In the suit, the Laborers' Local 265 Pension Fund of Cincinnati and the Plumbers and Pipefitters Local No. 572 Pension Fund of Nashville allege that several iShares ETFs spent funds on "grossly excessive compensation" to agents affiliated with the ETFs, as well as on other agents, and they want to recover the funds for investors.

Blackrock's iShares ETFs have "systematically violated their fiduciary duties, setting up an excessive fee structure designed to loot securities lending returns properly due to iShares investors," they say in the suit, filed on January 18 in the Middle District Court of Tennessee.

The two pension funds allege that Blackrock officials and the iShares ETFs ran a scheme to take at least 40 percent of securities lending revenues - which they called "entirely disproportionate" - for themselves at the expense of investors.

Blackrock President Robert Kapito and iShares Chairman Michael Latham are named as defendants in the suit.

Blackrock, the largest manager of ETFs, said on Sunday the complaint was without merit, adding it will "contest it vigorously."

The company's securities-lending program has delivered above-average returns to its ETF shareholders over time, Blackrock spokeswoman Caroline Hancock said in an email. "To achieve this, we run the program ourselves while bearing all the costs, rather than outsourcing to third parties as others do," she added.

The recently-acquired iShares unit has been a stellar performer for the New York-based asset manager, bringing in $36 billion of new business for Blackrock in the fourth quarter.

(Reporting by Jonathan Spicer; Editing by Marguerita Choy and Diane Craft)

By Jonathan Spicer