The Solicitor-General says the police investigation and raids made under terror laws had stopped some "very disturbing activities".
David Collins said the decision not to allow police to prosecute 12 people for terrorist acts might have been different if the law involved had not been "incomprehensible".
The raids on October 15 had stopped some "very disturbing activities", but there was not enough evidence to meet the high threshold required to authorise prosecutions under the act.
The decision may have differed if the Terrorism Suppression Act had been framed differently to suit domestic threats.
Sixteen people - including Tuhoe activist Tame Iti - were facing possible terrorism charges after they were arrested in police raids relating to suspected armed training camps in the Ureweras.
It was the first time the act had been used, and Dr Collins described it as "unnecessarily complex, incoherent, and as a result almost impossible to apply to the domestic circumstances observed by the police in this case."
He said difficulties in applying the Terrorism Suppression Act, rather than lack of evidence, were a "very significant factor" in his decision.
Some of those arrested "could on one view of it have possibly come close to meeting criteria under the act" and if police presented more evidence he could review his decision.
Dr Collins said his decision was not intended as a criticism of the police, who he said had "a sufficient and proper basis" for investigating the case under the act and referring to him to assess.
Attorney-General Michael Cullen yesterday agreed to Dr Collins' recommendation to refer the act to the Law Commission for a review.
Speaking in Parliament, Dr Cullen drew attention to Mr Collins' statement that the police had acted appropriately but the threshold was very high.
"Anybody who claims this is some kind of vindication for all those involved is misreading what the Solicitor-General said."
He also reiterated Dr Collins' plea for people not to make "ill-informed" comment about the events because of the pending Arms Act charges.
"This House doesn't try people and find them innocent or guilty."
Those close to the 16 arrested were last night celebrating the decision.
Moana Jackson, a lawyer working closely with those arrested, said he was delighted at the decision.
He said all those in custody were likely to apply for bail.
Maori Party MP Te Ururoa Flavell said he was not defending illegal activity - if people flouted the law they should pay the price - but the terrorism claims had gone too far.
Iwi spokesman Tamati Kruger said police should be looking long and hard at themselves because of the way they had treated Tuhoe people.
"It must result in a strong criticism for broadening the powers of the police," he said. "This definitely speaks against that."
Mr Jackson disagreed with some of Dr Collins' comments supporting the police investigation.
Police Commissioner Howard Broad said his actions were "prudent and in the public interest" and that had been backed up by the Solicitor-General.
"I stand by what we did," he said.
A spokesman for Helen Clark said in a short statement, the Prime Minister "noted" the decision but reminding that the 16 in question were still facing serious firearms charges.By Claire Trevett @CTrevettNZH Email Claire, Alanah Eriksen @AlanahEriksen Email Alanah, Alanah May Eriksen