Self-Interest

My recent blog post, “Wall Street Muscles In,” certainly got some attention: my largest readership ever for a single post, and a record number of comments both in this space and on LinkedIn, where people from around the country (nonprofit executives and financial services folks, mostly) debated my indictment of the commercial gift fund industry.

The majority of the comments on these various sites were positive, but one individual accused me of unfairly impugning the integrity of the financial services industry. He wrote, “There is an undertone that those [financial] advisors using donor-advised funds are somehow unethical because they are wanting to hold onto money to manage. A good advisor will listen to his client/donor and find the best solution, whatever it is. If he or she is simply standing between the ‘real’ charity and the donor, of course, that’s improper, but I may have a little more faith in the advisory community than you.”

Indeed, my critic does have more faith than I in the financial advisory community.

If you have an hour, watch the recent “Frontline” episode called “The Retirement Gamble,” which methodically describes the layers of fees and empty promises that provide the shaky foundation for our 401-k-based retirement system. If you have a weekend to spend with an important book, read Helaine Olen’s Pound Foolish, a brilliant and relentlessly infuriating take-down of the financial services industry. Frontline and Olen effectively rip away the curtain between the client and the financial services industry. What’s revealed isn’t pretty.

Here’s one central fact: Financial advisors who have a formal “fiduciary duty” to their clients agree at all times to act in the clients’ best interest. But it turns out that only 15% of financial advisors actually agree to abide by that fiduciary duty. Instead, the vast majority of financial advisors work to what’s called the “suitability standard.” That is, they can sell clients products that can be considered okay, or suitable – but not necessarily in the clients’ best interest.

In other words, financial advisors by and large act in their own interest, so long as it’s not patently disastrous for their clients. Rather than making recommendations that are in the absolute best interest of their clients, they are much more likely to push purchases of financial instruments that pay the highest commission. And that approach is both widespread and perfectly legal.

I’m not saying that financial advisors are bad people. I’m only pointing out, for not the first time, that it’s important to understand how they get compensated for their work. Financial advisors are driven by fees and commissions, a compensation structure that may or may not align with the welfare of their clients.

My suspicions about how donor-advised funds play into this dynamic first arose about ten years ago when I was attending a dinner meeting of my local estate planning council. The presenter that evening was from a financial services firm out of Baltimore. He was describing a very complex estate plan he had put together for an extremely wealthy family.

Most of his talk described the convoluted structure the presenter had created to allow that family to pass its wealth tax-free to the next generation. But the aspect of the presentation that’s relevant to us today was that in introducing the family’s situation, the speaker noted that the older generation had a very clear commitment to fighting leukemia, because they had lost a child to the disease many years before.

What was striking to me was that when the final plan was presented – all the bells and whistles and trusts and shelters to preserve the family’s wealth – there was only one provision for charity: the creation of a $1 million donor-advised fund, housed, as you might have guessed, under the financial services firm’s umbrella.

I went up to the speaker afterwards and asked him why the family decided to disinherit the Leukemia and Lymphoma Society. He stared back at me with a blank look on his face. I reminded him that at the start of the talk he had noted the family’s commitment to fighting leukemia, but at the end there was no gift going to any organization involved in that cause – only a transfer into the financial services company’s donor-advised fund.

The presenter really didn’t have an answer for me. It honestly had never occurred to him that the charitable gift he came up with should actually satisfy the charitable intent of the clients. His plan was all about shuffling money around to preserve wealth – for the clients and for his company. It was, financially speaking, an elegant solution. In terms of meeting the needs of society and the expressed charitable interests of the family, it was an utter failure.

The financial advisor I met with that night was not a bad person. I would not go so far as to call him unethical or immoral.  Instead, there was a certain amorality about him. Morality and ethics simply didn’t enter into his thinking. He had determined his goal, and he defined it narrowly: it was about preserving wealth for his client and income for himself and his company. Charitable impact, charitable intent, societal good: none of that factored into his thinking. The plan he developed was legal, and it was lucrative. And that was that.

It was a telling interaction. My critic’s protestations notwithstanding, most actions by financial advisors are driven by self-interest and not the best interest of the clients. The vast majority of financial advisors have, strictly speaking, zero interest in funds going out to charity. But they have plenty of interest in having the funds parked in a donor-advised fund within their institution. And that, I’m sorry to say, is the gravitational force that relentlessly and insidiously pulls them, and their clients’ money.

Copyright Alan Cantor 2013. All rights reserved.

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3 thoughts on “Self-Interest”

    1. Hi, Alex —

      I’m not in the business of suggesting financial advisors. That said, based on my understanding, my reading, and my own recent experience as a client, I would encourage people:

      1) To inquire if the advisor is abiding by the fiduciary duty or by the suitability standard (and do your best to get someone with the fiduciary duty);

      2) To look for a fee-only advisor, that is, the advisor charges a specified fee for the services, but doesn’t get compensated either as a percentage of funds under management or as a commission from the sale of financial products; and

      3) To try to invest in low-fee index funds wherever possible.

  1. You’ve hit the nail on the head. Many community foundations have created charitable partner programs that allow financial advisors to continue to manage the funds donated to them in an effort to try and warm up to those advisors who dissuade a client from a charitable gift. If it’s not a financial advisor it’s a banker or trust officer who have charitable gift funds as well.

    I have very much enjoyed reading your opinions on donor-advised funds. I know there is much to be decided within the field as well as from the government’s standpoint. I agree that there should be a minimum percentage of distribution, although 20% would seem high as community foundations are based upon endowment and you could not keep an endowment in perpetuity at that rate. Endowment is a very important component of charitable giving in the United States. I’m not sure what the answer to this issue is, but I do know that community foundations have these types of conversations regularly. In the nine years I have worked in the field I have seen many changes.

    Community Foundations did very well raising money prior to donor-advised funds, but the research tells us that younger donors don’t trust the establishment and will not just donate their money and entrust a foundation to make the best choice as experts in nonprofits. So, CFs jumped face first into the pool of donor-advised funds. The older established foundations have large unrestricted pots of money that allow them to make the best decision as to what nonprofit should receive the money today. I don’t think small donor-advised funds make sense, but I do understand them at large levels with an endowed component to them that have an end to the donor’s advising period with and ultimate disposition. The disposition would be a permanent fund at the foundation with a broad enough focus to serve the community forever. As an endowment a community foundation’s first job should be in their donor’s legacy. Some community foundations seem to have forgotten this very important component of their existence.

    Community Foundations are a great option for donors with no heirs or those who want their annual nonprofit gifts to continue forever. The community foundation will most likely outlive the nonprofit receiving that annual gift and will then decide for the donor what the most closely related charity is so that charity can receive the annual distributions. I personally support several nonprofits, but I’m not sure I would trust giving them the entirety of my estate if I was only giving them $1,000 a year when I was alive. But, I would trust a community foundation to endow the money for me and my favorite nonprofits.

    In 1952 a woman left $400,000 to a community foundation. Her $400k was used to start a scholarship fund for physicians. Since 1952 it has helped over 750 physicians attend medical school. It has given out over $2 million in scholarships and the value of the fund today is well over $2 million. If she had given that $400K directly to a charity it would be gone today. This only happened because she was clear with what she wanted the charitable dollars to do and why. That is the component missing from a donor-advised fund. There is no mission.

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