Lord Levy, the Labour Party's chief fundraiser, was arrested yesterday by police investigating the "cash for peerages" scandal - a humiliating blow for Tony Blair.
The Labour life peer, later released on bail, was not charged and denies any wrongdoing. His arrest under anti-corruption laws followed reports that he advised millionaire donors to provide loans to the Labour Party, which could be kept secret.
The arrest of Lord Levy, 61, a personal friend of the Blairs, severely damages the Prime Minister's authority, and adds to the impression that Mr Blair and his Government are losing control.
It sent shockwaves through the Labour leadership as it gathered for a TUC summer party last night. One former cabinet minister said: "This is going to run right up to the party conference in the autumn. It is the last thing we needed."
Scotland Yard's Specialist Crime Directorate, led by Deputy Assistant Commissioner John Yates, has not ruled out interviewing Mr Blair. It has seized computer hard disks and documents from Whitehall and is pursuing investigations by recovering deleted e-mails between civil servants and party officials.
One member of Labour's ruling national executive committee said: "The trail goes all the way back to Blair. He's up to his neck in it."
Police inquiries were launched in March after it was revealed that Mr Blair had nominated four businessmen for peerages who had also given donations in the form of loans, which did not have to be declared. The peerages were scrutinised by an anti-sleaze committee. Three were blocked and one nominee withdrew. This week it was reported the four had been advised to hide details of their £4m loans to the Labour Party.
They were: Sir Gulam Noon, the so-called "curry king" who gave £250,000 in a loan and was knighted in 2002; Sir David Garrard, a property tycoon, who loaned £2.3m and sponsors a city academy; Dr Chai Patel, founder of the Priory Clinics who loaned about £1.5m and Barry Townsley, a stockbroker who loaned £1m, but withdrew his nomination.
Sir Gulam, angry at having his peerage blocked, was reported to have been advised by Lord Levy to loan £250,000 rather than donate it. Labour admitted taking a total of £13.9m in loans from 12 businessmen.
There were suspicions at Westminster that the timing of Lord Levy's arrest may have been connected with Mr Yates being summoned to a meeting today at the Commons by the Committee on Public Administration, which is investing the alleged scandal.
The committee suspended its inquiry to allow the police to interview Lord Levy and other key witnesses and was ready to give Mr Yates an ultimatum to make progress or it would resume hearings. The arrest of Lord Levy is certain to mean it will put off plans to interview him to avoid any risk of tainting any possible court proceedings.
Many of those involved in the peerages row were also sponsors of the Prime Minister's city academies promoted by the education minister Lord Adonis, a former adviser to Mr Blair.
Lord Levy, who is president of the Specialist Schools and Academies, was preparing to meet Lord Adonis and Sir Philip Green, the recently knighted retail tycoon yesterday when he was arrested. Denying the allegations, Lord Levy said police had used their powers "totally unnecessarily". His spokesman said: "He has not been charged and does not expect to be, as he has committed no offence."
Referring to a rule change this week to clamp down on MPs who bring the party into disrepute, one Labour MP said: "The chief whip has got her yellow card. Blair should be the first to get it."Reuse content