The former Labor senator Sam Dastyari said he advised NSW Labor boss Kaila Murnain to “cover your arse” when she told him of potential fundraising misconduct and mentioned the name of Chinese billionaire and banned donor, Huang Xiangmo.

Murnain broke down on Thursday morning while explaining to the Independent Commission Against Corruption that she kept quiet about potentially illegal donations because she was “scared” for the “reputation of the party”.

Murnain called Dastyari for advice after learning of the potentially unlawful donations in September 2016, and the then senator picked her up in his car.

At the time of the meeting with Murnain, Dastyari was in the middle of his own scandal involving Huang’s Yuhu Group, which had forced him from the federal frontbench eight days earlier.

In evidence on Thursday morning, Dastyari said Murnain had told him the Labor fundraising accounts were “not reflective” of what had actually occurred.

She had “specifically singled out” Huang – banned from donating in NSW due to his property development links – as someone she was worried about.

Dastyari said he urged Murnain, then Labor’s assistant secretary, to go to the party’s lawyers, which he thought was the most appropriate course of action.

“I could understand the enormity of it because of how distressed she was,” Dastyari said.

A transcript of Dastyari’s earlier evidence to Icac investigators shows he said: “my advice to her would have been, cover your arse”, by talking to Labor’s lawyers.

Dastyari said he had not spoken to anyone else since about the matter, including the federal Labor president.

“I had no discussions with nobody about this matter in any shape or form,” he said.

Following his evidence, Dastyari told reporters that the current hearings showed the need for a federal integrity commission. He said Labor should not be above reproach.

“My message to the NSW Labor party is: enough’s enough, maybe it’s time to have a serious look at a proper, full statewide ban on private donations,” he said.

Murnain was removed overnight from her role as NSW Labor’s general secretary following explosive evidence to Icac on Wednesday that she knew as early as 2016 that Labor had likely taken unlawful donations.

Icac has heard that Huang – a Chinese billionaire, property developer and banned donor – gave $100,000 in cash to the party in 2015, but that the origins of the donation may have been masked by a series of straw donors.

Murnain struggled to hold back tears on Thursday as she explained why she had helped to keep revelations about potentially illegal donations quiet after state Labor MP, Ernest Wong, told her about them in September 2016.

Acting on the advice of Dastyari, Murnain said she went to Labor’s lawyers, who told her: “Don’t record this meeting. Don’t put it in your diary. Forget the conversation happened with Ernest … and don’t tell anyone.”

Murnain said she had followed the advice closely because she was “scared”. Asked why she was scared, Murnain responded: “For the Labor party, we had been through a lot that year,” she said. “There were multiple court cases, there were byelections coming. I was scared for the head office and the reputation of the party.”

When she first appeared on Thursday morning, Murnain was asked to confirm she had been suspended as Labor general secretary overnight.

The head table at a Labor fundraiser dinner in March 2015, picturing former opposition leaders Bill Shorten (third from left), Luke Foley (far right) and Huang Xiangmo (second from right). Photograph: Ernest Wong/Supplied by ICAC

Murnain said she had found out about the suspension “in the media”. A letter had been sent to her lawyers about the suspension, but she had only read it briefly, the inquiry heard.

Evidence to the Icac has claimed Huang visited the Labor party’s Sussex Street headquarters in April 2015 with an Aldi bag filled with $100,000. Official Labor records suggested the $100,000 came from 20 donations of $5,000, made by 12 donors at a Chinese Friends of Labor fundraising dinner several weeks earlier. Two of the donors have now told Icac that they did not make $5,000 donations to Labor.

The NSW Electoral Commission first investigated the discrepancies and sought evidence from Murnain and Labor about who had brought the $100,000 into Labor’s headquarters.

Murnain said the money had been brought in by Kenrick Cheah, a Labor staffer.

She conceded on Thursday that this evidence was “incorrect”, but said she hadn’t deliberately attempted to mislead investigators. She said the answer should have been either former NSW Labor boss, Jamie Clements, or Huang.

“I would answer the question very differently now, looking at it,” Murnain said.

Murnain said she had recused herself from involvement with the matter when the NSW Electoral Commission issued Labor with a notice to produce documents. She said she hadn’t wanted to interfere with the investigation.

But Icac chief commissioner, Peter Hall, said that only Murnain had knowledge of what Wong had told her about the potentially illegal donations. She had also known that the NSW Electoral Commission was seeking precisely that type of information.

“Wasn’t that a deliberate decision by you to not involve yourself, and not involve the others, by giving them the information you had, so that the true story wouldn’t come out?” Hall asked.

Murnain responded: “No, that wasn’t the intent.”

Hall also asked Murnain why she hadn’t gone back to Labor’s lawyers when the NSW Electoral Commission intensified its investigations. Murnain said: “I was told to forget it, and that’s what I did.”

Dastyari, who was forced out of parliament over his interactions with Huang, spoke to reporters on arriving at the Icac, saying he felt sorry for Murnain and had always given her frank and fearless advice.

Dastyari said he hoped the inquiry showed the “insidious” nature of donations and would start a “new page” for Labor. Asked why he was giving evidence, Dastyari responded: “I spent a lifetime running towards cameras. I’m not about to run away from them now.”

Murnain is expected to be recalled for possible cross-examination next week. Dastyari’s evidence to the inquiry continues.