Labour general secretary Peter Watt has resigned following the revelation that a property developer made donations to the party via three associates.
Mr Watt said he had resigned "with great sadness"
David Abrahams, who gave almost £600,000 over four years, said Mr Watt's resignation was "sad".
Mr Watt told a meeting of officers of Labour's National Executive Committee he had known about the arrangement.
Under the law, those making donations on behalf of others must give details of who is providing the money.
Mr Abrahams gave the money through colleagues Janet Kidd and Ray Ruddick, and solicitor John McCarthy.
Labour is investigating the donations and the Electoral Commission has also asked the party to explain.
BBC political editor Nick Robinson said he had been told there may be a fourth person "used as a cover" to make payments on behalf of Mr Abrahams.
In his resignation statement, Mr Watt said he had always "prided myself on having complete integrity" but added that, as general secretary, he was legally responsible for the reporting obligations for the party.
He added: "I was aware of arrangements whereby David Abrahams gave gifts to business associates and a solicitor who were permissible donors and who in turn passed them on to the Labour Party and I believed at the time my reporting obligations had been appropriately complied with.
"As a result of press coverage over the weekend, I sought legal advice on behalf of the Labour Party. I was advised that, unbeknown to me, there were additional reporting requirements."
Mr Watt, a former nurse who has been Labour general secretary since 2005, said he had informed the National Executive Committee straight away.
Ray Ruddick - £196,850
Janet Kidd - £185,000 since 2003
John McCarthy - £202,125 since 2004
Source: Electoral Commission
He added: "Consistent with my own and the party's commitment to the highest standards in public life, it is with great sadness I have decided to resign my position as general secretary with immediate effect."
Mr Abrahams told the BBC that Mr Watt "didn't deserve to resign".
He added: "He was an excellent and very efficient general secretary. If he wasn't aware of the law, he should have been given another chance.
"The party should review his resignation. It's not the way forward for the Labour Party."
According to the Electoral Commission, Mr Ruddick has donated £196,850; Mrs Kidd has donated £185,000 since 2003; and Mr McCarthy £202,125 since 2004.
Conservative frontbencher Chris Grayling said: "I think it's a question to put to Gordon Brown - did he have any idea about these donations?
"I wait with interest to hear what he has to say. But the broader issue is that day after day, week after week, we get announcements, get issues, get crises.
"This is a government which appears to be in a state of chaos, unable to get on with the job of governing Britain."
Acting Liberal Democrat leader Vince Cable said: "It is clear that there are many more questions that need to be answered about this whole affair.
"Gordon Brown promised a new style of politics upon becoming prime minister, but this promise, like so many others, has proven to be false."
Meanwhile, former independent MP Martin Bell, who was elected to the Commons following an anti-sleaze campaign, told BBC Radio 5 Live the issue was "not a passing matter".
"We have to find a better way of funding politics and restoring trust in public life," he said.