Money

Investors fight loyalty in court over tax relief deal

In the dying days of 2017, Malcolm and Emily Fairbairn thought they were all set to cushion the income tax impact of over $ 200 million in hedge fund income. They have prepared a large charitable donation, using their relationship with Fidelity Investments and a burgeoning energy store to maximize their tax deduction.

It did not go as they had hoped. Now, the charitable arm of Fairbairns and Fidelity is facing a contentious lawsuit in Federal Court.

The Fairbairns say Fidelity Charitable pressured them to donate by stating how and when the shares would be sold, then violated those promises and botched the deal. Fidelity has denied making such promises and said its trading was appropriate.

Case highlights so-called donor-advised funds managed by companies such as Fidelity, the Vanguard Group and Charles Schwab Corp.

Donor-advised funds held $ 121.4 billion in 2018, according to the National Philanthropic Trust.

For investment firms, funds can help attract and retain high net worth clients. Donors benefit from tax deductions when they donate money or securities. Investments then grow tax free and are distributed to operational charities on the recommendation of donors, functioning almost like a charitable checking account.

The catch: While donors can make these recommendations, and funds usually heed this advice, donors must cede legal control over the assets to gain tax relief. This tension is at the center of the Fairbairn affair.

The Fairbairns were racing to complete the donation in 2017 for a tax deduction. They authorized a donation of 1.9 million Energous shares Corp.

to Fidelity Charitable on December 28, then ensured that the stock reached Fidelity.

The timing seemed right: Energous’ price had jumped that week after gaining government approval for its wireless charging technology.

On December 29, Fidelity sold those shares – nearly 10% of the company – in 154 minutes, with the price dropping to $ 19.45 after a closing high of $ 31.57. The Fairbairns claim that Fidelity’s quick sale flooded the market and drove the price down.

At one point, the Fairbairns had $ 61 million in inventory, but ended up with a $ 52 million tax deduction and $ 44 million in the account to direct donations to charities, including research. on Lyme disease. These amounts were lower than expected and they can claim compensation for the tax deduction and replenishment of their donor account.

The virtual lawsuit began this week in federal court in northern California and resumes Monday; it focuses on whether Fidelity broke its promises and handled the sale of shares negligently. If Fidelity is found liable, a later phase would determine potential remedies for the Fairbairns.

Mr. Fairbairn testified that he knew Fidelity Charitable owned the stock after the donation and deduction was made in 2017 and could sell it. But he said he was told the sale would take place in 2018 and that he could offer advice to Fidelity Charitable on the sales strategy. As the price fell on December 29, he wondered who had sold so many Energous shares – only to learn in January that it was Fidelity Charitable that was selling the shares they had donated.

“I was upset and angry,” Mr. Fairbairn told court. “Normally I don’t get angry very often. It’s only when I feel like I’ve been lied to.

On cross-examination, the Fairbairns conceded that the promises regarding when and how the share sales were not written.

Donor-advised funds are increasingly popular and Fidelity Charitable is a giant in the field. In the fiscal year ended June 30, 2019, it had nearly 127,000 accounts, raised $ 8.6 billion, donated $ 6.1 billion, and held $ 31 billion.

For donors managing millions but not billions, funds may be more attractive and effective than private foundations, which have stricter rules requiring annual payments.

But sometimes charitable goals conflict with the profit motives of investment firms.

Messages posted during the trial showed that Fidelity employees were offering a reduced fee to attract the Fairbairns donation to Fidelity Charitable instead of a similar fund at JPMorgan Chase & Co. Justin Kunz, which managed Fidelity’s relationship with the Fairbairns, has defended his use of terms such as “winning the business” in internal emails to describe his discussions with the couple.

In his testimony, Kunz has at times described his role as facilitating the charitable efforts of donors, showing how Fidelity’s financial services professionals can help with the complex assets of the Fairbairns. At other times, he has described competing against JPMorgan.

The Fairbairn case shows how commercially sponsored funds differentiate themselves by focusing on how they can manage the assets of the rich, said Brian Mittendorf, an accounting professor at Ohio State University who is not involved in the case.

“Being a sponsor of a donor advised fund is kind of a commodity,” he said in an interview. “If Fidelity doesn’t take my funds, I can definitely find someone who will. Customer service is becoming a big deal. “

The Fairbairns say they are convinced by Mr. Kunz’s promises of a “soft” stock sale sophisticatedly designed to avoid damaging the stock price. This can be a challenge with such a large portion of a smaller stock like Energous.

Their lawyers posted messages between Fidelity employees speculating that Mr. Kunz had been too cowardly.

“I know I didn’t make any of the promises they are making out,” Kunz said.

Funds typically follow donor recommendations for giving money to charities, but they are not obligated to do so. Technically, once the Fairbairns donated their shares, they no longer owned them and had no legal control over the subsequent sale.

“Just like you can’t keep your cake after eating it, you can’t keep control of what a charity does with the assets after you donate them,” David Marcus, lawyer at WilmerHale, who represents Fidelity Charitable said in its opening plea.

The Fairbairns pointed to internal Fidelity posts to support their argument that the stock sale was mismanaged. A December 29 post described the sale result as “ugly.” A January 2018 email from Mr. Kunz described the business as “sloppy”, although he testified that he was repeating Mr. Fairbairn’s description.

Mr Fairbairn said any trader in his company, Ascend Capital, would have been fired for putting so many supplies of one stock on the market at a time.

“This literally, when I looked at this, was the most poorly executed trade I’ve seen,” he said.

Fidelity Charitable says its sale did not cause prices to drop on December 29. The stock never returned to its late 2017 highs and closed at $ 2.55 on Friday.

“Unlike the Fairbairns hedge fund, Fidelity Charitable does not place bets on stocks. The charity takes a conservative approach, ”said Marcus. “They blame Fidelity for not having perfectly synchronized the market.”

Write to Richard Rubin at richard.rubin@wsj.com

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