An opening montage, narrated by Sid Hudgens (Danny De Vito), publisher of Hush-Hush, a Hollywood sleaze magazine, explains that Mickey Cohen has taken over the organized crime rackets in Los Angeles (left behind by the murdered Bugsy Siegel) and that his actions have tarnished the reputation of the Los Angeles Police Department. That all changes when Cohen is arrested on income tax evasion and sent to prison on MacNeil Island in Washington state, leaving open the rackets he'd expanded for years. "Remember dear readers," he signs off, "You heard it here first. On the record, off the QT, and very Hush-Hush."
During the Christmas season of 1952, police officer Wendell "Bud" White (Russell Crowe), while out on a liquor run with his partner, Dick Stensland, checks in on a parolee he'd sent to San Quentin State Penitentiary and finds him physically abusing his wife. Bud has no tolerance for those who are violent with women, seeing how his own mother was killed by his drunk and abusive father. To lure the wifebeater outside, Bud yanks the man's lighted Santa sleigh and reindeer decorations from the roof of the house. When the man comes outside to confront White, White beats him senseless and handcuffs him to the porch railing. Bud tells the man he'll be sent back to prison for about 18 months and that he'll be watching him after he's released, threatening to send him back on a child rape charge.
At a lavish Hollywood Christmas party for the show Badge of Honor, Sgt. Jack Vincennes (Kevin Spacey), a narcotics detective, is dancing with his date when he is met by Sid Hudgens. Vincennes is a technical advisor to the show's lead actor Brett Chase, teaching him how to act like a cop. He's also got a hustle going on with Sid where he busts celebrities for minor offenses and Sid then writes trashy gossip to ruin their careers in Hush-Hush. Tonight, Sid has a hot tip for Jack: two starlets, Matt Reynolds and Tammy Jordan, have purchased a small quantity of marijuana and have rented a hotel bungalow. Sid promises Vincennes a $50 payment for doing the bust, in exchange for exclusive coverage in Hush-Hush, though Vincennes ups the demand to $100 to cover the additional payoffs for two patrolmen and a watch commander.
At Hollywood Station, Sgt. Edmund 'Ed' Exley (Guy Pearce) has been assigned as watch commander for the evening. He is interviewed by a reporter from the Los Angeles Times, who cite his late father Preston Exley's own famous reputation as a police officer, suggesting that Exley has a lot to live up to. Exley also talks to his captain, Dudley Smith (James Cromwell), who expresses disappointment in the young officer and warns that unless he's willing to adopt the brutal tactics (planting evidence, interrogative beatings) employed by officers like his father, he'll never be a successful detective in the department. Exley intends to build his career as an honest cop, even if that means being a pariah with the rank and file cops. As a last word of advice, Smith urges Exley not to wear his glasses because nobody else on the force wears them.
Bud and Stensland go to a liquor store where they buy alcohol for a party at their precinct. Bud meets a beautiful woman in the store named Lynn, who easily recognizes that he is a cop. Leaving the store, Bud notices a young woman, whose face is bruised and bandaged, sitting in the backseat of a car with another unidentified man. When Bud inquires about what happened, he is met by the car's driver, Leland 'Buzz' Meeks, who tries to shine him on. Bud disarms him and inquires further about the injured woman, who tells him herself that she's OK. He returns Meeks' pistol and wallet. When he gets back to his own car, Stensland confirms that Meeks is a former cop.
Vincennes busts Matt and Tammy and arrests them in a gaudy show that Sid headlines as the "Movie Premiere Pot Bust" (due to Vincennes directing Sid to frame the cover picture from such an angle so as to capture a movie theatre premiere going on in the background). While Vincennes is investigating the bungalow, he pockets the small amount of marijuana that the two brought and is intrigued to find a business card for an agency called "Fleur de Lis". He takes them to Hollywood Station and has them booked for possession of marijuana. Exley refuses the $10 bribe Jack offers him, a reply that perplexes Vincennes.
At that moment, three Mexican suspects are brought in; it is believed they assaulted two police officers, who came out of the incident with minor injuries. The details of the incident quickly become hyperbolic as gossip spreads. Vincennes himself contributes to the escalation and the drunk party goers are lead to believe both officers are near death in the hospital. Stensland and some of the other other party goers, already heavily intoxicated, rush downstairs to the holding area. Refusing to recognize Exley's authority as watch commander, the scene quickly becomes ugly as the Mexican prisoners are viciously beaten. Exley is locked in the isolation room when he tries to intervene. White tries to pull Stensland off one of the prisoners and calm him down only to get provoked into the attack when insulted by one of them. Vincennes joins in as well when a prisoner falls on him, bloodying his fancy suit. The reporters who'd been interviewing Exley are also present, snapping a photo of the fight.
The photo of the jailhouse melee makes the front page of the Los Angeles Times, describing the incident as "Bloody Christmas". The public are outraged, and demand that the officers responsible for the melee be held accountable. The LAPD Chief, District Attorney Ellis Loew and Dudley Smith meet with White, Vincennes and Exley separately.
White staunchly refuses to rat on Stensland as the ringleader of the incident and is ordered suspended without pay.
Exley is more cooperative, knowing that his own testimony will secure him a promotion to lieutenant and detective level, agrees to appear in court as a surprise witness, and also shows political acumen that even Smith couldn't imagine: the public will not be happy if the police bury this scandal. The best way to minimize fallout while giving the public what they want is to shift the guilt to participants who've already secured their pensions and can be forced to take early retirements, while indicting and trying Stensland and White as the ones who purchased the liquor for the party. DA Loew agrees, and the Chief immediately has Exley promoted to Lieutenant (noting parallels between Exley's rise and that of his father) on the spot.
However, Loew and Smith note that Exley's testimony will be worthless unless they can produce another witness. For this, Exley suggests Vincennes, figuring he can be compelled to testify with the threat of losing his technical advisor role on Badge of Honor. The officials invite Exley to observe as Vincennes meets with them and they lay out Exley's deal. Vincennes agrees and accepts a transfer to the vice department following a temporary suspension, though is quick to figure out that Exley is the star witness.
Within weeks, the fallout from the scandal blows over. Stensland is fired so the police have a scapegoat who can take all the blame for the incident, while several other officers are forced into early retirement. Exley moves up to Homicide downtown, and is immediately despised by his fellow colleagues. White is taken off suspension when he agrees to aid Smith, and detectives Michael Breuning and William Carlisle in a new project, in which they intercept mobsters who intend to move into LA and take over Mickey Cohen's businesses. The suspects are taken to a remote and abandoned motel complex called the Victory and are beaten by White and threatened into leaving the city. While this goes on, several former Cohen lieutenants are gunned down by two-man teams armed with Thompson submachine guns in what the media speculate to be a power struggle to gain control of the void left by Cohen's imprisonment. In one incident, Cohen's top heroin dealer is murdered in his house and 20 kilograms of product is stolen by the unidentified killers.
Vincennes is temporarily suspended, per his deal with the DA, and upon his reinstatement is assigned to a Vice task force looking to break up prostitution rings around the city. He's intrigued when he notices a symbol of a flower on the dossier he's given and recognizes it as the logo from the Fleur de Lis business card he found in Matt Reynolds' bungalow. However, his attempt to contact them over the phone is unsuccessful.
On his first night in Homicide, shortly after 2:00 AM, Exley gets a call about a murder at the Nite Owl coffee shop, a regular hangout for cops. Exley arrives on the scene and finds the cook shot dead behind the counter, and the cash register emptied, suggesting a robbery. He notices an overturned chair and realizes there were several customers inside. He then notices a blood trail that leads to the men's bathroom. Following this trail, he finds five more bodies piled up in the bathroom, all riddled with shotgun blasts.
Dudley Smith arrives and assumes command of the investigation, making Exley his second in command. The forensics team quickly reports that there were six victims. The shooters are determined to have fired fifteen rounds, which suggests three Remington shotguns with five-shot capacity and three gunmen. It also turns out that one of the deceased has been identified as Stensland.
White rushes to the hospital morgue to look at the body. Crestfallen to see his friend among the dead (especially considering that he'd only spoken to him a few hours earlier in the parking garage after he'd surrendered his badge and gun), he demands the story from Exley who fills him in. He and Exley then sit in as another of the victims, Susan Lefferts, is identified by her mother. When he sees her body, Bud immediately recognizes Susan as the woman in the car who appeared to be injured the night he and Stensland were purchasing the liquor.
Putting aside all other investigations, the senior detectives from all departments are assigned to the search and apprehension of the Nite Owl killers. Much to the consternation of his fellow detectives, Exley himself will lead the interrogations of the suspects when they are brought in. Leads are few but a report of three black men firing shotguns in Echo Park, driving a late 1940s Mercury Coupe, will be followed by all the two-man teams involved.
White is shaken by the fact that two of the Nite Owl victims - Stensland and Lefferts - crossed paths so shortly before the killings. Acting on his hunches, he strikes out on his own to follow this lead, refusing to be partnered. He returns to the liquor store where he met Lynn, and upon asking the owner, is given the address of a man named Pierce Patchett (David Strathairn), the man sitting next to Lefferts the night he met her and Meeks. Bud talks to Patchett and finds out that the woman he met in the liquor store, Lynn Bracken (Kim Basinger), and Lefferts are part of a prostitution ring run by Patchett himself that uses plastic surgery to give his women the appearance of famous movie stars. The prostitution ring is dubbed "Fleur de Lis", which unbeknownst to White is the ring that Vincennes has been looking into. Lynn is Patchett's Veronica Lake while Lefferts was his Rita Hayworth. However, Patchett refuses to divulge any details about Lefferts' murder and cuts the meeting short.
Exley joins Vincennes on a hunch and they turn up the address of Sugar Ray Collins, who drives the car mentioned in the lead. They track the man and his two friends to their home and find the car and shotguns in a garage. They also find Breuning and Carlisle have beaten them to it. Vincennes argues briefly with the two other officers about who will arrest the three men; Breuning and Carlisle had gotten there first and Vincennes knows the arrest will get him back in with the narcotics squad. Exley pulls rank and orders them to all proceed together and Collins and his buddies, Ty Jones, and Lewis Fontaine, are arrested without much incident, although Exley has to deflect Carlisle's shotgun to keep him from shooting one of the suspects.
During the questioning of the suspects and tactfully using the interrogation room's PA speakers and microphones, Exley demonstrates brilliant tactical skill, tricking the three men into believing they have informed on each other. The three already have criminal records and have spent time in juvenile facilities, which Exley also uses to his advantage. One of them, crying and nearly hysterical, tells Exley that they'd visited the house of another man, Sylvester Fitch, so he could lose his virginity to a woman held captive there. Enraged, Bud White rushes into Ty Jones' room and, drawing his pistol and emptying every chamber in the cylinder but one, he puts the muzzle in the man's mouth and plays Russian Roulette, demanding Fitch's address, which Jones gives up.
A team is sent out to Fitch's house. White sneaks in first, finding a young Mexican woman bound naked to a bed and obviously beaten, and possibly raped. Bud finds Fitch watching TV, and shoots him dead, before planting a fired pistol on him. When the victim is driven away in an ambulance, Exley tries to ask her when the three black men left her but White stops him, waving the ambulance away. Bud seems angered that Exley is only concerned about furthering his career, which Exley counters by saying that Stensland "got what he deserved" and White's fate will be the same. White tries to attack Exley but is held back. At that moment a report is issued that the three black suspects have escaped from the precinct.
Exley, talking to a stenographer, gets an address that was given by one of the black men where they had bought drugs. Unable to get Vincennes, Exley takes Carlisle with him to the address. They burst in to find the three suspects there with their narcotics supplier, Roland Navarette. When Lewis accidentally knocks a bottle off the table, the trigger-happy Carlisle shoots him. All hell breaks loose as Navarette lethally shoots Carlisle multiple times, until Exley shoots him. Ty Jones attempts to grab a revolver, but he is also shot dead by Exley. Collins tries to flee to the elevator, but Exley jams his shotgun in just as the door is about to close and takes him out as well.
Exley is greeted as a hero back at the station and Smith dubs him "Shotgun Ed." With the case closed, Exley is given the department's highest decoration, the Medal of Valor, for bravery in the line of duty, and earns the respect of the other detectives in the department who previously despised him. Vincennes returns to the Narcotics squad and the "Badge of Honor" TV show. In the meantime, Patchett breaks ground on an ambitious project, a freeway running from the eastern sections of LA to the beaches of Santa Monica, one he is heavily invested in. To do so, he has blackmailed a councilman into approving the project with some compromising photos showing him cavorting with Lynn. White eventually begins a romantic relationship with Lynn and continues his work with Smith, beating mobsters at the Victory. The work soon begins to burn White out, and his affair with Lynn gradually softens his vicious demeanor.
One day, during a campaign rally on the set of "Badge of Honor", Vincennes is approached by Sid Hudgens with another job: Hudgens is deliberately setting up LA District Attorney Loew in a blackmail scheme by arranging a sexual encounter with Matt Reynolds (the same young actor arrested by Jack himself at Christmas) both of whom will be busted by Vincennes. Vincennes tries to ask if Sid has any knowledge about Patchett's prostitution ring, but Sid is still not of help as Patchett isn't the sort of person he could ruin with a scandal.
While knocking off drinks at a bar and looking at the $50 bill Sid gave him, Vincennes begins to develop uneasiness about setting up Reynolds and the D.A. He decides he'll let the young actor off the hook, and goes to the motel ahead of the scheduled photo shoot to talk to Reynolds. Instead, to his shock, someone has broken into Reynolds' room and cut his throat.
White becomes suspicious of many of the details surrounding the Nite Owl murders and talks to the coroner. The files from the case are still in the doctor's lab. Studying a picture of the seating area, White notices a spot of blood on the wall next to one of the tables, as if one of the victims was knocked out before being dragged into the men's bathroom. The doctor notes that that blood stain was Stensland's blood. The food on the table, and a lipstick mark on the coffee cup opposite Stensland's place, indicate to Bud that Stensland had been there with a woman (White remembers Stensland said he was going on a date that night, and concludes that he may have had a girlfriend). He is led to believe that said girlfriend was Susan Lefferts as the only other female victim was the night shift waitress.
White's suspicion is confirmed when he visits Lefferts' distraught mother and she identifies Stensland from a photograph, a man she disapproved of. She also tells White that Stensland had previously been seen with another man carrying a large bundle into her backyard. When White notices that Mrs. Lefferts has a towel placed at the bottom of a door leading to her back sun room to block a strong unpleasant stench, he checks out the crawlspace under the house and finds a badly rotted corpse. He finds a wallet in the dead man's coat. Much to his shock, it's Buzz Meeks, Patchett's former chauffeur and the man Bud had first seen outside the liquor store at Christmas. Bud deliberately leaves the body behind for someone else to find and tells Lefferts' mother that the stench is a big rat, giving her the money in Meeks' wallet.
Back at the station, Exley also begins to have second thoughts about the Nite Owl case as well while wheeling Inez Soto, the suspects' rape victim out of the hospital to be paraded before the press, when Inez mentions being unsure as to what time the Nite Owl suspects left her. This leads him to go to down to the coroner that White had spoken to earlier. Exley follows White's lead to Mrs. Lefferts' home and finds Meeks' remains. He takes it to the morgue, demanding an identity on the body and that the coroner share it with no one else, then goes to Vincennes and asks for his help in investigating further details about the Nite Owl case. Exley convinces Vincennes by sharing the story of how his father was killed by a random mugger, whom was never identified, but whom Exley has named "Rollo Tomasi" to give him a personality. Vincennes agrees to help Exley if Exley will help him solve Reynold's murder.
Vincennes tails White to the Formosa Bar where White catches up with Mickey Cohen's former enforcer Johnny Stompanato, and finds out (after roughly squeezing the man's crotch) that Meeks had come into a large supply of heroin. White concludes that Meeks was murdered for it.
Vincennes and Exley next see White at Lynn Bracken's house. Vincennes remembers "Fleur de Lis" & realizes that Lynn is one of Patchett's prostitutes, and pay Patchett a visit to get some answers for Vincennes' case. As they're leaving, a call comes in telling them that Meeks' body has been ID'd. Exley sends Vincennes to get the news while Exley pays a call to Bracken. Refusing to answer the lieutenant's questions, she seduces him while Sid Hudgens photographs them both from behind a one-way mirror.
Vincennes, going through old records, finds a connection between Dudley Smith, Meeks, and Stensland. He goes to Smith's house to inquire about the work that Meeks and Stensland did for Smith on some Vice cases they worked twelve years earlier. What Vincennes isn't aware of is that Smith is in fact that Nite Owl ringleader, something he only realizes when Smith suddenly produces a pistol and shoots him after he admits that he's not yet confided this lead to Exley. Remembering what Exley confided in him about his father's killer, he has one last thing to say to Smith before he expires: "Rollo Tomasi."
Smith announces the next day that the department will suspend all other cases until Jack's killer is found. He talks directly to Exley about the only lead: Jack's last words, suspecting that Rollo Tomasi isn't a placeholder name but an actual person Vincennes is acquainted with. Exley manages to keep a straight face as he realizes that Dudley is the murderer they are looking for. He lies and says he knows nothing of the name.
Dudley then meets with White and criticizes him for what he deems a lack of enthusiasm concerning his job. He also tells White that they'll be going to the Victory Motel to interrogate the man he alleges last saw Vincennes alive. It turns out to be Sid Hudgens. Dudley asks him a few questions which don't provide much information. However, during the beating administered by White himself, Hudgens talks about how Pierce Patchett uses his women for blackmail. He mentions that he's photographed a cop having sex with Lynn. White becomes enraged, thinking that Hudgens spied on him. He turns Hudgens' chair over and rushes out to the reporter's car. In the trunk, he finds pictures, not of himself with Lynn, but of Lynn with Exley. White becomes further enraged and drives off. Meanwhile, Smith and Breuning decide they have no further use for Hudgens and suffocate him to death over his protests that he was part of a "team" with them.
Exley checks with records keeping for arrest warrant books on Buzz Meeks and finds nothing. When he checks the daily log books he finds that Smith had signed off on nearly all of Meeks' and Stensland's work for many years and realizes the connection between them is prominent. White visits Lynn's house, furiously and jealously demanding to know about her tryst with Exley. When she tries to calm him down, he hits her, bruising her face. White leaves in a fury.
White finds Exley in the records room at the station and attacks him after showing him the photo of he and Lynn together. Exley manages to fight White off and realizes that Dudley intended for White to find the pictures so he would be provoked into killing Exley, giving Dudley leverage over White. The two stop their battle and begin to review everything they've each uncovered about the conspiracy: Meeks, Stensland, Vincennes, Reynolds, the missing heroin are all linked. Exley now realizes that the black men that were charged with the Nite Owl attack were set up: when he and Vincennes showed up, Breuning and Carlisle were already there and had planted the shotguns, and were going to kill the three men so that no questions would be asked if they were caught resisting arrest. In order to piece it all together, the two agree to work as partners, even at the expense of Exley's reputation for solving the Nite Owl murder case, which built his career.
They go to Loew's office and demand wiretaps for Smith. Loew refuses and further refuses to divulge any information about Reynolds' murder and dismisses them, stepping into his office bathroom. White shoves the DA's head into the toilet and dangles him out the window. Loew caves and tells him that Reynolds was killed because he was present when he and Smith argued over the assumption of the Cohen drug-dealing rackets. Loew was allowed to live because of his influence and because he promised not to prosecute them. Bud and Ed agree that their next stop is Patchett's house.
When they arrive there, they find that they're too late, as Dudley or someone working for him has slit Patchett's wrists and made it look like a suicide. Believing that Lynn had some knowledge of Patchett's plan, they arrange to have her taken to a nearby police station for safety. Exley goes there and talks to her, saying Bud feels great remorse for beating her. White goes to Sid Hudgens' office and finds that Smith has dumped his body there, but the detectives note it'll be hard to pin it on anybody given the number of people Sid dug up trash on for Hush-Hush. While there, he receives a call telling him to meet Exley at the Victory Motel.
At the Victory, the two find that the calls were planted to get them together in a vulnerable location. They hold up in the same cabin where Sid Hudgens was murdered. Smith's men approach the cabin and White and Exley open fire; a fierce gunfight ensues. They eventually kill all of Smith's men, however they are confronted by Smith himself, who shoots White, forcing him to fall. Smith turns his gun on a cornered Exley, who says "Rollo Tomasi". Smith asks who the man is, Exley tells him it's Smith himself, merely because he's a man who can evade the law. Smith hears approaching police cars and tells Exley to walk out with him, promising to further the younger man's career. He also tells Ed to show his badge. Exley shoots Smith in the back and walks out, holding his badge as Smith instructed.
Sitting in one of the same interview rooms he used to interrogate the three black men, Exley explains the intricate connections in the case. The DA and LAPD Chief are incredulous but realize the department's reputation for upholding the law will be threatened. While floating the solution of glorifying Smith with Exley's help, they spot Exley beaming. When the Chief asks him why, he says they'll need more than one hero.
In the final scene, Exley is once again presented with the LAPD Medal of Valor. He spots Lynn and walks out with her. In her car is Bud White, bandaged and recovering from his wounds. Lynn says they're going to her hometown of Bisbee, Arizona. Ed and Bud shakes hands and Lynn drives off, Bud waving slightly to Exley.