He said he did not believe any of the information collected had been passed onto the FBI, although information about the location of Mr Dotcom and his acquaintances was sent to police. He doubted it would be admissible in a Court.
Mr Dotcom has tweeted his response to the apology extended by Mr Key:
"I accept your apology. Show your sincerity by supporting a full, transparent & independent inquiry into the entire Mega case."
Speaking from the United States, Mr Dotcom's lawyer Ira Rothken said the apology was "very appropriate under the circumstances''.
Mr Rothken had read the report, "and I know enough right now that report raises more questions than it answers''.
He said he and his team would "go through the judicial process'' before deciding whether it would take legal action in response to the report's findings.
But the apology was not enough for opposition parties, who were unanimous in calling for a more detailed independent inquiry into the matter.
Labour Leader David Shearer said Justice Neazor's report was "a whitewash because it ignores the complete failure of democratic oversight by Prime Minister John Key".
"What we are calling for is an independent wide ranging report, an inquiry into what has gone on here."
"The report is only really looking at the lower levels, it's very narrowly focused.
"Secondly, it doesn't deal with the real accountability, which is those right to the very top which is John Key's accountability. He is control as the Act says of this agency which seems to have been acting without proper control."
During a snap debate called in Parliament this afternoon on the matter, Green Party co-Leader Russel Norman also called for an independent inquiry as did NZ First Leader Winston Peters.
Mr Peters said the report didn't answer all of the questions that needed responses.
He said the matter was "a very profound issue" which "shook the confidence of the public".
Mr Key's oversight of the agency had "not just failed but seemingly never existed".
Mr Key this afternoon announced the findings of the report into the GCSB's illegal surveillance of the internet tycoon from Inspector General of Security and Intelligence Paul Neazor.
The report found the GCSB understood incorrectly that Mr Dotcom and his associate Bram van der Kolk had not fully gained permanent residence in New Zealand and were therefore not protected against surveillance.
Read the full report from Justice Neazor here
The GCSB is forbidden to spy on New Zealand citizens or permanent residents. However, in his report Justice Neazor noted that when asked by the police to monitor internet tycoon Mr Dotcom and three associates, the GCSB sought an assurance from the police that the men's immigration status meant it could spy on them legally.
Police gave that assurance.
But in his report, Justice Neazor noted: "As this matter went along what was discovered in the case of Dotcom and associated people was that resident status had been obtained on their behalf under the Immigration Act 1987 and carried forward under the later 2009 Act.
"It was understood incorrectly by the GCSB that a further step in the immigration process would have to be taken before Dotcom and associates had protection against interception of communications.''
Justice Neazor noted that Mr Dotcom was granted a residence visa in November 2010 under the Immigration Act 1987, Investor Plus category.
"At that point in time he did not meet the definition of `permanent residence' under the GCSB Act as it then was.''
However on November 29, 2010 the new Immigration Act 2009 came into effect that deemed Mr Dotcom to hold permanent residence as stipulated under the GCSB Act from that time.
Justice Neazor said leaving aside the "possible confusion'' around Dotcom and his associate's residency status, "the application made by the Police to the GCSB was a proper one'''.
"The request was made on the basis that the information sought was foreign intelligence contributing to the function of the New Zealand police and supporting the prevention or detection of crime.
"The GCSB action on it was proper.''
The only issue of illegality arose from "confusion in this instance'' over Mr Dotcom and his associate's residency status.
Justice Neazor said a repeat of the mistake could only be avoided "if the system is such that those requesting assistance from the Bureau about non citizens check with Immigration the immigration status of people who may become targets to be sure of what their immigration status in fact is (not may be) in terms of the GCSB Act definitions and tell the Bureau what they have ascertained''.
He put responsibility for ensuring the GCSB did repeat the error firmly on the police as they would inevitably be asked for similar assistance again in the future.
"What is needed is assurance available to GCSB that the subject of the information sought is not protected by the terms of the GCSB Act, ie that the person concerned is not a New Zealand citizen, that he or she is not a permanent resident and is not the holder of a residence class visa under the Immigration Act.''
Two basic errors - PM
Mr Key said the report showed there were two cases of human error at the heart of this matter.
"First, the GCSB originally relied on the police's information about the residency status of the people in question. They did not check further.
"Second, this error was compounded after the operation was concluded by a simply wrong interpretation of the law.
"The Inspector-General noted there was potential for confusion between the relevant agencies about changes to the Immigration Act in 2009 and the subsequent effect on the GCSB legislation.
"At the time in question, Kim Dotcom was not a New Zealand citizen. He was, however, classed as the holder of a residence class visa, but it was not interpreted by the Police or GCSB at the time that he fell into the protected category of permanent resident.
Mr Key said the GCSB has relied on information provided to it by the Organised and Financial Crime Agency New Zealand, which he described as "unacceptable".
"GCSB had a responsibility to fully understand what the change to the Immigration legislation in 2009 meant for its own operations, including whether individual visa holders were protected or not.
"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."
In a statement, the current director of the GCSB, Ian Fletcher, said he had apologised to the Prime Minister and deputy Prime Minister, Bill English.
"We got this wrong. Both factual errors and unacceptable errors of legal interpretation were compounded, most especially by our treating those interpretations as as fact for too long, It should not have happened."
Mr Fletcher said the GCSB would move immediately to make changes to prevent a repeat, saying he knew it would take time to regain trust and confidence.
* halting its work to support Police and other law enforcement agencies until new approval processes were in place.
* change the way confirmation of immigration status was determined before any law enforcement activity was done.
* ensure the Inspector General approved the changes before they were put in place.
Mr Fletcher said over the next few weeks it would also overhaul its compliance framework and tighten its processes, as well as conduct an internal audit.
"I know that it will take time to regain the trust and confidence that we have lost. But I also know that we will be able to do so and be able to re-establish the high standard of accountability expected of us."
Mr Key ordered the inquiry after being told on September 17 by the GCSB that it had been unlawfully monitoring Mr Dotcom's communications.
Court documents released this week show the bureau, which is forbidden to spy on New Zealand citizens and residents, was unaware that Mr Dotcom and another of his associates who was monitored, Bram van der Kolk had permanent residency in New Zealand.
That was in spite of the fact Mr Dotcom's residency status was widely reported in the media.
Yesterday, when asked why the GCSB which he is responsible for took so long to realise Mr Dotcom was New Zealand resident, Mr Key said it was "a very complex issue".
- additional reporting nzherald.co.nz
