The public should be "brassed off", claims Winston Peters.
Martin Matthews was the Transport Ministry's chief executive when ministry employee Joanne Harrison stole nearly $750,000.
The Labour Party and United Future is also calling for an independent inquiry into the extent of the fraud.
Mr Matthews was repeatedly alerted to what senior management regarded as Harrison's "astounding" behaviour, but for years did not act.
Politicians who appointed him as auditor-general say they were never made aware of the full scale of the fraud.
In addition to stealing money, Harrison also secured jobs in the public sector for those close to her.
A friend of hers was on the ministry's payroll for 10 months but never turned up or did any work.
She also tricked another government agency into hiring her husband, on a six-figure salary.
Every time red flags were raised with Mr Matthews, he accepted Harrison's explanations - making it clear he did not want to undermine her trust.
New Zealand First leader Winston Peters was furious Mr Matthews' lack of action was not made clear to politicians when they appointed him as auditor-general.
"The auditor-general himself, I believe, must stand down until a full-scale inquiry gets to the end of this matter."
Mr Peters said he found it hard to believe Mr Matthews did not know what was going on.
"The appointment process went to Parliament, and parliamentarians and parties are required to say whether they support or don't support.
"If we'd have known what had gone on, there's no way we would have said that. We feel seriously brassed off, and so should the public."
Labour leader Andrew Little said the failures at the Transport Ministry were disturbing and, given the ongoing revelations, it would be more appropriate for the State Services Commission to investigate exactly what went on.
Mr Little questioned whether the panel of politicians who interviewed Mr Matthews for the role in 2016 knew the full story.
"I've spoken to Trevor Mallard, our representative on the panel. He said there was information out there now that he wasn't aware of at the time the appointment was made."
Prime Minister Bill English said it would be a drastic step for Mr Matthews to step down.
While he was not familiar with all the details of the case, it had been dealt with satisfactorily, which showed the system was able to pick up problems, he said.
Any further investigation would be done by the State Services Commission, he said.
State Services Commissioner Peter Hughes refused to be interviewed but said Harrison's fraud had been "the subject of a number of independent reviews which have considered all the available information".
This article was originally published by RNZ.