The first man arrested in the cash for honours probe will not face charges, the Crown Prosecution Service has said.
Mr Smith said he was relieved at the outcome
Des Smith was questioned last April after allegedly suggesting that sponsors of the government's flagship City Academies would receive honours.
Prosecutors said there was "insufficient evidence" to charge Mr Smith with an offence under the Honours (Prevention of Abuses) Act 1925.
Mr Smith said he was relieved, adding: "It was nonsense from the beginning."
Police are investigating whether money was donated to political parties in exchange for peerages. All those involved deny any wrongdoing.
In January 2006, Mr Smith allegedly suggested to an undercover Sunday Times reporter that sponsors for the government's flagship city academies programme would be recommended for honours in exchange for funding.
He later resigned from his post with the Specialist Schools and Academies Trust, which helps the government recruit education sponsors.
He admitted he had been "naive" when talking to a reporter posing as a potential donor's PR assistant.
A CPS spokesman said: "Although it is clear that Mr Smith made some indiscreet comments to an undercover journalist, his conversations did not provide evidence that he was trying to obtain funding for City Academies in exchange for honours."
He added that Mr Smith's case concerned funding for City Academies, not allegations concerning loans or donations to political parties.
Mr Smith, whose lawyers say he "categorically" denies the claims against him, said he was pleased at the outcome.
Speaking from his home in Redbridge, east London, he said: "It's just been going for so long. I'm relieved that it's over. It was nonsense from the beginning."
A police spokesman added: "The wider police investigation is ongoing and as a result there will be no further police comment at this stage."
The police inquiry began after it emerged that secret loans had been made to Labour before the 2005 general election, and that some lenders had subsequently been nominated for peerages.
SNP MP Angus MacNeil whose complaint to police prompted the investigation, said he was not surprised at the development.
"I think he's been out of the picture for quite a while. He's on the periphery of the whole thing," he said.
"The inquiry seems to be centring on Downing Street."
About 90 people have been questioned as part of the inquiry, which widened to cover the other main parties. Among those questioned are Tony Blair and former Conservative leader Michael Howard.
It also appears the inquiry has widened in scope, from the original laws against selling honours, to whether anyone has attempted to pervert the course of justice during the police inquiry.
Four people have been arrested in total. Mr Smith, Labour donor Sir Christopher Evans, Downing Street adviser Ruth Turner and Labour's chief fundraiser Lord Levy.
No one has been charged and all involved deny any wrongdoing.