Securities lending—an obscure but decades-old practice—is getting more scrutiny amid criticism that some mutual fund companies are taking too big of a slice of the pie.

Investors in the popular iShares family of exchange-traded funds (ETFs), for example, received only about 55 percent of the income from securities lending, according to Securities and Exchange Commission filings. The balance of that income goes to an affiliate of asset manager BlackRock Inc., the owner of iShares.

The $12.6 billion iShares Russell 2000 Index Fund, for example, received $17.5 million in securities lending income during the fiscal year ended March 31. The BlackRock-affiliated lending agent for the fund received $13.6 million. That cut of the pie for the affiliated agent is about three times more than what is typical in the industry, SEC filings show.

BlackRock did not return messages seeking comment for this story.

In contrast, investors in ETFs run by State Street Global Advisors receive about 85 percent of the income from securities lending, SEC filings show. A State Street affiliated lending agent received about 15 percent, compared with the 44 percent received in the BlackRock example.

Even though State Street looks favorable next to BlackRock, it’s still not the most generous example in the industry for sharing securities lending income.

Rebecca Katz, a spokeswoman for Vanguard, said that fund company’s investors receive nearly all of the income from securities lending. A well-run securities lending program can be low risk while boosting shareholder returns, sometimes dramatically.

Instead of allowing their securities to gather dust in their portfolios, mutual funds frequently loan them out. They earn a premium on stocks that are in demand among hedge funds, for example, which may covet the securities for shorting or for an arbitrage play. Cash collateral—typically 102 percent of the loaned security—is then reinvested, with the fund collecting a portion of the earned-interest income.

In a rare event, the income from securities lending can offset a fund’s entire amount of expenses, putting more money in the pocket of investors. That’s what happened last year at SSgA’s $5.7 billion Financial Select Sector SPDR Fund.

Securities lending income for the fund was nearly $18 million during the fiscal year that ended September 30, more than offsetting the fund’s expenses.

“That rarely happens,” said James Ross, president of SSgA Funds Management Inc. “It shows that the value of securities lending can be significant.”

Meanwhile, State Street earned $3.1 million as the fund’s affiliated securities lending agent. Ross said the fund’s independent directors have to get quotes from outside lending agents to ensure fairness.

Peter Bassler, managing director of eSecLending, said his company has gotten business from funds concerned about using affiliated agents.

“We have won business because directors want to avoid any real or perceived conflict of interest,” said Bassler, whose company is an independent securities lending agent.

Bassler said fund customers also have rolled out more conservative guidelines for their securities lending programs. They’ve become less concerned about the yield on reinvested collateral and instead want to focus more on the loan side. That means they would rather make their money on lending securities that are scarce, a practice that attracts a higher premium from borrowers. Before, some funds emphasized high-volume lending.

“In the past, some lenders wanted higher loan balances to generate more returns on the cash collateral reinvestment,” Bassler said.

In reaching for higher yields, though, some funds put the cash they received as collateral for their loaned securities into riskier investments.

“That’s where the market experienced challenges during the credit crisis,” Bassler said.

Still, volatile market conditions can present a prime opportunity for securities lending programs. In the second quarter of 2009, for example, unprecedented demand for shares of Citigroup Inc. generated huge returns, according to a case study by eSecLending.

Citigroup’s plan to convert preferred stock into common stock created a wide price gap. Hedge funds shorted the common shares in order to capture the spread created by the conversion.

Hedge funds paid securities lenders fees of up to 13,000 basis points to borrow the stock.

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Tim McLaughlin writes for the Boston Business Journal.