Justice Secretary Chris Grayling said “uncertainty” created by the investigation into the company, which was the leading bidder to operate Hatfield, Moorland and Lindholme prisons, meant the process was being cancelled.
Both Serco and rival G4S are subject to an investigation by the Serious Fraud Office over their tagging of offenders. An audit suggested they took money for criminals who were either dead, in jail or never existed.
In a written statement to MPs, Mr Grayling said: “The House will recall that I made an announcement on July 11 2013 where I outlined that the leading bidder for these prisons was Serco, but that the award of this contract would be delayed as a result of the investigations into Serco’s operations.
“The investigations remain ongoing. The impact of the delay and the uncertainty this has created mean that for operational reasons we cannot postpone the outcome of the competition process any further.
“I have therefore decided that the competition for these prisons will cease and that all three prisons will be managed by HM Prison Service.”
The move to privatise the three sites, along with Northumberland Prison, was announced last year in a move ministers said would save millions of pounds.
Mr Grayling insisted that the Government remained “fully committed to a mixed market for public services, drawing on the best of public, private and voluntary providers to improve quality and secure value for money for the taxpayer”.
The two security firms have been barred from winning new government contracts pending a wider review of their operations.
Serco said it understood that the “urgent need for change at these prisons means that the typical six-month period of mobilisation and transition to the private sector would not be in the best operational interest of the prisons”.
Acting group chief executive Ed Casey, who took on the role after Christopher Hyman resigned last month, said: “From meetings with the UK Government, it is clear that the operational needs of the prisons will be best served by the necessary changes being implemented without further delay.
“We are also continuing to make good progress across the various audits, reviews and our proposed corporate renewal programme within the timing previously communicated by Government.”
The three prisons, all situated off the M18 north east of Doncaster, have a combined capacity of more than 2,000. HMP Hatfield, previously known as Moorland Open, and HMP Moorland, are category D and C prisons for lower-risk offenders, while HMP Lindholme houses life-sentence prisoners and those likely to try and escape.
Frances Crook, Chief Executive of the Howard League for Penal Reform, described the development as “a welcome U-turn by the Government”.
She said: “Only two days ago, Serco admitted to MPs that it had been ‘ethically wrong’ to charge the taxpayer for tagging work it never did.
“Nobody wants companies that, by their own admission, have behaved unethically managing prisons, of all places.
“The Justice Secretary shouldn’t stop at these three prisons in South Yorkshire. He should go further and continue to reverse the justice privatisation tide currently being witnessed across the country.”
Shadow justice secretary Sadiq Khan said: “This is a humiliating climbdown which shows the danger of being over-reliant on a private monopoly to run vast swathes of the justice system.”