The FSM and the RMI are located in the Pacific Ocean just north of the equator, about 3,000 miles southwest of Hawaii and about 2,500 miles southeast of Japan (see fig. 1). The FSM is a federation of four semiautonomous states and has a population of approximately 103,000 (as of 2010) scattered over many small islands and atolls. The FSM states maintain considerable power, relative to the FSM National Government, to allocate U.S. assistance and implement budgetary policies. Chuuk, the largest state, has 47 percent of the FSM’s population, followed by Pohnpei (35 percent), Yap (11 percent), and Kosrae (6 percent). By contrast, the RMI government is responsible for allocating U.S. assistance in that country, though the RMI’s 29 constituent atolls and five islands exercise local government authority. About three-quarters of the RMI population of approximately 53,000 (as of 2011) live in Majuro, the nation’s capital, and on Ebeye Island in the Kwajalein Atoll. U.S. relations with the FSM and the RMI began during World War II, when the United States ended Japanese occupation of the region. The United States administered the region under a United Nations trusteeship beginning in 1947. During the 1940s and 1950s the RMI was the site of 67 U.S. nuclear weapons tests. The four states of the FSM voted in a 1978 referendum to become an independent nation, while the RMI established its constitutional government and declared itself a republic in 1979. Under the trusteeship agreement, both newly formed nations remained subject to the authority of the United States until 1986. The United States, the FSM, and the RMI entered into the original Compact of Free Association in 1986 after lengthy negotiations. The compact provided a framework for the United States and the two countries to work toward achieving the following three main goals: (1) establish self-government for the FSM and the RMI, (2) ensure certain national security rights for all of the parties, and (3) assist the FSM and the RMI in their efforts to advance economic development and self- sufficiency. The compact’s third goal was to be accomplished primarily through U.S. direct financial assistance to the FSM and the RMI. From 1987 through 2003, the FSM and the RMI are estimated to have received about $2.1 billion in compact financial assistance. Under the original compact, the FSM and the RMI used funds for general government operations; capital projects, such as building roads and investing in businesses; debt payments; and targeted sectors, such as energy and communications. The FSM concentrated much of its spending on government operations at both national and state levels, while the RMI emphasized capital spending. While the original compact set out specific obligations for reporting and consultations regarding the use of compact funds, the FSM, RMI, and U.S. governments provided little accountability over compact expenditures and did not ensure that funds were spent effectively or efficiently. In 2003, the United States approved separate amended compacts with the FSM and the RMI that went into effect on June 25, 2004, and May 1, 2004, respectively. The amended compacts provide for direct financial assistance to the FSM and the RMI from 2004 to 2023, decreasing in most years (hereafter referred to as the annual decrements). The amounts of the annual decrements are to be deposited in the trust funds established under the amended compacts for the two nations (see fig. 2). For more information on compact assistance and trust fund contributions, see appendix III. The amended compacts and associated fiscal procedures agreements require that grant funding support the countries in six core sectors— education, health, infrastructure, environment, private sector development, and public sector capacity building—with the education and health sectors having the greatest priority. Within the core sector grants, the RMI must also target grant funding to Ebeye and other Marshallese communities within Kwajalein Atoll: $3.1 million annually for 2004 through 2013 and $5.1 million annually for 2014 through 2023 (hereafter referred to as Ebeye special needs funds). In addition to receiving compact sector grants, the FSM and the RMI are eligible for a supplemental education grant each year. The amended compacts’ implementing legislation authorized annual appropriations of about $12.2 million for the FSM and $6.1 million for the RMI beginning in 2005 to the U.S. Secretary of Education to supplement the education grants awarded under the amended compacts. Under the fiscal procedures agreements, permitted uses of the supplemental education grant funds include, among other things, support for direct educational services at the local school level focused on school readiness, early childhood education, primary and secondary education, vocational training, adult and family literacy, and the smooth transition of students from high school to postsecondary educational pursuits or rewarding career endeavors. Funding for the supplemental education grant is appropriated annually to Education and transferred to Interior for disbursement, with Interior responsible for ensuring that the use, administration, and monitoring of supplemental education grant funds are in accordance with a memorandum of agreement among Interior, Education, HHS, and the Department of Labor (Labor), as well as with the fiscal procedures agreements. In addition to amended compact grants, the FSM and the RMI receive other grants and assistance from U.S. agencies. For example, in fiscal years 2007 through 2011, the FSM spent about $197 million and the RMI spent about $46 million in noncompact grants from agencies including Interior, Education, HHS, Labor, and the Department of Transportation. See appendix IV for more information on noncompact grants awarded to the FSM and the RMI. The legislation and fiscal procedures agreements for the amended compacts established oversight mechanisms and responsibilities for the FSM, RMI, and the United States. JEMCO and JEMFAC were jointly established by the United States and, respectively, the FSM and the RMI to strengthen the management and accountability and promote the effective use of compact funding. Each five-member committee comprises three representatives from the United States government and two representatives from the corresponding country. The United States, the FSM, and the RMI are required to provide the necessary staff support to their representatives on the committee to enable the parties to monitor closely the use of assistance under the compacts. JEMCO’s and JEMFAC’s designated roles and responsibilities include the following: reviewing the budget and development plans from each of the governments; approving grant allocations and performance objectives; attaching terms and conditions to any or all annual grant awards to improve program performance and fiscal accountability; evaluating progress, management problems, and any shifts in priorities in each sector; and reviewing audits called for in the compacts. In practice, JEMCO and JEMFAC allocate grants and attach terms and conditions to grant awards through resolutions, which are discussed and voted upon at their meetings. From fiscal years 2004 through 2013, JEMCO and JEMFAC allocated about $1.1 billion in sector grants to the FSM and RMI under the amended compacts. In practice, JEMFAC has allocated Ebeye special needs funds as a separate grant allocation, resulting in seven sectors. For more detailed information on compact sector allocations, see appendix V. The FSM national and state governments and the RMI government are to manage the sector and supplemental education grants and monitor day- to-day operations to ensure compliance with grant terms and conditions. The governments are also required to track progress toward performance goals and report quarterly to the United States. The FSM and the RMI must annually report to the U.S. President on the use of U.S. grant assistance and other U.S. assistance provided during the prior fiscal year, and must also report on their progress in meeting program and economic goals. Each country has established an agency dedicated to providing compact oversight and ensuring compliance with regulations in the amended compacts, grant award terms and conditions, and JEMCO and JEMFAC resolutions. The FSM and the RMI must adhere to specific fiscal control and accounting procedures and are required to submit annual audit reports, within the meaning of the Single Audit Act, as amended. Single audits are focused on recipients’ internal controls over financial reporting and compliance with laws and regulations governing U.S. federal awardees and provide key information about the federal grantee’s financial management and reporting. Through its participation in the JEMCO and JEMFAC, the United States can require that terms and conditions be attached to any and all annual grant awards to improve program performance and fiscal accountability. Interior’s Office of Insular Affairs (OIA) has responsibility for the administration and oversight of the FSM and RMI compact sector and supplemental education grants. In addition to headquarters staff, OIA operates a Honolulu field office and has staff in the FSM and RMI to conduct oversight. Under the fiscal procedures agreements governing the amended compacts, OIA is responsible for using financial reports to monitor each country’s budget and fiscal performance, and for using performance reports submitted by the countries to evaluate sector grant performance. OIA officials are also responsible for monitoring compliance with grant terms and conditions. If problems are found in areas such as the FSM and RMI monitoring of sector grants or a lack of compliance with grant terms, the United States may impose special conditions or restrictions, including requiring the acquisition of technical or management assistance, requiring additional reporting and monitoring, or requiring additional prior approvals. Additionally, the United States may withhold grant funds if the countries breach the terms and conditions of certain sections of the amended compacts or of the fiscal procedures agreements, or fail to comply with the award conditions of a grant.