The Auditor-General will investigate why Labour MP Shane Jones granted citizenship to a Chinese millionaire even though the Internal Affairs department advised him not to.
Jones granted Chinese businessman Yong Min Yan, or Bill Liu as he is also known, citizenship as associate immigration minister in 2008.
Labour leader David Shearer last week asked the Auditor-General to investigate, saying "given the differing statements made in and outside of court and the questions that have been raised publicly," an independent agency should review the case.
He stood Jones down from his portfolio responsibilities and Labour's front bench pending an investigation.
In a statement today, Shearer said he welcomed the Auditor-General's decision to investigate.
"We referred this matter to the Auditor-General because we believe it is important that Shane Jones be given the opportunity to clear his name in the light of claims reported in the media," he said.
"It is also important that New Zealanders are reassured that the correct departmental and ministerial processes were followed in this case."
Jones claims he granted citizenship on humanitarian grounds. He said last week he would welcome an investigation as it would allow him to clear his name.
Yan was also red flagged by Interpol regarding arrests made in China.
He also last week found not guilty of falsifying citizenship papers.
Auditor-General Lyn Provost said in a statement Francis Cooke QC has been appointed to lead the inquiry.
It is expected to take several months to complete.
View the Terms of Reference for the inquiry here.