Ahmed Zaoui provided information to the Security Intelligence Service on Algerian groups with terror links which has been passed to the American CIA, intelligence sources say.
One of the reasons given yesterday for the SIS deciding Mr Zaoui is no longer a threat to New Zealand was that he had become "more candid" in his disclosures to authorities.
Both parties backed down to reach the unorthodox and face-saving compromise which allows the Algerian to stay in New Zealand under a written promise of good behaviour and co-operation with the SIS.
In a further twist, the intelligence source in Europe added that the CIA had been seeking information through the SIS on a former associate of Mr Zaoui, Anwar Haddam.
"Zaoui clearly gave [the SIS] all the information he had, just as he did the DST [French domestic intelligence service] when he was in France," the source added.
From France last night it emerged Mr Zaoui fears he could be targeted by former associates.
"Zaoui isn't a danger any more, he hasn't been for a few years and certainly won't be if he stays in New Zealand," the European intelligence source said.
"But he is under pressure from activists he once associated with and he wants protection from them."
Under the agreement, brokered by SIS director Warren Tucker, Mr Zaoui says the previous SIS chief, Richard Woods, was justified in issuing a security risk certificate against him when he arrived in 2002 and the SIS was justified in keeping it in force.
The SIS says that although Mr Zaoui had some potentially dangerous associations with extremist groups in Europe, they did not mature into active support for terrorism.
He was also considered helpful and more candid in recent hearings, giving new information that could be prejudicial to him, all of which culminated in Dr Tucker withdrawing the security risk certificate.
"Mr Zaoui is no longer considered to be a security risk," he said yesterday in a prepared statement.
Dr Tucker also said the time that had elapsed since Mr Zaoui's arrival was "a significant factor in assessing whether he presents a risk of substantial threatened harm if he is allowed to stay."
He regretted the length of time the process had taken "but the delay in itself has been an ally to Mr Zaoui".
The Algerian, a former MP, and his supporters were claiming yesterday that his name had been cleared.
The decision means that as a refugee he can stay in New Zealand and can expect to be joined by his family.
Mr Zaoui arrived in December 2002 from Vietnam. He flushed his false South African passport down the aircraft toilet before disembarking and claiming refugee status.
He was held in Paremoremo prison shortly after arriving, granted refugee status in August 2003 and granted bail in December 2004.
Dr Tucker's intervention curtails a process that was looming as a problem for the Government.
The Inspector-General of Intelligence and Security, Justice Paul Neazor, was due to give his decision soon on whether to uphold the security risk certificate.
If Justice Neazor had not confirmed the certificate, the SIS's credibility would have been damaged.
If he had upheld it, the Government would have faced difficulties, whether it let Mr Zaoui stay or deported him.
Asked last night if he was consulted on Dr Tucker's decision, Justice Neazor said: "I knew what the director was going to do."
But he would not offer a view. "I've got no comment about it at all."
Prime Minister Helen Clark said she had no involvement in the process, but effectively endorsed the outcome by saying she had confidence in Dr Tucker. National Party leader John Key also supported the deal.
But New Zealand First leader and Foreign Minister Winston Peters said it "advertised New Zealand once again as the number-one soft touch for illegal immigrants".
What happens now?
Ahmed Zaoui was declared a refugee by the Refugee Status Appeals Authority on August 1, 2003.
With the Security Risk Certificate now quashed, his lawyers are working on re-uniting him with his family, who he hasn't seen in the flesh since December 2002.
The United Nations High Commissioner for Refugees has twice asked the Government to allow Mr Zaoui's wife Leila and their four children to come to New Zealand.
Immigration minister David Cunliffe turned down a request for the Zaoui family to settle in New Zealand in July, 2006.
Department of Labour's acting Refugee Services Director Christina Fordyce said refugees are assessed after arrival in New Zealand.
If they are recognised as refugees, they can then apply for residence.
The character and health of applicants are assessed and once a New Zealand permanent resident, they are able to work, vote and receive benefits in New Zealand.
They are also able to apply to have their family join them.
Among the promises Ahmed Zaoui swore on the Koran as part of the deal:
* I undertake not to engage in any activities that are not consistent with NZ's laws or security interests, in particular the Crimes Act and Terrorism Suppression Act.
* I will not publish in any form any statements that could be interpreted as promoting violence. [blanked out]. If I am unsure about whether a proposed statement might be interpreted this way I will consult first with the SIS.
* I will not contact any intelligence agency of another country unless I first consult with the SIS.
* I will advise the SIS if I am contacted by any intelligence agency of another country.
* I will advise SIS if I have been in contact with [blanked out] and will advise the nature of the contact.
- additional reporting: Catherine Field, Mike Houlahan