Newell, who spent just under five years at Ewood Park in the early nineties, takes over the managers role from Joe Kinnear who was sacked by the Hatters earlier in the summer.
The former Rovers favourite guided Hartlepool to promotion from the third to the second division during his time in charge there for the latter part of last season after Chris Turner left 'Pool to join Sheffield Wednesday.
Newell, who spent two years as a player at Luton early in his playing career, has signed a two-and-a-half year contract at Kenilworth Road.