The peer was effectively sacked from the party’s front benches in the Lords after details of his attendance at the Presidents Club fundraising event came to light.
A Labour Lords spokesman said: “Jeremy Corbyn has this evening asked Lord Mendelsohn to step back from the front bench as he attended the Presidents Club dinner, and he has agreed to do so.
“Lord Mendelsohn has previously made clear that he attended part of the dinner as president of a charity that received support from the event and he had no knowledge of an after-party.
“Lord Mendelsohn did not witness any of the appalling incidents described in reports and has unreservedly condemned such behaviour.”
The peer had been a Labour spokesman on business and international trade matters in the House of Lords.
A spokesman for Labour leader Jeremy Corbyn said: “It’s right that Lord Mendelsohn has stepped down.
“The reports about this appalling event were deeply shocking and there can be no excuse for anyone’s attendance.”
A Financial Times investigation brought to light sexual harassment allegations at the Presidents Club dinner, where money was raised for charities through bids for prizes including lunch with Boris Johnson, and tea with Bank of England Governor Mark Carney.
Charities including Great Ormond Street Hospital have vowed to return money raised for them through the dinner, which is held at the Dorchester Hotel.
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The Charity Commission is looking into the allegations as a “matter of urgency”.
The Bank of England and the Foreign Office has made it clear that neither man knew the nature of the event and the engagements will not be honoured.