Azilah Hadri and Sirul Azhar Umar were convicted of the 2006 killing of Mongolian national Altantuya Shaariibuu, a 28-year-old model and interpreter at the centre of allegations of huge kickbacks in a government purchase of French submarines.
Their acquittal led activists to call for an independent enquiry to reopen the case into who killed the woman and her link, if any, to the submarine deal.
Defence lawyer Hazman Ahmad told AFP that "justice has been done".
Prosecutors said the government would appeal the decision.
More From This Section
Government critics have long alleged that the two men, members of an elite police unit that guards top ministers, were the fall guys in the killing to hide the involvement of their masters at the highest levels of government.
A three-judge appeals panel ruled that a lower court had erred, for example failing to connect the men to explosives used to blow up the victim's body, the news portal Malaysian Insider said.
The decision triggered an immediate reaction on Malaysian social media, with many calling it part of a conspiracy to free the men in return for their silence.
"It's a completely shocking verdict," she told AFP. "This really calls now for a full and thorough investigation into her death. Who killed her?"
"I think the justice system is not ready to deal with all the elements of this case."
Najib has vehemently denied any involvement in the affair, but the government has repeatedly ignored calls for a probe.
At the request of Suaram, French judicial officials opened an investigation in March 2010 into the sale of the two submarines, which were made by French shipbuilder giant DCNS.
The case stems from charges that Abdul Razak Baginda, a former close associate of Najib, arranged kickbacks in the $1.1-billion purchase of the submarines in 2002.
Najib was defence minister at the time.
Altantuya, who was then Abdul Razak's lover, had reportedly been involved in negotiations over the purchase.