Lord Levy, the chief fundraiser for Prime Minister Tony Blair's Labour Party, has been arrested by police investigating allegations state awards had been given in return for cash, according to several media reports.
The "cash-for-favours" row has dented Blair's standing in opinion polls and sparked calls for his resignation.
The reported arrest of Mr Blair's close friend and tennis partner will make the prime minister's position even more precarious.
A police spokesman said its specialist crime division had arrested a man at a London police station this morning in connection with alleged offences under the Honours Act 1925 and Political Parties, Elections and Referendum Act 2000.
"The man is currently in custody," he said, declining to confirm his identity as widely reported in the media. Labour came under pressure after it said it had received nearly £14 million of loans from 12 businessmen, some of whom were nominated for seats in Britain's unelected upper house of parliament after lending money.
Britain has a complicated system of awards and decorations. A 1925 law made selling seats in the upper chamber, known as the House of Lords, illegal.
Police have been investigating all parties in Britain after the row broke out in March.
Labour denies the allegations. The scandal has been particularly damaging for Blair because he had pledged his Labour government would be "whiter than white", in contrast to the previous Conservative government which was dogged by a slew of sleaze allegations.
"The issue here is one of corruption. Has cash or money been paid over in exchange for some sort of benefit?" David Davis of the oppositive Conservative Party told Sky News.
"I think it must be pretty worrying for the top ranks of the Labour Party."
Mr Blair swept to power in 1997 and won a third straight election victory in 2005 but little has gone right for him since then and the reported arrest of Lord Levy comes at a difficult time.
The prime minister's deputy John Prescott is the subject of a career-threatening investigation over his links to an American billionaire hoping to open a London casino.
Opinion polls last month showed Mr Blair was less popular than his main rival David Cameron, the youthful new leader of the Conservative Party.
Mr Blair's own pledge not to seek a fourth term has made him a lameduck leader in the eyes of some party critics and the setbacks come amid increasing calls for him to step aside sooner rather than later.
Asked about the reported arrest of Lord Levy, Mr Blair's official spokesman said: "This is a party matter and I am not going to comment on it."
In March, police arrested former government adviser Des Smith who had resigned after telling an undercover reporter that anyone making donations to Mr Blair's flagship schools programme could expect to receive state awards. He was released on bail.