AT the beginning of the month John Yates was riding high. The assistant commissioner of the Metropolitan police had completed his investigation into the cash for honours affair and his final report was ready for the Crown Prosecution Service (CPS).

Relaxed and confident that the case was heading for court, the detective took a day off on July 1: a keen cyclist, he rode the first stage of the Tour de France course from London to Canterbury. He covered the circuitous 120-mile route in seven hours and 16 minutes.

Three days later, according to Whitehall sources, he walked into the CPS headquarters in London and a multiple pile-up. In a conference room overlooking St Paul’s Cathedral, Yates sat down with Carmen Dowd, head of the CPS special crime division, and David Perry QC, a top lawyer and former Treasury counsel advising on the case.

After 16 months of inquiries, 136 interviews, the arrests of four people and three questionings of Tony Blair, then prime minister, Yates was optimistic.

Quite apart from material previously known, he had two other key pieces of evidence to support allegations that senior Labour party figures had traded honours for cash.

The Sunday Times can reveal that a draft list of people nominated by Blair for peerages had included eight people - not four as previously reported - who had lent or given the party money in the run-up to the 2005 election. This was hinted at in a CPS document last week, but its significance was overlooked.

Of 12 people who had made loans to Labour, four already had peerages or were ineligible for one. All the remaining eight funders were nominated for honours. One was the businessman Sir Christopher Evans.

The second piece of evidence was Evans’s diaries which, according to Whitehall sources, contained numerous references to discussions and meetings about honours with Lord Levy, a key adviser to Blair.

Moreover, the CPS seemed to agree that there was a case to pursue - after all, it was the CPS that had recently suggested Yates go back to interview Blair for a third time, as one one lawyer unnconnected with the inquiry observed. “Why would the CPS have troubled the former prime minister again if there was not a serious case to investigate?”

The CPS, said one source, "knew the case was built on” the agglomeration of pieces of a jigsaw rather than one damning find. But as the meeting unfolded, Perry dropped one bombshell - and then another.

First, he declared that Evans’s diaries would be inadmissible as evidence in a court case, or at least face significant challenges to their admissibility. They were, he said, merely “hearsay” - because the alleged meetings and discussions were disputed by Levy.

However, one CPS source alleged this weekend: “The Evans diaries are dynamite. They should have been enough for a case against Evans.”

Second, Perry declared that for a case to succeed, the prosecution would have to show evidence of an “unambiguous” agreement to bestow and honour in return for funding.

“He suddenly raised the burden of proof,” said a Whitehall source. “It was the first time he had mentioned unambiguous.”

Some sources say Yates reacted with equanimity; others say he left the meeting feeling as if he had been hit by a sledge-hammer. He could not understand why, if Perry’s points were so important, the CPS had not made them before.

As the CPS weighed up whether to bring the case to court, doubts grew. As one Met officer unconnected with the inquiry put it last week: “It just felt uncomfortable. We knew something wasn’t right.”

As it turned out, that was an understatement. On Friday the CPS announced that it would not press charges. There would be no day in court, no public questioning of witnesses, which might have included Jonathan Powell, Blair’s chief of staff, Ruth Turner, his director of government relations, and even Blair himself. The CPS conceded there was no case.

The questions and recriminations started to rain down on Yates. Tony Wright, chairman of the House of Commons public administration committee, said the decision not to pursue charges was a “disaster for the police and a disaster for the political system”.

Some of those caught up in the investigation vented their grievances. Evans, who had donated £1m to Labour, said: “I feel very angry and frustrated because I don’t feel this investigation was ever justified in the first place.”

How could one of the most high-profile police investigations in recent years run for so long yet implode so spectacularly at the end?

FROM the outset of the cash for honours inquiry in March last year, veteran politicians were doubtful that it would prove any criminal wrongdoing - even though they suspected honours were often bestowed dubiously or even corruptly. Long-standing denizens of Westminster knew all too well that such matters were conducted in the shadows and obtaining hard evidence would be difficult, if not impossible.

Even Angus MacNeil, the Scottish National party MP who triggered the investigation by making a formal complaint, said such deals were conducted on a “nod and a wink”.

However, the suspicions surrounding honours had grown under Blair. MacNeil submitted with his complaint a Sunday Times investigation in which Des Smith, a government adviser, had told an undercover reporter that someone who gave a large amount to funding school academies - one of Blair’s pet projects - might expect to receive an honour.

MacNeil also included another investigation by this newspaper revealing how Blair had recommended for peerages businessmen who had given the party secret loans of £4.5m when it was struggling to finance its 2005 election campaign.

The whiff of scandal was overpowering. But as Wright said: “I thought at the outset that it would not lead to prosecution because I could not see that buying and selling of honours was going on in an overt form.

“If you know the territory, you would know that is not how it goes on. It is a far more covert world.”

Into this world, however, stepped Yates, a career copper known for his honesty and thoroughness. Yates, who joined the force in 1981, was a highflying graduate who had investigated more than 20 murders and several celebrity cases.

He had also suffered a high-profile failure. Yates had been in charge of an investigation into Paul Burrell, the royal butler, about missing items that had belonged to Diana, Princess of Wales. The case had collapsed at the last minute after the Queen - whom Yates had not interviewed - remembered that the butler had told her he was taking some of Diana’s possessions for safe keeping.

Did that setback encourage Yates to pursue every angle in future cases? He was certainly determined to “follow the evidence” wherever it took him on cash for honours. He was not the sort of man to let dubious practices lie just because they had quietly been condoned for decades.

On March 27 last year, a week after the inquiry was announced, he wrote to Wright effectively asking the public administration committee to suspend its inquiry into political funding because it might overlap into the “arena of corruption” that Yates was investigating.

Despite this letter, many MPs continued to insist that the police investigation was “going through the motions” and would soon be over. But on the morning of April 13, Smith, the adviser on academies, was arrested.

The next month Yates told MPs that his team of eight detectives had submitted an initial file to the CPS of “over 1,000 pages of documents”. He said that his investigation had “already uncovered, in my view, a number of issues which merit further detailed examination”. He added: “We will have to go where the evidence takes us.”

Levy, who was at the heart of the deals involving the Labour loans, insisted that he was unabashed by the fuss. But his nonchalance was soon shattered. On July 12 last year he was arrested.

The 12 businessmen who had provided Labour with secret loans in the run-up to the last election were all interviewed, including at least four proposed for peerages: Chai Patel, Sir Gulam Noon, Sir David Garrard and Barry Townsley. Some were questioned under caution.

All the lenders interviewed vehemently denied any offer or promise of a peerage in return for a loan. Despite the lack of a key witness to support their case, the police ploughed on with their inquiry. Why?

Part of the reason is that on the face of it, Labour’s handling of funding and honours looked suspicious. Various businessmen who had bankrolled the party were nominated for places in the Lords; subsequently the suitability of three of those candidates was questioned by the House of Lords Appointments Commission.

It also emerged that during the summer of 2005 Levy had been involved in a series of meetings at No 10 to discuss the forthcoming honours list. Friends of Levy claim he was merely asked for his advice on potential nominees; others suggest he “put names forward”.

There remained the difficulty of proving beyond reasonable doubt that someone had deliberately gone out to sell or buy an honour.

“If you removed the high-profile names and took the star-dust out of people’s eyes then actually this is a pretty straightforward legal point,” said Mark Stephens, a leading London lawyer. “It was doing the rounds of London legal circles eight months ago.”

If that were the case, why did the police plough on for months more? Why did the CPS not call a halt after the initial investigations had turned up no killer fact?

One reason may have been that the most senior figures in the Metropolitan police and the CPS had stood aside from the investigation. Sir Ian Blair, the police commissioner, decided to take no part because of his regular contact with Tony Blair and other ministers. Sir Ken Macdonald, head of the CPS, had also moved aside because he had worked with Cherie Blair in private legal practice. So there were no senior figures above Yates and Dowd readily available to take a dispassionate view about the case’s chances of success. LAST November Yates wrote to MPs updating them on his progress. He said his inquiry had uncovered “significant and valuable material” and that “considerable progress continues to be made”.

Among the documentary evidence he had found were extracts from Evans’s diaries. One referred to a conversation with Levy and whether the bio-technology tycoon would be interested in “a k [knighthood] or a big p [peerage]”. It was intriguing, although not conclusive evidence of any wrongdoing.

Newspaper reports suggested that “major developments” in the case had yet to come to light - apparently the further “dynamite” detail contained in the diaries.

On December 14 Blair was questioned for two hours in Downing Street. It was the first interrogation of a serving British prime minister as part of an official investigation.

The police team could have cut their potential losses at this stage and submitted the file to the CPS. Instead, they opened up a new front in the investigation. Turner was arrested on January 19 on suspicion of perverting the course of justice. Eleven days later Levy was also arrested on suspicion of the same offence.

Detectives’ inquiries had focused on an internal e-mail which discussed how No 10 should approach the police inquiries. The role of Powell was also investigated by detectives.

Yates was increasingly confident that there would be enough evidence to charge Levy and Turner. He was working closely with Dowd, who in turn was copying the files to Perry, who studied them in his chambers at 6 King’s Bench Walk, in Middle Temple, the warren of lawyers’ offices just off the Strand.

Yates submitted his main report at the end of April. Having considered it, Dowd and Perry asked for further inquiries to be made, including a third and final interview with Blair. That was conducted amid great secrecy at the beginning of June. Yates sent his 17th and final report on July 2.

Then came the fateful meeting at CPS headquarters and silence ensued.

“That made people begin to feel worried and uncomfortable. ” one official said.

According to a well placed insider, the stumbling block was Perry who, as well as giving specialist advice on whether charges should be brought, also advised on which charges would be likely to lead to any prosecution. As a lawyer who acted for the government over Iraq, Perry was not known for taking an aggressive line against the Establishment. In the end he decided the evidence was not strong enough.

His arguments effectively destroyed Yates’s position in one blow. It exposed the simple fact that the police case was, to use the words of one of those involved, “circumstantial”.

One official said: “What I would probably say is that he [Perry] is a perfectly decent guy, but he’s risk-averse.”

Although a circumstantial case could be made for the unlawful trade in honours, the CPS was unwilling to put it before a jury.

It also concluded there was no evidence that there was a “positive action” to pervert the course of justice, or that there was enough evidence to prove that Labour had broken electoral law by failing to declare the loans. It was game over for Yates.

LEVY was dining out on Thursday evening when he was alerted by a text message from a friend about reports that the CPS would not press charges.

When the news was confirmed the next day, Levy said it was a “great relief” to be exonerated. Blair simply said he was “pleased” the investigation was over; he did not blame the police for doing their duty.

Speaking to The Sunday Times this weekend, Evans questioned why the investigation had even been launched. “The awarding of peerage to party donors has been going on for 200 years and should have been sorted out in Westminster,” he said. “It was never justified to have a police investigation.”

The Metropolitan Police Authority has already announced its own inquiry. Yates is keeping a low profile. A Scotland Yard detective said: “John is pretty tired. He doesn’t want to talk about any of this. He just wants to put it all behind him.”

However, his investigation was not in vain. The cash for honours controversy has already spurred significant reforms: loans to political parties must now be declared and the prime minister’s role in the honours system has been curtailed.

MPs want further changes. Most politicians now accept that honours have been handed out, in one way or another, in reward for party donations - and that this exchange has diminished the reputation of parliament.

Members of the public administration committee are keen to resume their inquiry into political funding and honours. Paul Flynn, one of the members, said: “If there is something wrong with the system, it needs to be put right.”

Lord Steel, the former Liberal Democrat leader, said: “Despite the decision [not to bring charges], the damage which has been done to this house in particular but to the political world in general by the cash for peerages allegations has been substantial.”

Additional reporting: Holly Watt

THE EVIDENCE

- Out of the 12 Labour businessmen who provided Labour with undeclared loans to help to fund the last election, eight were put on a draft list for peerages and four were put forward.

- During the summer of 2005, Lord Levy, Labour’s fundraiser, was involved in a series of meetings held at Downing Street to discuss the forthcoming honours list.

- Sir Gulam Noon, who was nominated for a peerage, was advised not to reveal his £250,000 loan to the commission which vetted peerage nominations.

- The £14m of loans provided by businessmen were kept secret - from senior party Labour officials as well as from the public.

- The three other Labour loaners were also advised that there was no requirement to disclose their loans. The Lords Appointments Commission later said the loans should have been declared.

- Police obtained a document addressed to Jonathan Powell, No 10’s chief of staff, in which it was alleged that Levy asked Ruth Turner to “lie for him”. Levy denied any wrongdoing.

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