Mark Coote / Reuters

The FBI requested the arrest of Kim Dotcom for leading a group that netted $175 million since 2005 by allegedly copying and distributing music, films and other copyrighted content without authorization.

New Zealand's spy agency illegally carried out surveillance on Megaupload founder Kim Dotcom, an official report showed Thursday, prompting an apology from the prime minister and dealing a possible blow to a U.S. bid to extradite him.

Washington wants the 38-year-old German national, also known as Kim Schmitz, to be sent to the United States to face charges of internet piracy and breaking copyright laws. 

The FBI requested the arrest of Dotcom for leading a group that netted $175 million since 2005 by allegedly copying and distributing music, films and other copyrighted content without authorization.

Dotcom maintains that the Megaupload site was no more than an online storage facility, and has accused Hollywood of lobbying the U.S. government to prosecute him.

New Zealand police asked the Government Communications Security Bureau (GCSB) to keep track of Dotcom and his colleagues before a raid in late January on his rented country estate near Auckland, which saw computers and hard drives, works of art, and cars confiscated.

Megaupload founder's homes raided, $5M in luxury cars seized

A report by Justice Paul Neazor found that the GCSB had illegally spied on Dotcom because it is only allowed to gather “foreign intelligence” and people who are New Zealand citizens or residents are protected.

The illegal surveillance may deal another blow to the U.S. extradition case after a New Zealand court ruled in June that search warrants used in the raid on Dotcom's home were illegal.

New Zealand Prime Minister John Key blamed “human error” in a statement, saying the GCSB had relied on information from the police about Dotcom’s residency status without checking further and also made a mistake in interpreting the law.

“It is the GCSB’s responsibility to act within the law, and it is hugely disappointing that in this case its actions fell outside the law. I am personally very disappointed that the agency failed to fully understand the workings of its own legislation,” he said.

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The director of the GCSB, Ian Fletcher, said he was “very sorry” over the affair in a statement, admitting that “we got this wrong.”

“I know that it will take time to regain the trust and confidence that we have lost,” he said.

Opposition Labour Party leader David Shearer described the Neazor report as a “whitewash,” and called for a broader inquiry in a statement.

He complained the report “doesn’t address why, in the 15 meetings the Prime Minister had with GCSB this year, he was not briefed about this issue given it involved national security and a massive police operation involving the FBI.”

Megaupload suspect Kim Dotcom denies Internet piracy, money laundering

Ira Rothken, a U.S. lawyer working with Dotcom’s defense team, told Radio New Zealand that he wanted to find out what Key knew and when he found out.

“We’ve seen a great amount of government aggression in this case, from the raid on a family with children – Mr. Dotcom’s residence – to illegal search warrants to what we think is an illegal search and seizure and we also have seen that the United States has illegally taken some data offshore,” Rothken said.

Feds shut down popular file-sharing website Megaupload

Asked if the case should continue, Rothken told Radio New Zealand, “The prosecution [lawyers] in both New Zealand and the United States likely has a discretion that when you have such a high dose of illegality that goes into the process of dismissing the case in the interests of justice. Of course we think that’s the right thing to do.”

U.S. authorities are currently appealing a New Zealand court decision that Dotcom should be allowed to see the evidence on which the extradition hearing will be based.

The extradition hearing has been delayed until March 2013.

Reuters contributed to this report.

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