Lawsuit over $21 million donor-advised fund highlights CFO risks

A version of this article first appeared in CNBC’s Inside Wealth newsletter with Robert Frank, a weekly guide for wealthy investors and consumers. Register to receive future editions, straight to your inbox.

As donor-advised funds gain popularity as a way for the wealthy to give back, risks and potential conflicts of interest are emerging — and are being highlighted in a lawsuit over a family’s $21 million charitable fund.

Philip Peterson, a 63-year-old Kansas resident, filed suit in January alleging that the nonprofit that manages his family’s donor-advised fund had refused to communicate with him and failed to make charitable grants he had recommended since early 2024. The suit, filed in federal court in Colorado, alleges that the Christian nonprofit, called WaterStone, cut off his access to account information and that he doesn’t know how the fund has performed since the end of the year. 2023, when it had $21 million in assets.

The attorney for WaterStone, founded as the Christian Community Foundation, said in a statement that the Colorado Springs nonprofit respected the wishes of Peterson’s late father, who originally established the fund in 2005 and died in 2019.

This case highlights the growing adoption and dangers of donor-advised funds, or DAFs, which have quickly become one of the dominant forces in philanthropy. Americans donated nearly $90 billion to DAFs in 2024, according to the latest annual report from the DAF Research Collaborative. According to the most recent data available, DAFs held $326 billion in cumulative assets in 2024.

For Americans looking to give back and save on taxes, DAFs are marketed as a simple and flexible way to do so, often described as charitable savings accounts or credit cards. Instead of writing a check to a nonprofit, donors contribute cash and other assets to a DAF. Although the tax deduction is immediate, the funds can be allocated to charity later.

DAFs, unlike private foundations, are not required to distribute assets within a given time frame, a common criticism among opponents who believe DAFs are vehicles for hoarding wealth.

The Peterson case serves as a cautionary tale about the trade-offs that need to be made – particularly when it comes to control. Although donors are able to recommend how funds will be distributed to charities, the assets are legally controlled by the organizations that administer the DAF on their behalf. Although these organizations, also known as sponsors, generally respect the wishes of their donors, donors have little recourse if they do not.

“It’s sold to the public as, ‘This is your account, and you can decide where it goes, you can move it, and you keep full control.’ “But if you don’t give up dominance and control, you won’t get tax benefits,” said Ray Madoff, a tax expert and professor at Boston College Law School. “There is a disconnect between the legal rules that govern it and the understanding of the parties. And this case is a perfect example.”

Peterson told Inside Wealth that the breakup with WaterStone began with a disagreement over how much to distribute.

In early 2024, Peterson says, WaterStone CEO Ken Harrison told him the organization was going to hold the fund’s capital in perpetuity and only make grants from investment income. Peterson said he disagreed with the proposal because it would not allow the fund to make its usual annual grants of between $2.3 million and $2.5 million.

Now, Peterson is suing to assert his advisory privileges and regain access to the DAF, which was started by his late father, Gordon Peterson, a real estate investor and devout Christian, to support evangelical Christian causes. Peterson ultimately asks the court to force WaterStone to transfer the DAF to another organization so it can restart donations to the fund.

He said he asked WaterStone to provide a $1 million grant in 2024, but he doesn’t know if that grant — or if any grants — were awarded that year. In 2025, WaterStone informed Peterson it would authorize a $400,000 distribution from the fund, he said.

“I made a promise to my father. I promised him that if I was the remaining person in the account, I would direct the funds because I knew he would approve 100 percent,” he said. “I want to be a man of my word.”

WaterStone declined to comment on the details of Peterson’s allegations. The deadline for WaterStone to respond to the complaint in court or decide whether to dismiss it is mid-March.

“WaterStone has consistently carried out the wishes expressed by the donor since the inception of the fund advised by the donor in question,” WaterStone’s legal counsel said in a written statement, referring to Peterson’s father. “The plaintiff in this case is not the donor.”

Andrew Nussbaum, Peterson’s attorney, said WaterStone helped Gordon Peterson appoint his wife, Ruth, and son Philip as co-advisers to the DAF before his death. Ruth Peterson died in 2021, leaving Philip Peterson as sole successor-advisor. Before 2024, WaterStone had granted Philip Peterson’s grant requests, Nussbaum said.

Nussbaum said the lawsuit could set a frightening precedent if the court upholds WaterStone’s argument that designated successors do not have advisory privileges.

“If WaterStone is correct, you’re talking about billions of dollars that are beyond any sort of legal reach of the original donor-advisors or their successors to exercise any oversight over the funds,” Nussbaum said.

Additionally, Peterson said he believed WaterStone failed to honor his father’s wishes. He alleges that WaterStone delayed or refused his grant recommendations, even though they met the mission statement written by his father, which included a list of approved charities.

“I can tell you this: My father would never have started a donor-advised fund if he knew that this was going to be the outcome. He was very passionate about this issue,” he said.

Law professor and DAF critic Roger Colinvaux said that in his view, donors who want to control DAF’s assets are trying to have their piece of the pie and eat it too.

“Whether you like DAFs or not, the sponsor of the DAF is an independent charity. It is an independent entity and its obligations do not concern the donor,” said Colinvaux, a professor at the Catholic University of America’s Columbus School of Law. “If the plaintiff wanted the kind of control that he appears to want, as evidenced in the complaint, there is a structure for that, and that is a private foundation.”

Dana Brakman Reiser, a professor at Brooklyn Law School, cautioned that Peterson’s story is a rare scenario. She said DAF’s biggest sponsors, like Fidelity Charitable and Schwab Charitable (now DAFgiving360), are affiliated with financial institutions and are generally inclined to keep donors happy.

“It’s in their best interest as long as honoring the donor’s request doesn’t get the sponsor in trouble,” she said. Brakman Reiser added that the IRS prohibits using DAF assets to purchase gala tickets or support private foundations or non-501(c)(3) organizations.

Yet the interests of sponsors and donor-advisors are rarely perfectly aligned.

Sponsors typically charge a fee for managing the DAF’s assets, creating an inherent financial incentive to shell out fewer assets, according to Chuck Collins, director of the Inequality and Common Good program at the Institute for Policy Studies, a progressive think tank. Although community foundations pioneered the DAF model, they now compete with larger corporate sponsors for donor dollars, he added.

“More and more, they have to compete with commercial DAFs like Fidelity, which have very low overheads and don’t take a lot of fees. And so what’s the business model of a community foundation where, you know, 80% of the donations come from people wanting to create DAFs? he said. “In reality, their business model now depends on people parking their assets for longer periods of time.”

Although Peterson’s case is unusual, it is not the first legal challenge involving DAFs.

In 2018, a pair of hedge funds sued Fidelity Charitable, claiming the sponsor broke an agreement to gradually liquidate their donated shares and sold 1.93 million shares, a position initially worth $100 million, within hours. Fidelity Charitable argued that it had followed the law and the case was decided in their favor.

In another notable debacle, in 2009, a Virginia-based charity, the National Heritage Foundation, destroyed 9,000 DAFs worth a total of $25 million to pay creditors after filing for bankruptcy.

Donating directly to a charity does not necessarily guarantee that the assets will be used according to the donor’s intentions. But adding a middleman into the equation adds another layer of complexity.

The few lawsuits filed by donor advisers over how DAF assets are spent or invested have so far largely failed in court.

In short, according to Colinvaux, the courts confirmed that the donors ceded all control in order to benefit from the tax break. If donors had the right to control their assets – as opposed to the privilege of giving advice – they would not be able to claim a deduction, he said.

Nussbaum said Peterson’s case is different because he focuses on his grant advisory rights rather than controlling how the assets are investments.

Peterson said he tried to resolve the dispute with Waterstone for about two years before going to court. Although he knows his trial faces considerable challenges, he said he felt he had no choice.

“People have a tremendous amount of trust in these companies, and we hope to find out what these companies can and cannot do,” he said. “It could have a big impact on the industry, and I don’t want to be that guy. All I want is to be able to carry on my father’s legacy.”