A local newpaper letters to the editor column carried a letter
claiming that Michael Moore's Fahrenheit 9/11 lost its Best
Documentary prize as it was proven to have been fiction. Where did
this allegation come from (if not just from some unhinged mind?)

I have found no echo to this accusation. However, Moore won The Golden
Palm, the first documentary to win that prize.

The Golden Palm is considered to be a distinguished prize, and giving
it to a documentary doesn't seem to indicate that the film is "not a
documentary", but to indicate that the judges in Cannes thought it was
the best film in the competition.

According to IMDB, the film won only another more award, FIPRESCI (the
international federation of film critics) Prize, also at Cannes
<http://www.fipresci.org/awards/awards_2004.htm>. It won the "Prize
for a film in the official section: Fahrenheit 9/11 by Michael Moore
(USA, 2004, in competition)", again, without reference to the fact
that the film is a documentary.

In other words, both prizes won so far were in "normal" categories. I
found no evidences that a prize or an award was denied because the
film was found to be fictitious.

The "Festival de Cannes" official website still shows Fahrenheit 9/11
as having won the Palme d'Or in 2004 (as of June 20, 2004):

http://www.festival-cannes.fr/palmares/index.php?langue=6002&tp=lmcm&edition=2004

I hate to contradict you, politicalguru, but it seems that Farenheit
9/11 is not the first documentary to have won the Palme D'Or. Jacques
Cousteau's "The Silent World" won the award in 1956. This is slightly
offtopic for this discussion, but it does, at least, seem to indicate
that "fictionhood" is not a prerequisite for winning the Golden Palm.

Reference:
http://www.imdb.com/title/tt0049518/awards

You might be interested to read Christopher Hitchens' Unfairenheit
9/11: The lies of Michael Moore at:

http://slate.msn.com/id/2102723/

I couldn't find the documentary requirements for the Cannes Film
Festival, but the Oscars defines a documentary like this:

Rule Twelve
Special Rules for The Documentary Awards

I. DEFINITION
1. An eligible documentary film is defined as a theatrically released
non-fiction motion picture dealing creatively with cultural, artistic,
historical, social, scientific, economic or other subjects. It may be
photographed in actual occurrence, or may employ partial re-enactment,
stock footage, stills, animation, stop-motion or other techniques, as
long as the emphasis is on fact and not on fiction.

2. A film that is primarily a promotional film, a purely technical
instructional film or an essentially unfiltered record of a
performance will not be considered eligible for consideration for the
Documentary awards.

http://www.oscars.org/77academyawards/rules/rule12.html


By that definition, it really doesn't matter if the whole story isn't
fact, so long as "the emphasis is on fact and not on fiction."