Since the FSM and the RMI became sovereign nations, the U.S. relationship with the two countries has been defined by the original Compact of Free Association and the subsequent amended Compacts of Free Association. In 1986, the United States, the FSM and the RMI entered into the Compact of Free Association. This compact represented a new phase of the unique and special relationship that has existed between the United States and these island areas since World War II. The compact provided a framework for the United States to work toward achieving its three main goals: (1) to secure self-government for the FSM and the RMI, (2) to ensure certain national security rights for all of the parties, and (3) to assist the FSM and the RMI in their efforts to advance economic development and self- sufficiency. The first goal was met; the FSM and the RMI are independent nations and are members of international organizations such as the United Nations. The second goal was also achieved. At the time that the compact was negotiated, the United States was concerned about the use of the islands of the FSM and the RMI as “springboards for aggression” against the United States, as they had been used in World War II, and the Cold War incarnation of this threat—the Soviet Union. The compact and its related agreements established several key defense rights for all three countries. For example, the compact obligates the United States to defend the FSM and the RMI against an attack, or the threat of attack, in the same way it would defend its own citizens. Further, through a compact-related agreement, the United States secured access to military facilities on Kwajalein Atoll in the RMI through 2016. The third goal of the compact—advancing economic development and self- sufficiency for both countries—was to be accomplished primarily through U.S. direct financial payments to the FSM and the RMI. For 1987 through 2003, U.S. assistance to the FSM and the RMI to support economic development was estimated, on the basis of Interior data, to be about $2.1 billion. We found previously that many compact-funded projects in the FSM and the RMI experienced problems because of poor planning and management, inadequate construction and maintenance, or misuse of funds. Economic self-sufficiency had advanced but had not been achieved; although total U.S. assistance as a percentage of total government revenue fell in both countries, the two nations remained dependent on U.S. funds. U.S. direct assistance maintained standards of living that were higher than could be achieved in the absence of U.S. support. Another aspect of the special relationship between the FSM and the RMI and the United States involves the unique immigration rights that the compact grants. Under the original compact, citizens of both nations were allowed to live and work in the United States as “nonimmigrants” and could stay for long periods of time, with few restrictions. Further, the compact exempted FSM and RMI citizens from meeting U.S. passport, visa, and labor certification requirements when entering the United States. In recognition of the potential adverse impacts that Hawaii and nearby U.S. commonwealths and territories could face as a result of an influx of FSM and RMI citizens, the Congress authorized compact impact payments to address the financial impact of these nonimmigrants on Guam, Hawaii, and the Commonwealth of the Northern Mariana Islands (CNMI). In the fall of 1999, the United States, represented by the Department of State, and the two Pacific island nations began negotiating economic assistance and defense provisions of the compact that were due to expire in 2003. The negotiations also addressed immigration issues. Separate compacts were completed for the RMI and the FSM and went into effect on May 1, 2004, and June 25, 2004, respectively. Prior to formal implementation of the amended compacts, the United States provided funding via a continuing resolution and the Department of the Interior’s fiscal year 2004 appropriation legislation. According to the Department of State, the aims of the amended compacts are to (1) continue economic assistance to advance self-reliance, while improving accountability and effectiveness; (2) continue the defense relationship, including a 50-year lease extension (beyond 2016) of U.S. military access to Kwajalein Atoll in the RMI; (3) strengthen immigration provisions; and (4) provide assistance to lessen the impact of Micronesian migration on Guam, Hawaii, and the CNMI. The amended compacts’ second objective, continuing the U.S.-RMI defense relationship, has been addressed, as expiring defense provisions of the compact have been renewed and U.S. access to Kwajalein Atoll has been extended. However, one notable difficulty remains regarding this objective; although the U.S. government negotiated an agreement with the RMI government that allows for U.S. access to Kwajalein Atoll until 2086, the RMI government has not reached an agreement with Kwajalein Atoll landowners (who own the land under use by the U.S. government) that allows for this long-term access. The U.S. government is not involved in efforts to negotiate such an agreement, and neither the RMI government nor the Kwajalein Atoll landowners are actively pursuing resolution of this issue. The third and fourth objectives have also been addressed. Compact immigration provisions have been strengthened by, for example, requiring passports from FSM and RMI citizens entering the United States and clarifying requirements for bringing FSM and RMI children into the United States for adoption. Further, the amended compacts’ enabling legislation appropriates specific annual nonimmigrant impact compensation of $30 million for Guam, Hawaii, and the CNMI for fiscal years 2004 through 2023, with the distribution of funding between the locations based on periodic surveys identifying the number of FSM and RMI nonimmigrants in each location. The U.S. government intends to achieve its first objective—continuing economic assistance to advance self-reliance, while improving accountability and effectiveness under the amended compacts—by annually providing direct financial assistance, in the form of grant agreements, to the FSM and the RMI, for 20 years (fiscal years 2004 through 2023) (see tables 1 and 2). Grant assistance to the FSM and RMI is targeted to six specific sectors—education, health, public infrastructure, the environment, public sector capacity building, and private sector development—although the priority sectors are education and health. RMI grants must also target some funding to Ebeye and other Marshallese communities within Kwajalein Atoll. The U.S. Congress, in approving the amended compacts, also authorized a supplemental education grant for each country. The Congress determined that rather than remaining eligible for appropriations under certain education and labor program assistance, such as Head Start and Job Corps, the FSM and the RMI would instead receive supplemental direct grant assistance. In addition to providing sector grant funds, the amended compacts provide for the establishment of trust funds for both countries. While providing the direct grant assistance, the U.S. government will also contribute to the trust funds for both countries, and the FSM and the RMI will replace the grant assistance with trust fund earnings beginning in 2024. In addition, the FSM and the RMI must each make one-time contributions to its trust fund of $30 million, and other donors can contribute to the funds as well. Except for the fixed amounts set aside as audit grants, the amounts listed in tables 1 and 2 will be partially adjusted for inflation, with fiscal year 2004 as the base year. Grant funding can be fully adjusted for inflation after fiscal year 2014 under certain economic conditions. Including estimated inflation adjustments, total U.S. assistance to both countries combined is projected at more than $3.5 billion over the 20-year assistance period. The amended compacts and their subsidiary fiscal procedures agreements (FPA) also establish numerous new accountability requirements. For example, under the amended compacts, the United States established a Joint Economic Management Committee (JEMCO) with the FSM and a Joint Economic Management and Financial Accountability Committee (JEMFAC) with the RMI to strengthen management and accountability and to promote the effective use of the compact funding. Each committee comprises five members, three from the United States and the other two from the FSM for the JEMCO and from the RMI for the JEMFAC. The Departments of the Interior, State, and HHS supply the three U.S. representatives, with the Department of the Interior representative serving as Chairman. The FSM and RMI governments select their respective representatives. The amended compacts require the committees to meet at least once annually, no later than 30 days before the beginning of the fiscal year, to review the budgeting and development plans of each of the governments, approve grant allocations and performance objectives, attach special conditions to any or all annual grant awards to improve program performance and fiscal accountability, and evaluate progress made under the amended compacts. JEMCO and JEMFAC render decisions by majority vote, except decisions regarding the division of RMI grants, which are made by consensus. Budget consultations with each country are also required prior to JEMCO and JEMFAC meetings to ensure that proposed compact budgets estimate sector grant requirements for the upcoming fiscal year. In addition, trust fund committees are required to address issues associated with the operations and investments of the FSM and RMI trust funds. The trust fund committee for each country is comprised of representatives from the United States and the FSM or the RMI, and other contributors may also join the committees. Language contained in the amended compacts’ enabling legislation states that it is the sense of the U.S. Congress that U.S. appointees to the trust fund committees “should be designated from the Department of State, the Department of the Interior, and the Department of the Treasury.” The FSM and RMI must also adhere to specific financial and performance reporting requirements as part of the amended compacts and the FPAs. The FPAs state that financial management systems must meet several standards addressing financial reporting, accounting records, internal and budget controls, cash management, and source documentation, and also specify applicable procedures regarding real property, equipment, and procurement where compact funds are involved. As part of their budgeting process, both countries must submit plans for the division of annual economic assistance among sectors. Additionally, per the terms of the FPAs, the FSM and RMI must submit quarterly financial status and cash transaction reports, and final annual financial reports and single audits must be completed following the end of each fiscal year. Further, for each sector grant, the FSM and RMI must submit quarterly performance reports comparing actual accomplishments with program objectives and identifying any problems or issues encountered during the reporting period. The FSM and RMI are responsible for the management and monitoring of the day-to-day operations of all sector grants and their activities to ensure compliance with all grant terms and conditions. In addition, the FSM and RMI must prepare and submit an annual report to the President of the United States on the use of grant assistance and describe progress toward mutually agreed-upon program and economic goals. Similarly, the President of the United States must submit an annual report to the Congress regarding several issues such as general social, political, and economic conditions in each country; the use and effectiveness of financial assistance; status of efforts to increase investments; and recommendations on ways to increase the effectiveness of assistance and to meet overall economic performance objectives. (See fig. 1 for a time line of key funding and accountability events that are required for each fiscal year.) OIA staff work closely with Department of State staff in Washington, D.C. and the U.S. embassies in the FSM and the RMI regarding compact matters. Department of State officials emphasized to us that they are primarily responsible for conducting foreign relations with the two countries and safeguarding U.S. strategic interests in the region, and these objectives necessarily include involvement in compact issues. An executive order is currently under preparation that identifies the specific responsibilities of U.S. agencies regarding compact matters. Further, OIA coordinates with HHS, a U.S. JEMCO and JEMFAC member, and in February 2005 a senior official from HHS began work in OIA’s Honolulu field office (which opened in 2003) and told us that he provides support to the OIA health sector efforts under the amended compacts, provides technical assistance for an array of U.S. federal health grants in the Pacific, and works to improve coordination with other public health entities in the region, such as the World Health Organization. The amended compacts differ from the original compact chiefly in that they provide for direct assistance through sector grant agreements, establish trust funds, and strengthened accountability and reporting provisions (all discussed earlier). In addition, unlike the original compact, the amended compacts do not include a “full faith and credit” guarantee, which had made it impracticable for the U.S. government to withhold compact funds. Instead, the FPAs contain provisions that explicitly allow for the withholding of funds if compact, FPA, or grant requirements are not met. Further, the FPAs allow for the suspension of funds if the FSM or RMI engage in gross negligence, willful misconduct, or material breach of terms and conditions with respect to the use of financial assistance provided under the amended compacts. In addition, funds can be withheld if the FSM and RMI do not cooperate in investigations regarding whether funds are being used for purposes outside what is authorized in the compact. Finally, the FPAs prohibit the FSM and RMI from issuing negotiable or transferable obligations evidencing indebtedness or encumbrance of compact economic assistance funds. In 2000, we found that under the original compact, the FSM and the RMI issued compact revenue-backed bonds in order to obtain greater funding in the earlier years of the compact. The funding was used to retire existing debt, pay for capital projects, and make financial investments. In later compact years, FSM and RMI bond debt payments (especially for the RMI) limited the availability of compact funds for other uses. The U.S. government has signed sector grant agreements with the FSM and RMI as provided for in the amended compacts, and trust funds for both countries have been established. The two countries did not spend about one-third of available funding in fiscal year 2004. Some of this unspent funding resulted from a lack of planning required to obtain access to certain grants—the FSM did not complete plans to obtain infrastructure grant funding and for the RMI did not complete plans and reforms for the use of funds targeted to address the special needs of Kwajalein Atoll. The U.S. government has not provided either country with a supplemental education grant established in the amended compact’s enabling legislation. Strategic planning issues that impact the long-term, effective use of funds have not been addressed by the three governments: (1) the allocations of sector grants are not linked to amended compact development goals such as the promotion of economic advancement and budgetary self-reliance, (2) the FSM and RMI have not developed strategic plans to manage required annual grant funding decreases, and (3) the trust funds have not been placed with investors that can maximize trust fund earnings (although efforts are under way to resolve this issue). The U.S. government signed grant agreements with the FSM and the RMI for fiscal years 2004 and 2005 in the compact-designated areas of health, education, infrastructure, environment, private sector, and public sector capacity building (see fig. 2 for FSM and RMI fiscal year 2005 grant allocations). FSM sector grant funding totaled $76 million annually for both years. The FSM national government, which directly signs grant agreements with the U.S. government and is the “grantee,” provides the majority of grant funds to the four FSM states, which are “subgrantees.” RMI grant funding totaled about $35 million annually for the 2 years. The RMI’s public sector capacity building grant was $103,514. This amount accounts for under 1 percent of total grant funding. While section 211(b)(2) of the amended compact with the RMI provides for an annual $1.9 million (with a partial inflation adjustment) for Kwajalein impact, these funds have not yet been provided pending the completion of a spending plan for these funds. The FSM’s largest grant for fiscal years 2004 and 2005 is in the area of education. This grant accounted for over a third of total sector grants. The health sector received the second highest grant amount for 2005, at 23 percent of total grant funding. The FSM has not yet met the goals outlined in the amended compacts’ enabling legislation, which states that it is the sense of the U.S. Congress that infrastructure improvements and maintenance should account for not less than 30 percent of all sector grant funding each year; the amount of funding intended for infrastructure for 2005 is slightly smaller than the funding for health grants and also accounted for about 23 percent of grant funding in that year (a grant in this area was awarded by Interior on May 13, 2005, and accepted by the FSM national government on May 26, 2005). A resolution adopted by the JEMCO during an August 2004 meeting requires the FSM to move to reach the goal of funding infrastructure at not less than 30 percent of annual compact grant funding by fiscal year 2006. In addition, the United States agreed to an FSM request for fiscal year 2004 to spend about 90 percent of its $11.6 million public sector capacity building grant to fund basic government operations, rather than to support this sector’s principal compact objective of promoting effective, accountable, and transparent government. According to a senior OIA official, the FSM needed to use these grant funds for basic government operations to be able to adequately support the use of other sector grant funds. As a 2004 grant condition, the FSM is required to stop funding basic government operations from Compact grant assistance over a 5-year period. Similarly, in 2004, the FSM also had to commit to shifting basic government operations out of its much smaller private sector development grant—a grant primarily intended to support efforts to attract new foreign investment and increase indigenous business activity. The RMI’s largest grant for fiscal years 2004 and 2005 is in the area of infrastructure. The RMI has easily met the “sense of the U.S. Congress” language regarding infrastructure for fiscal years 2004 and 2005, with an infrastructure grant of about $13.5 million accounting for around 39 percent of total sector grant funding in 2005. The next largest grant is in the area of education, which represents more than 30 percent of total grant funding for both years, followed by health grants at 20 percent of the total funding. An additional grant of $1.9 million authorized in amended compact section 211(b)(2) (representing 6 percent of total grant funds in fiscal year 2005) exists specifically to address needs on Kwajalein Atoll, although grant documents had not been signed as of mid-May 2005. In contrast to the FSM, the RMI allocated no compact funding to a public sector capacity building grant in fiscal year 2004 and less than 1 percent of compact sector grant funding to such a grant in fiscal year 2005. (For a more detailed description of FSM and RMI sector grant allocations for fiscal years 2004 and 2005, see app. II.) As provided by the amended compacts, trust funds have been established for both countries, the earnings from which are to replace sector grants when grant assistance ends in 2023. According to an OIA official, the RMI trust fund was incorporated in April 2004, and the FSM trust fund was incorporated in August of that year. The FSM government contributed $30 million to its trust fund in October 2004, while the RMI government, as of March 2005, had contributed $26.5 million to its trust fund and was $1 million behind with its scheduled trust fund contributions. As provided in the amended compacts, the U.S. government has provided $32 million to the FSM trust fund and $14.5 million to the RMI trust fund for fiscal years 2004 and 2005. In addition, according to a State official, the RMI has signed an agreement that will provide for a $50 million trust fund contribution from Taiwan (which has also provided economic assistance to the RMI). The FSM and the RMI each did not spend about one-third of authorized grant funding for fiscal year 2004 (the only completed year under the amended compacts). Some of this unspent funding resulted from a lack of planning required to obtain access to certain grants—the FSM did not complete plans to obtain infrastructure grant funding, and the RMI did not complete plans and reforms for the use of funds targeted to address the special needs of Kwajalein Atoll. Further, both countries did not spend (obligate) some portion of other available sector grants for 2004; the FSM spent a smaller percentage of each of these grants than the RMI (see fig. 3 for FSM and RMI use of sector grants for fiscal year 2004). These funds remain available for use in future years. The FSM did not spend almost $25 million (33 percent) of its authorized sector grant funding of $76 million for fiscal year 2004. This amount includes more than $17 million in infrastructure funding (100 percent of the grant amount) that was not provided to the country because of the time it has taken the FSM to complete a required infrastructure development plan that identified infrastructure projects that adequately integrated state and national priorities. Further, the FSM has only recently established a required project management unit to oversee individual infrastructure projects. Finally, the FSM did not spend more than $7.7 million in other available sector funds (primarily in health and education); OIA officials have expressed frustration that financial management practices in the FSM allowed over 10 percent of the available compact grant funds to go unused for fiscal year 2004. Of this amount, Yap state had the largest unobligated, or carryover, compact fund balance, at more than $4 million. The RMI did not spend about $12 million (35 percent) of its total authorized grant funds of $35 million. The RMI, which met compact requirements related to infrastructure spending, did not spend $9.6 million (66 percent) of its infrastructure grant, owing to the time involved in bidding and initiating infrastructure projects. According to an OIA official, infrastructure activity is now well under way in the RMI. Further, the RMI government did not spend $1.9 million targeted for special needs on Kwajalein Atoll. These funds remain with OIA until the RMI government submits a plan regarding how the funds will be spent. The funds will be used by a local government agency, the Kwajalein Atoll Development Authority (KADA), which has experienced problems in effectively and efficiently using funds in the past. As of early 2005, legislation had been passed that contains plans for KADA’s restructuring, but the agency was not operating. Finally, the RMI had a carry-over balance of about $750,000 from other available fiscal year 2004 sector grants, chiefly in the education sector (5 percent of funding under this grant, the RMI’s second largest for 2004, was unspent for the year). In addition, the U.S. government has not provided one grant established in the amended compacts’ enabling legislation. Neither the FSM nor the RMI has received a supplemental education grant (SEG) that is to begin in fiscal year 2005. The Departments of the Interior, Education, Labor, and Health and Human Services are still finalizing an interagency agreement to determine how funds authorized under the amended compacts’ enabling legislation for this grant will be transferred from other agencies to Interior. The annual SEG amount--$12.23 million for the FSM and $6.1 million for the RMI--is substantial, compared with the funding amounts provided for other compact sector grants. The U.S., FSM, and RMI governments have not addressed several strategic issues that impact the long-term, effective use of funds. Fiscal year 2004 and 2005 allocation of compact sector grant allocations were not clearly tied to broad development goals, and therefore the extent to which existing grants contribute to the FSM’s and the RMI’s long-term development is unclear. The JEMCO and JEMFAC reviews of sector grant allocations for fiscal years 2004 and 2005 did not include discussions of FSM and RMI plans to establish goals regarding the amended compacts’ primary objectives of economic advancement and budgetary self-reliance, and how grant allocations in each sector will help to achieve these larger goals. FSM and RMI plans that could assist in this effort are incomplete. The required development plan for the FSM and the medium-term budget and investment framework (MTBIF) for the RMI are to be strategic in nature and identify how the countries will use compact funds to promote broad compact development goals such as economic advancement and budgetary self-reliance. However, JEMCO has not considered the FSM development plan. Further, U.S. officials are unclear as to whether JEMFAC has approved RMI’s framework plans for the use of grant funds and have acknowledged that this issue needs attention. U.S. government officials have noted that the issue of linking the use of grant funds to the achievement of long-term development goals has not been addressed to this point. Further, while the amended compact states that grant funding is provided to assist the economic advancement of the people of the FSM, the FSM’s process for internally distributing sector grant funding does not address national sector priorities or consider sector disparities between the FSM states. Compact funds are allocated among the five FSM governments—the FSM national government and the four state governments—primarily according to a formula used under the original compact. In addition to providing funds to the four states, the formula established funding to the FSM national government, which resulted in a funding allocation percentage for Chuuk and Pohnpei states that is notably lower than their percentage of the FSM’s population. An FSM law enacted in January 2005 establishes a very similar distribution among the five governments. Although the U.S. government has signed grant agreements for fiscal years 2004 and 2005 that provide for the distribution of funds to the five governments according to this formula, U.S. government officials have stated that this formula may not result in grant allocations that reflect national needs. For example, there are currently substantial differences in sector per capita funding in the FSM states. We calculated that the Yap state compact education grant provides at least twice as much funding per student as the Chuuk state education grant, and almost three times as much funding per person regarding health grants. The extent to which such variances between states benefit the nation or reflect differences in state needs is not clear. Lack of strategic planning in both countries to address necessary grant decreases could result in funding allocations that do not facilitate the most critical and effective use of remaining compact resources. For example, the FSM and the RMI have not developed a strategy to manage the annual sector grant decreases—for the FSM, $800,000 starting in fiscal year 2007 and for the RMI, $500,000 since fiscal year 2005—mandated in the amended compacts. A senior RMI official told us that although the government recognizes that the decrements should be of major concern, government officials are not addressing the problem. Likewise, a senior FSM official reported that although the government has created a task force to examine ways to increase tax revenues to, among other things, compensate for lost compact grant funding, no plan is currently being devised to determine how to respond to the annual decreases. This official also noted that such issues are up to each of the five governments to address as they see fit. In addition, the FSM has no strategic plan to shift basic government operations expenditures from the public sector capacity building grant to local revenues. Although the FSM, according to the terms of a grant condition, provided OIA with a document that calculates percentage decreases of these expenditures from the grant through 2009, there is no additional plan describing the policy steps that will be taken or the agencies and activities that will be affected. Funding for this grant began decreasing in fiscal year 2005, and some officials have expressed concern over the consequences of reduced compact funding to support routine government activities. The FSM and RMI trust funds are earning low returns on trust fund contributions, raising concerns about the future adequacy of the trust funds to ultimately replace grant assistance. All trust fund contributions are currently in commercial bank accounts earning up to 2.63 percent in interest, because neither trust fund has been placed with an investment advisor that will work to maximize returns. According to an OIA official, this circumstance has resulted from the time it took the FSM and the RMI to approve the amended compacts as well as the process involved in selecting an investment advisor and placing funds with money managers. In February 2005, the RMI trust fund committee selected a trust fund investment advisor; no advisor has been selected for the FSM as of mid- May 2005, although the process to select one is under way. This situation is important in the context of our prior analysis that raised questions about the sufficiency of the trust funds to generate earnings that could replace compact grants beginning in 2024. For example, assuming an annual return of 7.9 percent realized by the trust funds at the beginning of fiscal year 2004, we projected that the FSM trust fund earnings by 2048 would be inadequate. However, future earnings in excess of 7.9 percent could counterbalance the slow start for the trust funds. The FSM appears to be in a weaker position relative to the RMI, in that it has not selected a trust fund investment advisor and has not yet obtained additional contributions from other donors. Regarding a separate trust fund issue, U.S. membership in the FSM and RMI trust committees is not yet aligned with language contained in the amended compacts’ enabling legislation, which states that it is the sense of the U.S. Congress that U.S. appointees to the trust fund committees “should be designated from the Department of State, the Department of the Interior, and the Department of the Treasury.” Current U.S. government trust fund committee participants are from the same U.S. agencies that participate in the JEMCO and JEMFAC: the Departments of the Interior, State, and Health and Human Services. An OIA official noted that an effort is under way to eventually include the Department of the Treasury as an additional member of the RMI trust fund committee when Taiwan contributes to the RMI trust fund and can become a member of the committee. (The trust fund agreements allow additional donors to become members of the committees but also require a U.S. majority vote in trust fund committees; therefore, the U.S. government will add another member if Taiwan joins the RMI trust fund committee.) The U.S., FSM and RMI governments have taken several actions to fulfill key accountability requirements, such as meeting annually to approve grants, establishing special grant terms and conditions, and preparing various reports. Further, the U.S. government has withheld grant funding for noncompliance with compact and grant requirements and initiated an investigation into the possible misuse of compact funds in the FSM state of Chuuk. However, a few important requirements, such as the preparation of annual compact spending and development reports, remain uncompleted. (See app. III for a table listing requirements that have and have not been met.) In August 2003 and 2004, the U.S. government held bilateral meetings with the FSM through JEMCO and with the RMI through JEMFAC to discuss and approve fiscal year sector grants allocations. The minutes for the August 2004 JEMCO and JEMFAC meetings showed a discussion of committee procedures and approval of specific sector grant levels. JEMCO and JEMFAC have focused on grant approval and performance assessment, while other committee duties, such as reviewing other donor assistance or audit findings, have received limited attention. Although the JEMFAC meetings with RMI reached consensus on grant issues, the JEMCO meetings with the FSM showed areas of strong disagreement between the U.S. and FSM representatives; these disagreements were decided by a vote, split between the countries, that adopted the U.S. position. The FSM government sent a letter to the U.S. government expressing frustration over the 2004 JEMCO meeting and the manner in which decisions were reached. Special meetings can be called by three JEMCO or two JEMFAC members. A special bilateral meeting with the FSM was held in Honolulu on March 11, 2005, to discuss grant management problems regarding one of the FSM subgrantees, Chuuk state, and a special JEMCO meeting was held that same day to reach decisions regarding the FSM infrastructure development plan and the use of fiscal year 2004 carry-over funds. In addition, the amended compacts require budget consultation meetings before the compact budgets are submitted and the formal JEMCO and JEMFAC meetings are held. These consultations were held with the FSM before the 2005 JEMCO meeting. However, no consultations were held with the RMI because that government was late in providing a draft budget to the U.S. government; a budget was not provided until 1 week before the JEMFAC meeting. Budget consultations were held with both countries in 2003 in preparation for fiscal year 2004. JEMCO and JEMFAC specified additional accountability requirements by including special terms and conditions that were included in the fiscal year 2004 and 2005 individual grants agreements. These special terms and conditions ranged widely, from requiring information on the three FSM health insurance programs to requiring that both countries submit appropriate environmental performance measures and baseline data for approved activities to OIA. According to OIA officials, the RMI met most of the special grant terms and conditions attached to the country’s grants; however, the FSM met only some of its specific terms and conditions. For example, according to OIA staff, the FSM has had difficulty identifying useful performance baseline data for most sectors because of information disorganization and fragmentation. OIA officials reported that the FSM was unable to satisfy more conditions because of a lack of skilled staff in all four FSM states and the national government. They stated that the staff members with responsibility for sector grant compliance did not always have the requisite level of understanding or skill to make sure that problems were being addressed. The FSM and the RMI have submitted their annual compact budgets to the U.S. government, as well as all quarterly financial and performance status reports, and annual financial reports. OIA has asked for FSM to revise its budgets to include more specific data, such as the number of people working on a particular program. OIA officials have found the FSM’s 2004 quarterly financial and performance reports to be in need of improvement, while such reports from the RMI were viewed as adequate. A senior HHS official noted that the FSM has had significant difficulty in providing standardized performance data between the states that can be compared. FSM officials told us that the national government does not assess the quarterly performance reports prepared by the five governments and simply compiles them for transmission to OIA. Both countries have submitted financial and performance reports to the U.S. government on time, and Pohnpei and Chuuk states have withheld pay for officials responsible for performance reports that were not provided on time to the FSM national government. OIA has been working with the FSM to improve and standardize the FSM’s performance reporting format; and, as of the first quarter of fiscal year 2005, all FSM governments were using a uniform reporting format that was approved by OIA. Officials in both countries told us that the requirement to produce performance reports was a positive step and would help to create a linkage between expenditures and their impact. However, the officials acknowledged that they are still in the process of learning how to generate such reports, and that, although the reports have the potential to be used as a management tool, the governments are not yet able to use the reports in this capacity. In several instances, the U.S. government has not provided compact funds to the FSM or RMI in order to ensure compliance with compact requirements, and accountability over sector grants. In two instances, OIA withheld compact funding from the FSM when the country was slow to meet grant conditions. Further, OIA suspended FSM funding due to possible misuse in another situation. Finally, in an effort to ensure prudent financial operations, OIA has delayed providing FSM and RMI grant funding due to cash management concerns. A Department of State official noted that the FSM and RMI governments are definitely taking note as the U.S. government makes use of this new tool to ensure the appropriate use of compact funding. In the first instance, in approving FSM use of most of its public sector capacity-building grant funds for basic government operations rather than for the principal compact objectives for this sector, as mentioned earlier, JEMCO also adopted a grant condition for the fiscal year 2004 public sector capacity building grant. This condition required a “transition plan” by March 2004 explaining how these expenses would be removed from this grant. When the FSM did not provide such a plan, OIA withheld FSM public sector capacity-building grant funding, totaling approximately $1.9 million in May and June 2004 combined. After the FSM provided the plan to the U.S. government in July, OIA released the funding. The second, similar instance occurred simultaneously with a much smaller grant. JEMCO attached a special grant condition to the FSM’s private sector development grant, requiring that the FSM provide a 5-year transition plan for shifting basic government operating costs away from this grant to local revenues. When the FSM did not provide the plan on time, OIA withheld about $630,000 of sector funding in May and June 2004 until the FSM provided a plan in June 2004. Further, as of March 2005, OIA suspended the Chuuk education grant’s meal service program funding, because of questions surrounding the delivery of meals to students. The program was allocated almost $1 million in fiscal year 2005. Because OIA staff were unable to verify that food purchased by the program was received by the Chuuk Education Department or served to students, OIA has suspended—following a bilateral meeting that addressed this issue—$80,380 each month until the FSM national government reports on corrective actions to ensure that the meal service program operates effectively. As of May 2005, this issue, which was uncovered during a field visit to Chuuk by an OIA Honolulu office employee, had not been resolved. OIA also contacted Interior’s Office of the Inspector General for a follow-up investigation to determine whether Chuuk is misusing compact grant funds. According to a senior OIA official, the FSM national government is cooperating with this investigation. Finally, OIA took action in response to FSM and RMI cash management issues (an area not directly related to fulfillment of grant conditions or misuse of funds). OIA delayed payments to the FSM and the RMI in August 2004, when the required third-quarter cash transactions report showed that both countries had notable excess grant sector funding that had not been spent. OIA subsequently resumed funding when the governments reported that they needed cash to meet their obligations. OIA also stopped payments to the FSM in May 2005 when an OIA review showed that the FSM had about $9.7 million in cash on hand. Compact payments will be delayed until the FSM demonstrates its need for additional funding. Despite progress in many areas, a few important accountability reporting requirements have not been met, preventing the U.S., FSM, and RMI governments from fully gauging FSM and RMI performance in utilizing compact funds and from beginning to assess the impact of compact funding. Required broad annual reports summarizing compact spending and progress in meeting development goals have not been completed by any of the three governments. The U.S. government has not provided its fiscal year 2004 report from the President to the U.S. Congress, due in December 2004, though a draft is being circulated for interagency approval. Similarly, the FSM and the RMI have not submitted fiscal year 2004 reports to the U.S. President, although they were due in February 2005. Key development planning efforts remain incomplete, as mentioned in the previous section. These plans were due no later than 90 days after the amended compacts went into effect. The FSM has prepared a development plan, and the FSM Congress approved transmittal of this plan to the U.S. government in May 2005. JEMCO has not yet considered the plan. The RMI has provided the U.S. government with a required medium-term budget and investment framework, as well as a policy framework paper and annual plans for each sector, but it is unclear whether the JEMFAC has approved RMI planning documentation addressing the use of grant funds. OIA officials have provided contradictory views; while one senior official reported that the RMI’s approach was approved during the 2003 bilateral meeting, another official disagreed, and no record exists to document this meeting. No subsequent action has been taken to approve the RMI’s planning efforts. A senior OIA official noted that this particular issue has not received the attention it requires. Required audits that OIA intends to use to gauge compact compliance in specific areas such as procurement, remain outstanding or have been late. Single audits for fiscal year 2004 were due on April 1, 2005. The FSM has not completed its fiscal year 2004 single audit. The RMI has been late in meeting this requirement; the RMI completed its fiscal year 2004 single audit in June 2005. In October 2003, OIA took a significant step toward facilitating implementation and oversight of the amended compacts by opening a Honolulu field office to manage compact issues. However, OIA has not conducted a review to determine the extent of oversight of compact activities in the FSM and the RMI that would adequately promote compliance with compact requirements, though officials from all three governments told us that OIA staff should be spending more time in the two countries. Staff are currently spending about 15 percent of their time in the two countries. The FSM and the RMI governments have subsequently acted to create or identify central offices responsible for compact matters. The RMI government is progressing more quickly than the FSM government in this regard, and it has also taken other actions to facilitate compact implementation, such as creating an infrastructure project management unit. In October 2003, OIA opened a new Honolulu field office specifically intended to facilitate implementation and oversight of the amended compacts, although OIA has not determined how much on-site review of compact activities in the FSM and the RMI is necessary. During the congressional approval process for the amended compacts in 2003, in addressing why OIA should open an office in Honolulu rather than placing OIA staff in the FSM and the RMI, the Deputy Assistant Secretary for Insular Affairs reported to the House Committee on International Relations, Subcommittee on Asia and the Pacific, that “The Honolulu team will be able to travel frequently to the . While travel costs are high from Honolulu, additional travel costs are offset by not having to supply permanent housing, post differential, home leave, and education for dependents that come with foreign posts.” The office has five professional staff—specialists in health, education, infrastructure, private sector development, the environment, and financial management— that provide program and financial expertise along with a knowledge and understanding of the region, and work with the OIA Compact Coordinator in Washington, D.C. The Honolulu staff perform activities such as analyzing FSM and RMI budgets and other required reports, traveling to the islands to discuss and review expenditures and performance with FSM and RMI government officials and conduct site visits, providing briefings and advice to OIA and State officials regarding progress and problems, and providing support for bilateral meetings. However, in conjunction with establishing the Honolulu office, OIA did not determine the extent of on-site review of compact activities in the FSM and the RMI that would adequately promote compliance with compact and grant requirements. OIA fieldwork in the FSM and the RMI is necessary to ensure accountability over funds and compliance with compact and grant requirements, and is one of the principle reasons why the office was established in Honolulu. According to a cable from the U.S. Ambassador to the FSM “The constant flow of compact-related queries highlights the need for continued, intensive hands-on involvement… ffective oversight by Interior’s staff in Hawaii will be critical in realizing the compact’s full potential… staff will need to meet regularly with state officials from both the executive branch and the legislatures. Working more closely with state officials as they develop their budgets would enable staff to spot and resolve problems well before budgets are finalized… Oversight by e-mail is not an option.” Officials from all three countries told us that while they view the creation of OIA’s Honolulu office as a positive development, they believe that the Honolulu staff should spend more time in the FSM and the RMI than they currently do, to provide additional guidance on meeting compact requirements and conduct site visits. For example: The Deputy Assistant Secretary for Insular Affairs told us that he is not satisfied with the amount of on-site review that his staff is able to conduct but that his office must deal with the budget available to it. The OIA Compact Coordinator and staff from the Honolulu office report that on-site time in the field is inadequate and does not allow for detailed reviews of federal funds in the various remote islands. The U.S. Ambassadors to the FSM and the RMI both told us that OIA Honolulu staff should have the resources to conduct more work in the two countries. For example, more on-site work by OIA staff with country budget and finance issues is needed, as well as sufficient time to conduct site visits to schools. The HHS official that participates in the JEMCO and the JEMFAC noted the value of OIA on-site review in Chuuk and said that there needs to be more on-the-ground work. FSM and RMI officials also noted a need for additional on-site review and inspection by OIA staff, including site visits to schools in Pohnpei and infrastructure projects that are under way in the RMI. For fiscal year 2005, the OIA Honolulu office has a travel budget of $170,000, and for fiscal years 2004 and 2005 (through mid-April), staff in OIA’s Honolulu office spent about 15 percent of their total work time reviewing compact-related activities in the islands. OIA officials report that they are allocating their travel based on available funds for travel, while the OIA Honolulu office reports that they have had no input into the preparation of OIA’s budget or the allotment process. Examples of the impact of on-site review include the previously mentioned visit to Chuuk state by OIA Honolulu staff that uncovered possible misuse, as well as meetings OIA program specialists have held in the islands to discuss key issues, such as standardizing and improving both financial and performance measurement reporting, with FSM and RMI officials. According to OIA officials, the office has no assessment under way to establish if this amount of time spent in the FSM and the RMI meets oversight needs. While OIA officials believe the funding for on-site review is insufficient, the department has not supported increased funds for this purpose. Both the FSM and the RMI are seeking to centralize their government contact with the U.S. government and provide for day-to-day management of grant operations, as required in the FPAs. Although the RMI is making more rapid progress than the FSM in this area, both countries are in the early stages of establishing centralized offices responsible for compact matters. In early 2005, the RMI government identified the Office of the Chief Secretary as the official point of contact for all communication and correspondence between the U.S. government and the RMI government concerning compact sector grant assistance. The Chief Secretary is the head of RMI public service and will coordinate and direct the various ministries receiving compact funding with respect to the FPA and compact provisions. The Chief Secretary will also work closely with the RMI Economic Policy, Planning, and Statistics Office to develop the annual budget and sector portfolios and quarterly and annual monitoring and evaluation reports. While the Office of the Chief Secretary will provide oversight and coordination, the Chief Secretary has reported that most of the daily activities and compliance will be conducted by the ministries themselves. The Chief Secretary has outlined his plan to coordinate with agencies and reported to us that he will hold weekly meetings with all secretaries to address compact implementation issues, review reports on specific issues, and provide guidance to the ministries and agencies of the RMI government on compact matters. The FSM Congress recently enacted legislation to establish a Compact Management Board and a supporting Office of Compact Management. The board will consist of seven members; the FSM President will appoint two members, each state will appoint one member, and the final member will be the head of the Office of Compact Management. Whereas the board will be responsible for actions such as formulating JEMCO guidelines for FSM members, the compact office will be responsible for daily communications with JEMCO and the United States with regard to JEMCO and compact matters. A senior FSM official told us that although he expects compact office staff to undertake actions such as compliance visits to the FSM states, he does not expect the constitution of the board to be completed and the office ready to function until October 2005. Although there are ongoing differences between the FSM executive and legislative branches over which branch the compact office should be accountable to, the FSM Congress appropriated $100,000 in 2005 for the operation of the board. Although both countries have taken steps to provide for a centralized approach to addressing compact implementation and day-to-day management of grant operations, neither government’s efforts in this important area are yet under way, and the ultimate effectiveness of such efforts is unknown. The FPAs state that the FSM and RMI are responsible for the management and monitoring of the day-to-day operations of all sector grants to ensure compliance with all applicable grant terms and conditions; however, officials from both countries told us that this issue had not received much attention. Further, a senior FSM government official told us that the national government is not monitoring the day-to-day implementation of the compact by the states. Notably, a senior OIA official emphasized that the FSM’s and the RMI’s partnership with OIA in monitoring compact implementation is key to the success of the amended compacts. The RMI has also made more rapid progress than the FSM in managing implementation of its infrastructure grant. The RMI government hired a foreign firm to be the project management unit that designs and oversees individual infrastructure projects and work is under way. Following an extensive survey to assess the state of RMI education and health infrastructure and determine priority infrastructure projects, several contracts have been awarded, for example, for the construction and maintenance of schools and a hospital. The FSM just established a project management unit in June 2005. Per a JEMCO resolution, such a unit must be established in order to receive infrastructure grant funds. In addition, the FSM and RMI are each working to improve their accounting software systems. The RMI government has adopted a new accounting software system that meets with OIA’s approval and is currently being reviewed within the RMI to ensure that it allows for compliance with compact FPA requirements. Further, the RMI Ministry of Finance has hired fixed-asset and procurement specialists and established a satellite office in Ebeye to handle the specific needs of that area. The FSM, which currently has three different accounting software programs spread among the four states and the national government, is in the process of purchasing a unified accounting system. It will install the program and train each government’s personnel to satisfy compact reporting requirements. The amended compacts differ significantly from the original compact in that they target funding to identified priority areas; require grant agreements; substantially increase accountability requirements to include new dimensions, such as performance measurement; and allow for the withholding of funds for noncompliance with compact or grant requirements. Diligent and sustained effort by the U.S., FSM, and RMI governments will be required to adapt fully to this new approach for providing and accounting for U.S. economic assistance to the FSM and the RMI. Within this new environment, all three countries have demonstrated a commitment to meeting new compact funding and accountability requirements. The U.S. government has undertaken notable actions during the early stages of compact implementation that reflect its commitment. It has embraced new accountability options in the amended compacts by, for example, requiring data that will facilitate performance measurement and suspending funds as a result of possible misuse. Further, by holding infrastructure funding until the countries provide sufficient infrastructure project and identification management, the U.S. government has taken a new approach to ensuring the effective use of compact funds. In addition, by establishing a Honolulu field office and investing in staff to provide monitoring and oversight, OIA has demonstrated its commitment to successful implementation of the amended compacts. Such staff are critical to conducting work in the field to monitor performance and financial accountability, as OIA’s review of education expenditures in the FSM state of Chuuk has demonstrated. However, officials from all three governments believe that more OIA field work is in order. OIA needs to determine the extent of on-site work in the FSM and the RMI necessary to adequately promote compliance with amended compact and grant requirements. The FSM and the RMI have also acted to meet compact requirements, although many of these actions are in an early stage. Both countries have taken steps to establish centralized offices responsible for ensuring compact implementation and day-to-day oversight; however, it is too early to assess how well these offices will meet this goal. Further, both countries have responded in a positive fashion to many new reporting requirements. For example, the FSM and the RMI expressed a desire to provide useful performance reports and have been responsive to working with OIA to strengthen and improve this new approach to accounting for compact funds. In addition, both countries have been timely in providing quarterly financial and performance reports. While both countries are moving to meet compact requirements, to date the RMI is progressing more quickly than the FSM in spending authorized grant funding, meeting special grant conditions, preparing adequate required reports, taking steps to centralize compact management, and selecting an investment advisor who can work to maximize trust fund returns. Although the three governments’ commitment to meeting compact requirements is clear, challenges for future performance exist. The failure of all three governments to complete required annual compact spending and development reports means that, for the first year under the amended compacts, there is no assessment of the use of U.S. assistance and initial performance in key areas such as health and education. Similarly, the lack of timely single audits deprives the United States of a key source of information on the FSM’s and the RMI’s compliance with detailed compact requirements. Additionally, the FSM’s difficulties in preparing a national infrastructure development plan to obtain substantial infrastructure grant funding demonstrate the difficulty the country is having integrating state and national priorities and using compact funds to advance national goals. Finally, it is unclear why strategic issues, such as the need for planning to use compact funds to achieve long-term economic advancement or to address annual grant decreases, are not being actively considered by all three governments, regardless of the early stage of the amended compacts’ implementation. The U.S. government has not pursued resolution of these issues, which have implications for the FSM’s and the RMI’s long-term, effective use of funds. To effectively use Interior staff resources and to maximize the effectiveness of U.S. monitoring of compact expenditures, we recommend that the Secretary of the Interior direct the Deputy Assistant Secretary for Insular Affairs to determine, relative to other office responsibilities, the extent of OIA on-site review in the FSM and the RMI of compact activities that is required in order to adequately promote compliance with compact and grant requirements. To improve grant administration and oversight and to facilitate planning for the effective use of compact funding, we recommend that the Secretary direct the Deputy Assistant Secretary for Insular Affairs, as Chairman of the Joint Economic Management Committee, in coordination with other U.S. agencies that participate in this committee, to work with the FSM government to take the following four actions: establish sector grant levels for each of the five governments that are consistent with national priorities and will assist in promoting long-term development goals such as economic advancement and budgetary self- reliance, establish a time frame for the completion of required and overdue FSM establish a time frame for the completion of FSM government plans to manage decreasing annual grant amounts and to shift basic government operations under the public sector capacity building to local revenues in a strategic fashion, and outline specific actions that the FSM government will take in managing and monitoring day-to-day sector grant operations to ensure compliance with all grant terms and conditions. To improve grant administration and oversight and to facilitate planning for the effective use of compact funding, we recommend that the Secretary direct the Deputy Assistant Secretary for Insular Affairs, as Chairman of the Joint Economic Management and Financial Accountability Committee, in coordination with other U.S. agencies that participate in this committee, to work with the RMI government to take the following three actions: establish sector grant levels that will assist in promoting long-term development goals such as economic advancement and budgetary self- reliance, establish a time frame for the completion of an RMI government plan to manage decreasing annual grant amounts in a strategic fashion, and outline specific actions that the RMI government will take in managing and monitoring of day-to-day sector grant operations to ensure compliance with all grant terms and conditions. We received technical comments from the Departments of the Interior, State, and HHS, as well as the FSM and RMI governments. The RMI submitted particularly extensive technical comments that stressed, among other things, that government’s detailed strategic planning efforts and provided suggestions to improve the factual accuracy of this report. We incorporated technical comments into our report, as appropriate. We also received formal comment letters from all parties. All letters found our work to be useful, although the RMI remarked that the report overstated long- term strategic planning issues, provided insufficient emphasis on economic components of the amended compact that have not been fully implemented, and included passages that were in need of factual correction. The Department of the Interior concurred with our recommendations and stated its intention to implement them. State, HHS, and the FSM government did not comment on our recommendations to Interior. The RMI government stated that some of the recommendations did not reflect the purpose or intent of the amended compact. In addition to providing copies of this report to your offices, we will send copies of this report to other appropriate committees. We will also provide copies to the Secretaries of the Interior, State, and Health and Human Services, as well as the President of the Federated States of Micronesia and the President of the Republic of the Marshall Islands. We will make copies available to other interested parties upon request. If you or your staff have any questions regarding this report, please contact me at (202) 512-4128 or gootnickd@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made major contributions to this report are listed in appendix IX. The Chairman and Ranking Minority Member of the House Committee on Resources, and the Chairman and Ranking Minority Member of the Senate Committee on Energy and Natural Resources requested that we report on the progress of initial efforts to implement the amended compacts. This report evaluates actions taken by the United States, Federated States of Micronesia, and the Republic of the Marshall Islands governments since fiscal year 2004 to (1) meet funding requirements and plan for the use of this funding, (2) meet accountability requirements, and (3) establish operations to facilitate compliance with funding and accountability requirements. To identify actions taken by the three governments to meet funding requirements, we reviewed the amended compacts as well as the subsidiary fiscal procedures agreements and subsidiary trust fund agreements to identify such requirements as well as expectations of the U.S. Congress in this area. We reviewed all fiscal year 2004 and 2005 grant agreements with both countries, including special terms and conditions included in these agreements, and identified instances where no grant agreement had been signed. We examined annual financial data prepared by the FSM and the RMI to determine the amount of funding that was not spent for fiscal year 2004 and what sectors were affected by this circumstance. We discussed the FSM and RMI data with an Office of Insular Affairs official who has used this information, and determined that the data are sufficiently reliable for the purposes of our report. We also corroborated our calculations of unspent funds with this official. We did not review funding provided to Kwajalein landowners in exchange for U.S. military access to Kwajalein Atoll. This funding is for landowner use and is not included as part of U.S. economic assistance that is subject to sector grants and accountability requirements. To identify issues that impact planning for the use of compact funds, we discussed planning efforts with U.S., FSM, and RMI government officials and also identified issues through our own analysis (such as the use of the distribution formula in the FSM). We then reviewed such issues by examining documents such as FSM and RMI legislation and documentation provided to the U.S. government (such as the FSM’s transition plan to shift ineligible spending under the public sector capacity building grant to local revenues). To identify FSM education spending per capita, we used FSM education grant data and divided grant amounts provided to each state by the student population for each state—the latter data were provided to us by OIA, which received them directly from the FSM. To identify FSM health spending per capita, we assessed health grant amounts against FSM population data. We determined that these data were sufficiently reliable for the purposes of our report. To identify actions taken by the three governments to meet accountability requirements, we reviewed the amended compacts as well as the subsidiary FPAs to identify such requirements. We also reviewed the briefing documents created by the U.S. government in preparation for the annual bilateral meetings with the two countries, as well as the minutes and resolutions, when available, related to the meetings. We further reviewed FSM and RMI documents—such as budget justifications and portfolios, quarterly financial forms and performance reports, and annual financial reports—submitted by the FSM and RMI governments to the U.S. government to confirm compliance with accountability reporting requirements. We discussed the sufficiency of such reports with OIA officials. We also examined FSM and RMI laws and letters exchanged between the FSM and U.S. governments. To identify actions the three governments have taken to establish operations to facilitate compliance with funding and accountability requirements, we reviewed the amended compacts and FPAs to identify specific monitoring responsibilities. In the case of the OIA Honolulu office, we reviewed senior management statements regarding the purpose and function of this office and job descriptions for all staff. To identify the extent of Honolulu office staff travel to the FSM and the RMI, we obtained the travel records and start dates of all five program specialists and discussed this information with OIA officials to ensure that the data was sufficiently reliable for our use. We calculated the percentage of time spent conducting on-site review in the two countries over fiscal years 2004 and 2005 (through mid-April) time span and compared this to the total work time for the program specialists. We obtained OIA travel budget data for the Honolulu office from OIA officials. We reviewed FSM and RMI laws that address structural changes to compact management, as well as unclassified cables from the Department of State. To address all objectives, we held extensive interviews with officials from the U.S. Department of the Interior (Washington, D.C., Honolulu, Hawaii, the FSM, and the RMI) and the Department of State (Washington, D.C., the FSM, and the RMI). We also interviewed officials from the U.S. Department of Health and Human Services (Washington, D.C., and Honolulu, Hawaii). We traveled to the FSM (Pohnpei and Chuuk) and the RMI (Majuro and Ebeye). We had detailed discussions with FSM (national, Pohnpei, and Chuuk governments) and RMI officials from foreign affairs, finance, budget, health, education, public works, and audit agencies. Further, we met with the presidents of the FSM and the RMI. We also met with officials from the U.S. Army Kwajalein Atoll to discuss compact implementation issues. We met with representatives from private sector businesses within the Marshall Islands and with leaders from the Micronesian Seminar, a nonprofit organization in Pohnpei, FSM that provides public education on current FSM events, to obtain their views on compact implementation and development issues. We also met with officials from the Interior Inspector General’s Office (Guam, Honolulu, Hawaii, and Washington, D.C.) to discuss ongoing investigations in the FSM and RMI. We conducted our review from August 2004 through May 2005 in accordance with generally accepted U.S. government auditing standards. We requested written comments on a draft of this report from the Departments of the Interior, State and Health and Human Services, as well as the governments of the FSM and RMI. All comments are discussed in the report and are reprinted in appendixes IV through VIII. Further, we considered all comments and made changes to the report, as appropriate. Compact budget by sector grant Budget consultations with U.S. government Quarterly performance reports by sector Annual compact report to the U.S. President Approved FSM Development Plan or Approved RMI Medium-Term and Investment Framework (MTBIF) Approved FSM Infrastructure Development Plan and RMI Infrastructure Development and Maintenance Plan N/A = Nonapplicable. The following is GAO’s comment on the letter from the Department of the Interior dated June 13, 2005. We recognize that the Department of the Interior has supported the creation of the OIA Honolulu field office to assist in compact implementation. However, officials from OIA have stated that budgetary constraints have prevented staff from conducting sufficient on-sight review in the FSM and the RMI and that the department has not supported increased funds for this purpose. The following is GAO’s comment on the letter from the Department of State dated July 1, 2005. We agree that the amended compacts and their subsidiary agreements contain no commitments regarding the level of revenue that will be generated by the trust funds, and they do not speak of the revenue from the trust funds as “replacing” annual U.S. grant assistance after fiscal year 2023. However, for the sake of assessing the possible difficulty of transitioning from grant assistance to trust fund earnings, we have performed calculations based on U.S., FSM, and RMI trust fund contributions and various rates of return, to forecast the possibility that trust fund earnings will fully replace grant assistance beginning in 2024 (see p. 25). The following is GAO’s comment on the letter from the Department of Health and Human Services dated June 7, 2005. We have made the requested corrections. Specifically, we now use the term “health grant” to characterize this particular compact sector grant throughout the report, and we have deleted the footnote describing travel to the FSM and the RMI by the HHS representative stationed in Honolulu. The following is GAO’s comment on the letter from the government of the Federated States of Micronesia dated June 27, 2005. The report notes that the FSM government submitted a document to OIA that calculates percentage decreases for basic government operations expenditures from the FSM’s public sector capacity building grant through 2009. We also note that there is no additional plan describing what policy steps will be taken or the agencies and activities that will be affected by the decreases. Therefore, we do not believe that this schedule can be construed as a “strategy” that identifies where spending decreases will occur and how they will be managed. The following are GAO’s comments on the letter from the government of the Republic of the Marshall Islands dated June 28, 2005. 1. We made several factual corrections to the report, based on the RMI’s technical comments (see comment 5). 2. The RMI’s technical comments emphasize the government’s detailed strategic planning efforts. We do not dispute that the RMI government has undertaken planning initiatives regarding the use of compact funds in each sector. Our point remains that (1) it is unclear whether JEMFAC has approved RMI planning documentation addressing the use of grant funds and (2) there have been no bilateral discussions addressing how the RMI will achieve the amended compact’s stated goals of economic advancement and budgetary self-reliance. 3. Our recommendations, which are intended to further ensure planning for the effective use of compact funding, are directed to the Department of the Interior. In its formal comment letter, Interior concurred with the recommendations and stated its intention to implement them through the department’s internal budget and planning process and, to the extent possible, through the joint economic management committees. 4. We intend to review the trust funds, the supplemental education grant, and the judicial training funding in more detail during subsequent work. 5. Per an agreement with the RMI government, we are not reproducing the RMI’s technical paper. However, we have used comments in the paper to make factual corrections to the report. In addition to the contact named above, Emil Friberg, Leslie Holen, Eddie Uyekawa, Reid Lowe, Kendall Schaefer, and Mary Moutsos made key contributions to this report.

Summary: From 1987 to 2003, the United States provided economic aid to the Federated States of Micronesia (FSM) and the Republic of the Marshall Islands (RMI) through a Compact of Free Association. A previous GAO report found little accountability for the assistance provided by the U.S. Department of the Interior under this compact. In 2004, amended compacts with the FSM and RMI went into effect and will provide $3.5 billion in assistance over 20 years, consisting of grants and contributions to trust funds that are to replace the grants after 2023. The amended compacts include funding and accountability requirements that were not present in the original compact. To better understand the status of the compacts' implementation, GAO evaluated actions taken by the U.S., FSM, and RMI governments since fiscal year 2004 to (1) meet funding requirements and plan for the use of this funding, (2) meet accountability requirements, and (3) establish operations to implement the new agreements. In fiscal years 2004 and 2005, the U.S. government signed grant agreements with the FSM and the RMI focused on six sectors, such as health and education, as provided for in the amended compacts. Authorized grant amounts for each year were about $76 million for the FSM and about $35 million for the RMI. Required trust funds were also established. Strategic planning issues impacting the long-term, effective use of funds have not been addressed. The allocations of the grants to the sectors have not been linked to the countries' development goals; the FSM and RMI have not planned for annual required decreases in grant funding; and trust funds have not been invested to maximize interest earnings (though efforts are currently under way to resolve this final issue). The U.S., FSM, and RMI governments have taken actions to meet compact accountability requirements. For example, the FSM and the RMI have provided financial and performance reports, and the U.S. government has withheld funding to ensure compliance with grant requirements. However, a few important accountability requirements have not been met. For instance, the FSM's development plan has not been approved by the U.S. government, and it is unclear whether the U.S. government has assessed the RMI's planning documents. Finally, the FSM has not completed single audits for fiscal years 2003 or 2004, and none of the three governments has submitted its required annual compact spending and development report for fiscal year 2004. The Department of the Interior took a significant step in October 2003 to facilitate implementation and oversight of the amended compacts by opening a new office in Honolulu, Hawaii. However, Interior has not determined how much oversight of compact activities in the FSM and the RMI is necessary, though the current level of on-site review is viewed as insufficient. The FSM and RMI governments have each taken actions to establish centralized compact management offices; the RMI government is progressing more rapidly in these efforts than the FSM government.