The Billy Wright Inquiry, which cost £30m and lasted five years, found no evidence of collision between the authorities and the three INLA gunmen, although prison negligence facilitated the killing.
The report recommends a shake up of the prison service after identifying "a number of serious failings".
"The report is a clear account of the shortcomings in the management and running of the Maze at the time of Billy Wright's death", Northern Ireland Secretary Owen Paterson told the House of Commons.
"His murder should never have happened. But any allegations that the state colluded in this violent killing have now been examined and rejected," Mr Paterson added.
"Billy Wright was in the "protective custody of the state" at the time of his death. Whatever horrendous crimes Billy Wright or the LVF committed, his murder in a high-security prison should never have happened".
"It was wrong and I am sincerely sorry that failings in the system facilitated his murder."
Billy Wright's father, David has branded the report a "total whitewash and a failure to get to the truth".
At a press conference at Belfast's Stormont Hotel, Mr Wright said the investigation "had adapted a narrow interpretation of collusion".
"Having considered the factual findings, they look like collusion, they sound like collusion and in my mind amount to firm and final proof of collusion by state agencies in acts of omission," he said.
"The inquiry has endorsed the suspicion that evidence has been concealed which might have been damaging to the reputation of the RUC."
Among the family claims dismissed by the report is MI5's role in a plot.
"The panel reject the charge of collusion made by the Wright family against the security service," the report said, adding it was "most unfortunate" MI5 officers did not communicate intelligence about a threat to Wright from the INLA as far back as April 1997.
The report also noted that an April 1997 threat against Wright was not acted upon properly by the RUC.
The report said: "The panel's conclusion is that the RUC's failure to communicate the intelligence was a wrongful omission which facilitated the death of Billy Wright in a way that was negligent rather than intentional."
Mr Wright Sr has always claimed that authorities colluded to have the LVF leader killed because he had posed a major threat to the peace process in the run-up to the Good Friday Agreement.
Billy Wright is believed to have masterminded a string of loyalist killings and funded his terror campaign through drug-dealing.
He was serving time for threatening to kill a woman when his murder was carried out.
On 27 December 1997, Wright was sitting in the back of a prison van waiting to be taken to meet his visiting girlfriend when he was shot seven times.
Crip McWilliams, John Glennon and John Kennaway had climbed through a hole which had been cut in the fence, gone over the roof of 'A' wing and into the yard where the van was parked.
McWilliams opened the door of the van and shouted: "Armed INLA volunteers," before he and Glennon fired into the van - killing Billy Wright.
The three prisoners then returned to their cells, later handing over their guns to a priest before surrendering to the authorities.
The report's authors say they still did not know how the guns used to kill Wright ended up in the Maze.
"To our regret, no explanation emerged in the evidence as to how the two firearms were introduced into the prison and put into the hands of his INLA murderers," they say.
The 704-page report highlights a catalogue of security failures which were the result of "negligence rather than intentional acts".
The inquiry found that the decision to allocate Wright and the LVF faction to H-Block 6 where the INLA were being held was a "wrongful act" which directly facilitated his murder.
The prison authorities also failed to strengthen roof defences at the jail, failed to ensure the exercise yards were checked and secured each night, and failed to carry out full risk assessment before LVF were moved to the block.
Special branch, the Northern Ireland prison service and MI5 are all subject to varying degrees of blame for neglecting to take sufficient precautions for the shooting inside the Maze prison.
But the Prison Service suffers the most serious criticisms over Wright's death.
The Director General of the Prison Service Robin Masefield said he accepted the findings.
"I would point out that NIPS had previously, as long ago as 2002, accepted negligence in civil proceedings.
"But it is important to note that the report, after its exhaustive proceedings over four years, makes no finding that any failing by any manager or member of staff was intentional," he added.
The inquiry report said a review of the Northern Ireland prison service similar to Lord Patten's police overhaul should be launched.
"The Prison Service will be looking to see if there are lessons that can be learned for application to the current context and will consider how best to take forward the recommendations which apply to it, " Mr Masefield said.
Mr Paterson said there will be "no more costly and open-ended public inquiries."
Billy Wright's report: Key Findings
- There was no collusion in the death of Billy Wright;
- Security files on prisoners were destroyed on two occasions;
- The failure of the Prison Service to classify killers Christopher McWilliams and John Kenneway as top-risk prisoners after they held a prison officer hostage in April 1997 was a wrongful omission which facilitated the murder of Wright;
- The free run of prisoners may have made it easier to cut the yard fence before the attack;
- The Prison Service failed to strengthen roof defences and secure the exercise yard;
- Prison Service head Alan Shannon was criticised for appointing Martin Mogg governor of the Maze prison while he was still director of operational management. This severely weakened the operational capacity of the directorate;
- Management failures mean there should be a review of the prison service similar to Lord Patten's overhaul of policing;
- There was no proper risk assessment of the prison van transfer which the gunmen targeted to ensure hostile inmates did not come into contact;
- The Prison Service did not properly consider a Red Cross warning in November 1997 that the LVF and INLA wing of the jail was a "powder-keg";
- There was a suspicion of deliberate police malpractice in destroying audit trails and concealing evidence.
- The RUC in 1997 lacked the capacity to analyse information which led to "missed opportunities";
- There was an endemic culture of secrecy between the police's Special Branch and criminal investigation departments;
- The RUC failed to continue its INLA surveillance into December 1997;
- The secret services did not tell the prisons minister of the threat to Wright's life by the INLA when he was considering his 1997 transfer to the Maze from Maghaberry prison.
Billy Wright's report: Reactions
Ian Paisley Jr, North Antrim MP, DUP: "I think people feel short-changed and are right to feel short-changed. It was a £30m investigation into a murder that took place in confined circumstances inside Her Majesty's prison and yet provides us with no more material substantively than we had before the investigation started. I feel we can only conclude that this is a whitewash."
John O'Dowd, Upper Bann MLA, Sinn Fein : "The question of money, while very important, is also used as an attempt to block the truth. When I listen to Mr Paterson speaking in the House of Commons this afternoon when he said there would be no more costly inquiries, what he really means is there will be no more inquiries into the role of the British State in Ireland."
Margaret Ritchie, SDLP Leader and South Down MP, MLA: "Given the litany of errors identified by the report many will ask that if they don't add up to collusion then what do they add up to? We must never have any repeat of these failings and the recommendations of the inquiry must be implemented without delay."
Tom Elliott MLA, Ulster Unionist Party Justice Spokesperson: "Today's report may have significant implications for our prison service and in particular Maghaberry prison which is the sole high security prison in Northern Ireland. Politicians and the Minister for Justice will have to fully digest this report and reflect on its implications for current operations in Northern Ireland."
Stephen Farry MLA, Alliance Party Justice Spokesperson: "The political, policing and security context has changed significantly over the past decade, as the nature of the prison system. Nevertheless, it is only right that the recommendations of the inquiry are properly tested. Reform of prisons is a priority for new devolved Department of Justice, and a Prison Review team, agreed as part of the Hillsborough Agreement, is currently conducting the public consultation aspect of its work."