IRC 4967, as another commenter suggests.  

Finally, some commenters assert that investment advisors don’t often make recommendations regarding disbursements.  The regulations suggest that an investment advisor might counsel against disbursements to keep assets under management (and thus fees) higher.  Commenters suggest that investment advisors mostly provide investment expertise,  not disbursement advice.  I suppose the distinction might not be real, because an investment advisor might recommend holding.  That advice, if followed, necessarily reduces disbursements.  Still, the asserted distinction makes me think of a suggestion I have not seen in the comments yet.  If an investment advisor provides no disbursement expertise, but only advises on investments, the concerns motivating the proposed treatment of PIA as automatic donor-advisors seem unnecessary.  Presumably, investment advice will always be objective and well researched regardless of whether the investment advice concerns DAF assets or the donor’s personal assets.

darryll k. jones