Senior Tory Sir Peter Tapsell asked Mr Major if DPP Barbara Mills would be examining whether Mr Fayed should be prosecuted for 'attempted blackmail'.
The businessman was the source of allegations against Mr Hamilton and Tim Smith, the Northern Ireland minister who resigned last week.
Mr Major deplored the 'feeding frenzy' among opposition MPs over sleaze but in announcing the committee of inquiry under Lord Nolan he acknowledged the need to restore confidence in the system of public administration.
'It has always been the wish of this House that British government, Parliament and administration should be entirely free of malpractice. I am determined to ensure it is.
'In the present atmosphere there is public disquiet about standards in public life and I have concluded that action is imperative.'
The terms of reference of the committee will be: 'To examine current concerns about standards of conduct of all holders of public office, including arrangements relating to financial and commercial activities, and make recommendations as to any changes in present arrangements which might be required to ensure the highest standards of propriety in public life.'
Public office holders will include ministers, civil servants and advisers, MPs and MEPs, members and senior officers of quangos, NHS trusts and other bodies discharging publicly- funded functions, councillors and senior officers of local authorities.
Tony Blair and Paddy Ashdown have been invited to nominate a member of the committee which Mr Major hoped would be able to produce a first report within six months. It will be able to take evidence in public and its report will be published.
As for Messrs Hamilton and Smith, Mr Major quoted from a report he had received from Sir Robin Butler, the Cabinet Secretary, into the allegations of Mr Fayed. An informant had said Mr Fayed wanted a meeting with the Prime Minister principally to get the DTI inspector's report on his takeover of the House of Fraser revised or withdrawn. 'He had made a number of allegations against government ministers and was contemplating passing them to others.'
'Sir Robin then sets out my reply,' Mr Major went on. 'He records that I replied that it would be impossible for me to see Mr Fayed in these circumstances.
'If ministers had been guilty of wrong-doing - as Mr al- Fayed alleged - I was not going to make any sort of deal, regardless of the cost to the Government's reputation.'
Mr Major said Sir Robin had found no evidence to controvert Mr Hamilton's assurances that the allegations made against him by Mr Fayed were false. But he went on: 'I have, however, to tell the House that since Sir Robin completed his report, other unconnected allegations which were not the subject of his investigations have been made against Mr Hamilton. I must consider whether the combined impact of these allegations disables Mr Hamilton from carrying out his responsibilities as minister for corporate affairs. I believe they do and Mr Hamilton agrees and has resigned from the Government.'
Mr Blair, the Labour leader, welcomed the standing committee as 'plainly sensible and necessary' , but added: 'It would not be unfair to describe today's statement as decision- making on the run. Indeed the resignation of the trade minister just announced suggests something of the same.'
The warning signs had been ignored for too long. 'Public anger over these issues goes far, far wider than merely the matters raised by Mr al- Fayed,' he said, pointing to the disclosure that the chairmen of some 66 NHS trusts were either prominent Tory party members or had made donations to the party.
Mr Blair said that if the new body was not going to examine specific allegations against ministers or MPs, there was an overwhelming case for the privileges committee holding its cash-for-questions inquiry in public. If Mr Major ruled out both, 'then there will be justifiable public concern that the general inquiry is being used to sweep the particular allegation from public view'.
Mr Ashdown, leader of the Liberal Democrats, said a welcome for the principle of a general inquiry into the ethics of public office ought not to be taken as satisfaction for the way Mr Major had handled individual concerns about his ministers. His 'indecision' stood in stark contrast to his clear undertaking a week ago to root out wrong-doing.
Dennis Skinner, Labour MP for Bolsover, said there were 550 directorships, consultancies and advisorships, mainly held by Tory MPs. 'This matter of taking money from big business can never be properly cleared up until they face the question: MPs should have one job and one job only . . . Clean up the stables now.'
Mr Major replied: 'Mr Skinner may be the latest living example of the old Levellers, but there are many other people in the House, on both sides, who believe the concept of the wholly professional politician will only isolate politicians more and more from the people who send us here.'
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