Hain faces the sack as Commons watchdog launches sleaze inquiry into dodgy donations

The Parliamentary watchdog is to launch an investigation into the Work and Pensions Secretary's failure to record more than £100,000 in donations to his campaign for the Labour deputy leadership.

If the inquiry, expected to take several months, concludes that the rules have been broken, he could be suspended from the House for up to a fortnight.

In that event, the expectation is that he would have no choice but to resign as a minister.

But insiders said that he could find himself dropped from the Cabinet before the outcome of the inquiry is even known.

Gordon Brown's first reshuffle is expected after the May elections. The latest blow to Mr Hain's political prospects came amid signs that his carefully-constructed defences have begun to unravel.

Embarrassingly, two of his major contributors raised the prospect of another fake donor scandal by denying all knowledge of a payment to his campaign.

And there were growing questions about a "think tank" set up by Mr Hain's campaign treasurer which appears to have been little more than a front for chanelling donations.

Mr Hain has been battered by suspicions about his campaign finances for two months, ever since he admitted he had failed to make a full declaration to the Electoral Commission.

He blamed his failure to abide by the rules on the pressure of Government work. On Thursday night, after MPs had deserted Westminster for the weekend, he slipped out what he said was a complete list of donations.

But what was supposed to be a definitive statement prompted further questions by exposing both a controversial collection of supporters and a mysterious fund-raising scheme.

Attention centred on the Progressive Policies Forum, a company set up in December 2006 by former Labour communications director John Underwood, treasurer to Mr Hain's campaign.

PPF has no website, no staff and appears to have never carried out any political work.Yet on six occasions last year it acted as a conduit for donations and loans to Mr Hain's campaign totalling £51,613.75.

There was confusion over the role of 82-year old diamond dealer Willie Nagel, who told the Financial Times he had no idea his donation to PPF would then be paid to Mr Hain's campaign.

He issued a statement in which he said he had 'no objection' to supporting the minister's bid for the deputy leadership.

But he did not deny that he had not been informed of the payment.

In an echo of the David Abrahams fake donor row, the FT revealed that Mr Nagel had been asked by Mr Underwood to contribute directly to Mr Hain's campaign, but he had refused because he did not want any publicity.

He was then asked to give money to PPF instead, and provided a £25,000 interest-free loan and a £5,000 donation.

The BBC claimed that a second donor, Christopher Campbell, who donated £1,990 to PPF which was then handed to the campaign, was uncertain about whether he had been told his cash would go to Mr Hain, but said afterwards he was happy for the money to be used in that way.

Yesterday Downing Street continued to express its "full confidence" in Mr Hain, and insisted he was merely the victim of administrative incompetence.

But the Government must await the formal inquiry by Parliamentary-Commissioner for Standards John Lyon.

It follows a formal complaint by Tory backbencher David Davies.

"Clearly, based on what Peter Hain has said, there has been a breach of the rules," he said. "Peter Hain should also issue a statement about this think tank which many people will perceive is no more than a front for channelling cash to his campaign."

The undeclared sums accounted for more than half Mr Hain's total campaign spending of £185,000.

According to his statement, he had been forced to seek additional cash after the contest finished in June and a number of unpaid invoices came to light.

Plaid Cymru's Westminster leader Elfyn Llwyd called for Mr Hain's resignation. He said: "The whole thing is a total circumvention of all the rules appertaining to elections and, as a Cabinet minister, it will be very difficult for him to stay in office."