Local authorities across the UK are thought to be borrowing millions of pounds from staff pension schemes to boost returns on their own cash deposits - without sharing the full interest with the pension fund.
Unions want this investment practice banned, and have suggested that councils' investment strategies may be illegal.
The Local Government Association said that councils were acting within the rules, stating that the law requires councils to invest their pension fund money properly and prudently, and that is what they do.
The dispute focuses on the conflict of interest among council finance officers, many of whom are responsible for pension investments as well as for the general council funds.
Lord Oakeshott, the Liberal Democrat pension spokesman, said councils were acting irresponsibly and in breach of basic governance principles. "Why should public pension funds have inferior corporate governance standards and protection from conflicts of interest than private funds? Councils playing this game are on a slippery slope that ended with Bob Maxwell mixing pension fund cash with his own. They should stop it now, for good," he said.
A spokesman for Unison said: "The government has been negligent and has not observed UK pension fund law, principally the Occupational Pension Scheme (Investment) Regulations 2005, which disbar employers from borrowing from their staff retirement funds. According to legal advice obtained by the union, this is a potentially criminal act."
Most local government pension schemes have suffered large falls in value over the past two years, which will only be made worse by part of their investments being channelled into low-interest bank deposit accounts.