But U.S. District Judge Gerald Rosen said the two, as well as a third man, must stand trial again on charges of document fraud.
The judge's decision came after the Justice Department admitted widespread prosecutorial misconduct in the case and asked the judge to dismiss the terrorism charges against two men accused of being part of a Detroit terror cell.
In a case the government once hailed as a victory against terrorism, Karim Koubriti, 26, and Abdel-Ilah Elmardoudi, 38, were convicted in June 2003 of conspiracy to provide material support for terrorism and to engage in fraud and misuse of visas and other documents.
A third man, Ahmed Hannan, 36, was convicted of only the fraud charge, and Farouk Ali-Haimoud, 24, was acquitted.
The government's change of heart, outlined in court papers Tuesday, came after a months-long court-ordered review of documents connected to the case. The Justice Department uncovered several pieces of potentially exculpatory evidence that should have been given to the defense before trial.
In a 60-page memo that harshly criticizes its own prosecutors' work, the Justice Department told Rosen on Tuesday night it supported the Detroit defendants' request for a new trial and would no longer pursue terrorism charges against them.
The reversal comes during the buildup to President Bush's nomination acceptance speech at the Republican National Convention, where he and his allies have been touting their success in the war on terror.
The internal investigation of prosecutorial misconduct found enough problems that there is "no reasonable prospect of winning," the government conceded, drawing back from a case once hailed by the Bush administration as a major victory in the war on terror.
"In its best light, the record would show that the prosecution committed a pattern of mistakes and oversights that deprived the defendants of discoverable evidence (including impeachment material) and created a record filled with misleading inferences that such material did not exist," Justice told the court.
The decision was hailed by lawyers for the Detroit men who were convicted last year.
The memo attached to Justice's filing was harshly critical of Assistant U.S. Attorney Richard Convertino, the lead prosecutor in the case. It quotes Convertino's colleague who worked on the case as saying he would never have proceeded if he knew the problems uncovered by the internal investigation.
For instance, Justice alleged that Convertino was told about photos of a Jordanian hospital that the alleged Detroit cell was accused of making surveillance sketches of, but never introduced the photos at trial or told defense lawyers. Instead, the prosecution elicited testimony from an FBI agent suggesting there were no such photos.
"Misleading testimony was elicited that created the false impression that there was initial consensus that the drawing depicted the Queen Alia Hospital and that photos could not be taken due to diplomatic red tape," Justice conceded.
Convertino has been under investigation for months and filed a whistle-blower lawsuit against Attorney General John Ashcroft earlier this year. In an interview with the AP, Convertino accused Justice Department superiors of thwarting his efforts to introduce some evidence against the defendants at trial.
Convertino's lawyer, William Sullivan, declined comment Tuesday night, citing the judge's gag order.
In the new court papers, the Justice Department also divulged testimony from a recently retired CIA officer who directly called into question another of the government's key conclusions at trial — that the alleged Detroit terror cell had made a surveillance sketch of a Turkish air base used by American fighter jets.
The retired CIA officer, William McNair, told the Justice Department he told Convertino during five to 10 conversations that CIA experts "did not believe the sketch conveyed any useful information" and was probably created by "someone who was not very well-trained."
The filing also noted that the government uncovered new evidence, recently reported by the AP, that FBI agents in Las Vegas and Detroit disagreed over whether a videotape found in the Detroit terror cell's apartment was surveillance footage of American landmarks, as jurors were told.