• Supergrass use described as 'dancing with the devil' • Gary Eaton's evidence dismissed by second judge • Key witness in Daniel Morgan case mishandled by Met, report shows

Scotland Yard's supergrass system has been called into question after a judge ruled a key criminal witness was a "pathological liar" for the second time in six months.

Full details of the handling of the man – a career criminal with psychiatric problems and convictions for bribing police, blackmail and firearms offences – and how tens of millions of pounds have been spent on cases based on his flawed evidence have been revealed for the first time. Gary Eaton was used in a failed prosecution of four men for the murder of the private detective Daniel Morgan.

Now a leading police officer has warned of the inherent dangers in using such so-called "assisting offenders". Chief Constable Jon Murphy, head of crime for the Association of Chief Police Officers (Acpo), says using supergrasses is akin to "dancing with the devil".

"The use of a supergrass … demands some really informed, critical decision-making by experienced people who fully understand all of the implications and who aren't just focused on the end result for that particular investigation," he said.

The story of how Eaton, 51, was used can be revealed after a crown court judge ruled he was a "pathological liar". The judge excluded his evidence from a second criminal case.

The decision to drop him from the case – which was based solely on his supergrass evidence – came six months after the judge in the Morgan case ruled that he was a liar who had been "prompted and coached" by a senior police officer into providing a crucial part of his testimony.

The Crown Prosecution Service said the decision to continue using Eaton was made by a senior lawyer with the knowledge of the director of public prosecutions. It refused to say how much the latest case had cost, but the Morgan case cost in excess of £30m.

It is understood some senior police officers opposed the use of Eaton as a supergrass after revelations during the Morgan hearings about his violence, history of lying and serious psychiatric problems. They felt they could have no further dealings with such a tainted witness.

The Guardian can now publish details of a document written by the judge in the Morgan trial that reveals how he was mishandled. The report shows:

• Eaton was taken by a senior police officer to a covert location, left alone in a vulnerable state and eventually prompted into implicating two brothers in the Morgan murder.

• Eaton and his girlfriend were paid £72,000 in 11 months as officers tried to manage his heavy drinking, erratic behaviour and violent threats.

• Officers failed to pass on his history of serious psychiatric problems to a separate team who were debriefing him.

• Eaton had a 27-year sentence for 51 crimes including conspiracy to murder, bribery, supplying drugs, blackmail and possession of firearms reduced to three years. He remains at liberty, living as a protected witness under a new identity.

Eaton was the one of the first supergrasses to be recruited by the Metropolitan police under the Serious Organised Crime and Police Act, which came into force in 2006 and was designed to clean up the supergrass system after it came into disrepute in the 1980s.

He is one of 158 supergrasses used since 2006, primarily by the Met, Merseyside police and the Police Service of Northern Ireland.

In his report on Eaton, Mr Justice Maddison finds that he was prompted and coached by Detective Chief Inspector Dave Cook, the officer investigating the murder of Morgan. He finds that Cook repeatedly contacted Eaton after he had signed an agreement to be an assisting offender, and in doing so the officer breached guidelines in supergrass cases that a "sterile corridor" must be put up between the investigating officers and an independent team who handle the witness and take his statements.

Maddison found that an appropriate adult should have been present when police interviewed Eaton during a lengthy debriefing process over 16 months between August 2006 and December 2007 because of his history of serious psychiatric problems. Without this appropriate adult in place the whole process should have ceased. It did not.

One of the most "concerning" events for the judge came on 5 September 2006, a month after Eaton was recruited as a supergrass and while officers were still taking his witness statements. Eaton was taken by DCI Cook to a "covert location" near Reading, and left alone in the bedroom of a hotel. He became very distressed and broke down.

Half an hour later Cook – who had been trying to get Eaton to implicate two brothers, Glenn and Garry Vian, in the Morgan murder – sent him a text message that the officer then deleted from his mobile phone, according to the judge's ruling.

An hour after Eaton had been put into the hotel room he changed his story and prepared a statement implicating the Vian brothers in the murder for the first time.

His evidence was eventually thrown out of the Morgan murder trial and the case collapsed in March of this year.

Despite this he was put forward as the star witness in the second criminal case, but on Friday his evidence was thrown out by the trial judge who said it was "not just unreliable but false and highly dangerous".

Scotland Yard and the CPS are carrying out a review of the use of "tainted witnesses" but no officers have been disciplined as a result of the Eaton revelations.

The attorney general's office said the use of such witnesses was constantly under review and regular conversations were held with prosecutors on the issue.

Senior police officers appear to be split on the issue of supergrasses. Assistant Chief Constable Andy Cooke, Acpo lead for witness protection, defended their use. "It can be seen as a high-risk practice, because of the nature of the people you are dealing with who are involved in criminal behaviour, but it does have a real place in tackling crime," he said.

Sir Hugh Orde, the president of Acpo, was more sceptical, saying in Northern Ireland not one supergrass case during the Troubles has stood the test of time.