Special report: The empire strikes back

On Friday, the shaming of a naked Prince Harry on The Sun's front page may have sent morale plummeting inside the royal palaces, but the spirits of reporters lifted for the first time since the before the phone-hacking scandal erupted in July 2011. Despite criticism from some MPs and peers (but support from other parliamentarians), the splash had a "transformative" effect on The Sun newsroom, said insiders. "It is good to feel that we are working for a paper that gets noticed again," said one staffer.

The publication of the pictures, against the wishes of St James's Palace and the Press Complaints Commission, has triggered more than 850 complaints from the public (although none so far from Prince Harry himself). But this number is dwarfed by The Sun's total readership and the millions who have viewed them online, both on the newspaper's website and TMZ.com, the American site that broke the story. And to Mr Murdoch, what matters is not a few hundred readers upset at the invasion of Harry's privacy, but the act of defiance he has carried out against the establishment – including Lord Justice Leveson, the Royal Family and David Cameron.

Mr Murdoch's revenge was played out in an extraordinary transatlantic phone call from the News Corporation chief early on Thursday to News International chief executive Tom Mockridge. The newspaper proprietor had kept himself at arm's length on Wednesday, when editors across Fleet Street held fraught discussions over whether they should publish pictures of the third in line to the throne partying naked in room 2401 of the Encore Wynn Hotel in Las Vegas with young women he had just met. Executives spoke of a "Leveson chill" that had descended across not just The Sun, Daily Mirror and The Star, but also the Daily Mail, whose robust editor, Paul Dacre, was on holiday. Some 18 months ago, newspapers would have published the pictures without debate, but the Leveson inquiry into phone hacking, and Lord Justice Leveson's threat of tighter regulation on newspapers, has left editors and executives terrified.

Insiders said that on Wednesday afternoon, Mr Murdoch was fully aware of the pictures but as unanimity formed across all newspapers that they should abide by the Royal Family and the PCC's wishes, he did not get involved. The Sun's editor, Dominic Mohan, was on holiday; Simon Cousins, a long-standing and experienced Sun staffer, was in charge and, with Mr Mockridge, took the decision not to publish.

Instead, Thursday's edition of The Sun would feature a mock-up of the scene, with a picture desk assistant named Harry Miller and a fashion intern called Sophie Henderson volunteering to be photographed naked for the front of the paper. On Thursday in New York, Mr Murdoch awoke to a growing consensus back in Britain that editors had been cowed by Leveson into not running the pictures. According to those familiar with the fast-moving developments on both sides of the Atlantic, Mr Murdoch was "furious".

The 81-year-old proprietor instructed Mr Mockridge to splash Friday's edition with the real Harry pictures. A source said: "Rupert said, 'There is a principle here. I know this is about Leveson but this is humiliating. We can't carry on like this. We should run them, do it and say to Leveson we are doing it for press freedom.'" The Murdoch empire was striking back.

Mr Murdoch, whose republicanism is well known but often restrained through the pages of The Sun and other News International titles, which are usually sympathetic to the royals, is a "natural iconoclast", said a well-placed source. "He knows when it gets dangerous. This is classic Rupert territory: spoilt rich royals doing what the hell they want and the rest of us not being allowed to know about it. When Rupert is outraged by something, his forehead reddens. This would have got him going."

Sources said it was "liberating" as Sun staff put together the edition they should, they believe, have published 24 hours earlier. They paid Splash News, the agency syndicating the TMZ.com photographs, £10,000. Friday's Sun ran with the headline: "Heir it is! Pic of naked Harry you've already seen on the internet." The explanation was that the pictures were already widely available online and that this was a "crucial test of Britain's free press". Not only was The Sun showing Prince Harry's bottom, but Mr Murdoch was, figuratively speaking, mooning the British establishment, including Lord Justice Leveson. This was also a veiled attack on Mr Cameron, whom Mr Murdoch, it is said, blames for the looming threat of statutory regulation by setting up the Leveson inquiry in the first place.

But, as all dynastic sagas contain twists and turns, Mr Murdoch's muscular anti-establishment assault came as his daughter, Elisabeth, launched her own attack: in the direction of her father and brother, James, the former chairman of News Corporation (Europe & Asia), which controls the Murdoch newspaper empire in Britain. In a sensational speech at the Edinburgh International Television Festival on Thursday, the chief of Shine Television, a subsidiary of her father's company, said News Corp had "significant and difficult questions about how some behaviours fell so far short of its values" during the hacking scandal. Sister and brother have drifted apart since last summer, and Ms Murdoch admitted that she was instrumental in forcing the resignation in July 2011 of her friend Rebekah Brooks as chief executive of News International.

Ms Murdoch's speech was not checked with her father or brother. Murdoch Snr's reaction to his daughter's speech is not known, but her deliberate support for the BBC licence fee – in contradiction to James Murdoch's position – may not have gone down very well, even if it didn't enrage her father enough to cause his forehead to redden.

But will Mr Murdoch's strike against the establishment make any difference? By yesterday, St James's Palace had not registered a complaint of breach of privacy with the PCC. The Prime Minister has declined to comment on whether The Sun was right. Which leaves it to Lord Justice Leveson to respond, in due course, with his report in the autumn. It is possible that Lord Justice Leveson has noticed Mr Murdoch's line drawn in the sand and has softened his position on regulation. But what is more likely, and that many in journalism fear, is that the sight of a naked Prince Harry on the front of The Sun will only send the judge further down the road of statutory regulation.

Where do you draw the line?

The revealing pictures taken of Prince Harry in Las Vegas last week have reignited the row that has been at the heart of the Leveson inquiry: what is in the public interest? Despite months of evidence, agonising and deliberating, no consensus has emerged. Here, The Independent on Sunday asks leading commentators – and victims of press intrusion – where they draw the line between the right to privacy and the public's right to know.

Mary-Ellen Field

Intellectual property expert

"Everyone is entitled to privacy in a private space unless illegal activities are taking place, no matter who they are. I don't buy the argument that because the royals receive public money they are not entitled to privacy. If everyone who is funded by the taxpayer – teachers, nurses, police, doctors, social workers – had this rule applied to them, hardly anyone would have the right to a private life."

Adrian Sanders MP

Commons Culture, Media and Sport select committee member

"I haven't seen the Prince Harry pictures, but if I wanted to see the crown jewels I'd go to the Tower of London rather than buy 'The Sun'. The prince is unmarried and I'm not aware that anyone in that room was caroused into doing anything they didn't want to do. What is wrong is the person who took the photos and shared them."

Hugh Tomlinson QC

Specialist in media law

"I personally don't think that public interest is a problem at all. I think it's absolutely plain, and the only reason why it's said that there's a difficulty about public interest is that newspapers are desperately searching for justifications for publishing things that aren't in the public interest."

Brian Cathcart

Professor of journalism at Kingston University London and a founder of Hacked Off campaign

"You should be entitled to claim a public interest for what you are doing if you are making the world a better place: is it for the greater good? A good definition of the public interest can be found in the Media Standards Trust's submission to Leveson, which says: 'Exposing or detecting crime, incompetence, injustice or significant anti-social behaviour amongst private or public officials in positions of responsibility; protecting the public from potential danger; preventing the public from being misled by erroneous statements or by the hypocrisy of those attempting to create a false image for potential material gain; revealing information which fulfils a democratic role in advancing a better understanding of issues that are of importance to a significant portion of the public, or that assists the public in making important decisions in public life'."

Steven Barnett

Professor of Communications at the University of Westminster

"What annoys me is when editors claim to be speaking on behalf of the public... I've done research that shows categorically that the public do not support invading people's privacy when there is no obvious public interest. They do not support the classic Fleet Street excuse that [it] can invade people's privacy because that's what people want to read about."

Paul McMullan

Former News of the World deputy features editor

"I always quite liked stories about gay affairs. I remember following a married judge who was going to gay nightclubs. I liked bringing down people like that. If you haven't got the honesty to stand in front of the people who elect you and say 'there's nothing wrong with being gay' then you have a right to be brought down."

Neil Wallis

Former executive editor of the News of the World

"[Prince Harry] is third in line to the throne, a very visible member of the Royal Family, whose power and position was used to get a free £30,000 luxury hotel stay, where he invited 15 semi-dressed young women he didn't know to join him in a 3am 'let's get naked' jaunt. No reasonable expectation of privacy."