The decision comes after a lower court last year ruled that the evidence against the man was too weak and acquitted him of the murder charges themselves.
The case was then appealed to the Supreme Court, including by Daniel Pearl's family, writes Reuters.
On Thursday, the Supreme Court acquitted the man of the death penalty and the court demands that he and three other men be released immediately.
The government has appealed
The Supreme Court's decision received strong reactions, angered and disgusted Pearl's family and prompted the US administration to act.
Since the decision, the Pakistani government has struggled to keep the man in jail.
Both the government, the prosecutor and Pearl's family have appealed the decision.
"The Pearl family is completely shocked by the decision," family lawyer Faisal Sheikh told Reuters.
Instead, the man should be placed in a "safe house" that he is not allowed to leave.
He will be supervised by guards but will have the opportunity to meet his wife and children, according to the Supreme Court's decision.
- It's not freedom.
It is a step towards freedom, says the man's father who was present at the court hearings.
Lawyer: We have little chance
The family's pearl lawyer Faisal Sheikh has previously said that an appeal has a small chance because it is the same judge who acquitted the man who is also sitting on the jury that is examining the case.
The US government states that they will demand that the man be extradited to them if his acquittal lasts.
The man has been suspected of having beheaded Daniel Pearl and a kidnapping of a US citizen in Kashmir in 1994. That person was later released, writes AP.
US Secretary of State Antony Blinken calls the decision "an insult to victims of terrorism worldwide, including in Pakistan".