Benon Sevan, who ran the humanitarian programme, was charged in a report from Paul Volcker, the former head of the US Federal Reserve, of soliciting and getting the allocations for a trading firm connected to the family of former secretary-general Butrus Butrus-Ghali.
A second official, Joseph Stephanides, now director of Security Council affairs, was alleged to have intervened in selecting large contractors for the programme he helped organise in 1996, before Sevan took over in late 1997.
Annan said on Thursday that he, too, would be disciplined and that if criminal acts were committed, diplomatic immunity would be lifted.
Shadow over UN
The oil-for-food programme, which began in December 1996 and ended in November 2003, allowed Saddam Hussein's government to sell oil to buy humanitarian goods. It was intended to ease the life of ordinary Iraqis under 1990 UN sanctions.
The fraud allegations have cast a shadow over the world body and Annan himself, who chose Volcker to lead an independent investigation.
"Mr Sevan never took a penny"
Benon Sevan's lawyer
"I think it is a fact that Mr Sevan placed himself in a grave and continuing conflict of interest situation that violated explicit UN rules and violated the standards of integrity essential to a high-level international civil servant," Volcker told a news conference.
However, Sevan's lawyer, Eric Lewis, said: "Mr Sevan never took a penny. Unfortunately, in the current political climate, the Independent Inquiry Committee needs to find someone to blame."
But Annan, who took over the top UN post from Butrus-Ghali in January 1997, said in a statement the report contained "extremely troubling evidence of wrongdoing" by Sevan, who has retired from the United Nations but gets only a token pension because of the inquiry.
Volcker said few institutions had subjected themselves to such "intensity of scrutiny". The report also cited "convincing and uncontested evidence" that three firms, Banque Nationale de Paris, the Dutch Saybolt Eastern Hemisphere and Britain's Lloyd's Register Inspection, were awarded contracts without competitive bidding in 1996.
But Volcker said in the interim report - the final one will be in June - the most serious violations of the UN sanctions involved illegal oil sales outside oil-for-food.
"And there is no question that those sales were known by the UN Security Council," which included the United States. A CIA investigation in September found Saddam Hussein earned $1.7 billion via kickbacks on goods and oil under the programme. He got an additional $8 billion in oil sales to Jordan, Turkey and
Syria, which were known to the council.
UN officials' wrongdoing
Volcker said he was concentrating on wrongdoing by UN officials. Specifically, the report said Sevan had convinced Iraq to sell oil allocations to the African Middle East Petroleum company, an obscure trading firm registered in Panama with
offices in Switzerland and Monaco.
The company is headed by Egyptian Fahkri Abd al-Nur, a cousin of Butros-Ghali's. The deal was helped along by Fred Nadler, the former secretary-general's brother-in-law, the report said.
"There is no question that those sales were known by the UN Security Council"
Paul Volcker's report
The trading firm, according to Iraqi records, netted a profit of $1.7 million, the report said.