A federal District Court in California has allowed donors of $100 million to a donor advised fund at Fidelity Investments Charitable Gift Fund to proceed with a suit for damages they claimed resulted when, contrary to its representations, Fidelity dumped the gift stock immediately upon receipt and depressed the value of the gift for charitable donation deduction purposes.  The Court has rejected a motion to dismiss the case, holding that the plaintiffs have standing to sue and have adequately alleged causes of action.

Emily and Malcolm Fairbairn, who run Ascend Capital, a San Francisco investment advisor that manages billions of dollars of investments, were facing “a substantial tax payment” for 2017 and decided to make a gift to a donor advised fund in order to claim the deduction.  On December 27, they spoke with a representative of Fidelity, who “aggressively pitched” them on why Fidelity would be a better vehicle than JP Morgan or Vanguard.  According to the complaint, the rep repeatedly boasted of Fidelity’s sophistication and “superior ability to handle complex assets.”

The Fairbairns decided to donate 1.9 million shares of Energous stock.  Energous stock had just jumped 39% because the Federal Communications Commission had approved its core technology.  The Fairbairns would face a significant capital gains tax if they sold, and would have more money for a fund to fight Lyme disease if they gave to a DAF. 

Not a current Nonprofit Issues subscriber? Start an introductory subscription for just $17.95.

They said they were concerned with Fidelity’s policy of liquidating stock at the earliest possible date, but that the rep made four “critical representations” about how it would handle the liquidation.  According to their complaint, he said Fidelity would employ “sophisticated, state-of-the-art methods” for liquidating large blocks of stock, would not trade more than 10% of the daily trading volume of the company, would allow the Fairbairns to advise on a price below which it would not sell the stock without first consulting them, and would not liquidate any shares until the new year.

The Fairbairns gave 700,000 shares on December 28 and 1.2 million more on December 29.  Fidelity liquidated all within a three-hour window on December 29, the last trading day of the year, causing a loss of “tens of millions of dollars” of overall value. 

The Fairbairns sued in August, 2017, claiming misrepresentation, breach of contract, negligence, and violation of the California Unfair Competition Law.  Fidelity filed a motion to dismiss.

Fidelity argued that the misrepresentation claim was governed by Rule 9(b) of the Rules of Civil Procedure, which required the plaintiffs to “state with particularity the circumstances constituting fraud or mistake.”  The Court found that the complaint adequately alleged facts to put Fidelity on notice of the particular misconduct charged.  It also found that the promise to use “state-of-the-art methods” for liquidation was not mere “puffery” when made in the context of the specific representations.

Fidelity also argued that the plaintiffs lacked standing to sue because the Attorney General had exclusive authority to bring such cases.  The Court considered the law of both California and Massachusetts, finding that although both states generally say the AG has primary authority, both have exceptions when someone has a particularized interest beyond that of the general public. 

The Court found that the plaintiffs had such an interest because (a) Fidelity holds funds in a dedicated account and ultimately makes donations in the donors’ name; (b) gave the donors “exclusive advisory rights” over the fund; (c) agreed it could not take money out of the account without action by the donors; and (d) only has a veto power over the donors’ decisions, which it agreed to exercise only when the donor attempts to use the money for an improper or non-charitable purpose.

The Court also rejected Fidelity’s claim that the negligence claim should be dismissed because it owed no duty of care to the donors and because it was inconsistent with their breach of contract claim.  The Court said a duty of care could be imposed by law on the basis of a “special relationship” and that at this stage of the proceeding it was permissible to plead the theories in the alternative.  (Fairbairn v. Fidelity Investments Charitable Gift Fund, N.D. CA, No. 18-cv-04881, 11/28/18.)

YOU NEED TO KNOW

It is not clear from the opinion exactly how much value is involved in this case.  The average of the high ($33.50) and low ($27.58) price of the stock on December 28, 2017 was $30.54.  The following day, the high was $30.56 and the low was $19.44, for an average price of $25.  The difference in the value of the deduction for December 28 and December 29 ($5.54 x 1.2 million) is about $6.6 million.  Assuming that most of the stock was sold near the end of the day on December 29 when it closed at $19.45, about a $10 per share loss in the value of the shares that were worth about $30 the day before, the loss, calculated for the full 1.9 million shares, is about $19 million in dollars available for charity. 

The Court seems to be correct in holding that donor/advisers on DAFs have a “special relationship” to the Fund and the gifts bearing their name that gives them standing, along with the Attorney General, to enforce their expectations for the Fund, especially when the DAF sponsor gives them additional rights.