Federal Agency: U.S. Department of Interior AL Program: 15.875 Economic, Social, and Political Development of the Territories Federal Award No.: D23AF00263, D24AF003334, D24AF00335, D24AF00336, D24AF00340, D24AF00341, D24AF00344, D24AF00350, D24AF00378 Area: Subrecipient Monitoring Questioned Costs: $94,422,154 Criteria: Article VI, Section 1(n) of the Fiscal Procedures Agreement (FPA) states that the Government of the Federated States of Micronesia will follow its laws and procedures when awarding and administering Sub-Grants. The Governments shall ensure that: (i) Every Sub-Grant includes any clauses required by the 2023 Amended Compact, the Grant terms and conditions, and this Agreement; (ii) Sub-Grantees are aware of requirements imposed upon them by the 2023 Amended Compact, the Grant terms and conditions, and this agreement; and (iii) The Sub-Grantee can meet the financial management standards of this Agreement. Article VI, Section 2(a)(i) also states that the Government of the Federated States of Micronesia shall be responsible for the management and monitoring of the day-today operations of all Sector Grants and their activities, to assure compliance with all applicable Sector Grant terms and conditions. Additionally, Article VI, Section 1(h) requires The Government of the Federated States of Micronesia shall not award funds received pursuant to the 2023 Amended Compact to any party which is debarred, suspended or otherwise excluded from and ineligible for participation in United States assistance programs. The Government of the Federated States of Micronesia shall ensure that Grants shall not go to those parties identified in the SAM Exclusions List. Furthermore, Article IV, Section 5(b)(ii) says the Government of the Federated States of Micronesia maintains procedures to minimize the time elapsing between the disbursement of funds to the Government of the Federated States of Micronesia and its payment of the Accrued Expenditure. Condition: 1. The FSM National Government does not have subrecipient monitoring procedures as required by the FPA. Thus, the FSM National Government did not perform the minimum subrecipient monitoring requirements over the $94,422,154 amounts passed to subrecipients. a. Ensure that every sub-grant includes any clauses required by the 2023 Amended Compact, the Grant terms and conditions, and the FPA. b. Ensure Sub Grantees are aware of requirements imposed upon them by the Compact, as amended, the sector Grant awards and the FPA. c. The Sub-Grantee can meet the financial management standards of the FPA. d. Suspension and debarment verification procedures prior to approving of the subaward. 2. FSMNG did not properly monitor payments to subrecipients, with a total population of $23,177,976, to ensure that the subrecipients timely disbursed the funds upon receipt from FSMNG. No questioned costs are presented as amounts are already questioned at Condition 1. Cause: 1. FSMNG does not have policies and procedures that comply with Article VI, Section 1 of the Fiscal Procedures Agreement. 2. FSMNG does not have established policies and procedures to minimize time elapsing between the transfer of federal funds to the subrecipient and the disbursement of such funds by the subrecipient. Effect or potential effect: 1. FSM National Government is in noncompliance with applicable subrecipient monitoring requirements and questioned costs of $94,422,154, which is the total subrecipient disbursements made during the year, result. 2. The FSM National Government is in noncompliance with the applicable subrecipient cash management monitoring requirements. Identification as a Repeat Finding: 2023-009 Recommendation: 1. FSMNG should update their established policies and procedures to be in accordance with Article VI, Section 1(n) and Section 2(a)(i) of the Fiscal Procedures Agreement to comply with the requirements for pass-through-entities. FSMNG should consider adopting the provisions identified in 2 CFR 200.322 when designing the policies in procedures, which provide details regarding the requirements for Pass-Through Entities for subrecipient monitoring. 2. FSMNG should establish a policy and implement formal monitoring procedures to ensure that the subrecipient complies with the requirement to minimize the time elapsing between the transfer of federal funds to the subrecipient and the disbursement of such funds for program purposes. Management should consider the three-business day rule on cash advance funding stated in 31 CFR part 205.12(b)(4). Views of Responsible Officials: Management disagrees with condition 1. The FSM National Government does have a subrecipient agreement in place. All Compact sector grants are properly allocated through JEMCO for all sub-grantees, and a subrecipient agreement is transmitted to the FSM State Governments for their concurrence each year, under which the states are obliged to the grant terms and conditions. This agreement is signed by both parties — the President and the Governors, as the allottees of the funds — and the process is facilitated by the Office of Compact Management. The matters listed at conditions 1(a) through 1(d) — the inclusion of clauses required by the 2023 Amended Compact, the sub-grantees' awareness of the requirements imposed upon them, their ability to meet the financial management standards of the FPA, and verification prior to approval of the subaward — are all part of this signed subrecipient agreement. Management further notes that condition 1's statement that subrecipient monitoring procedures are 'required by the FPA' is not accurate: nowhere in the FPA is such a requirement prescribed. Throughout the FPA, the obligations rest with the 'Government of the Federated States of Micronesia,' which the FPA itself defines as the Government established and organized by the Constitution of the Federated States of Micronesia, including all the political subdivisions and entities comprising that Government. Under the FSM's longstanding interpretation of that definition, each FSM State Government is itself a grantee within the Government of the FSM and is entitled to its own management and monitoring of the day-to-day operations of its sector grants, consistent with Article VI, Section 2(a)(i). Under the recent interpretation advanced by DOI, however, these responsibilities rest with the FSM National Government, which is now to be classed as a pass-through entity in respect of the states' shares of Compact funds. This classification is a new proposed treatment arising from the ongoing Compact discussions with DOI, consistent with the matters described in the responses to Findings 2024-008 and 2024-009. The FSM National Government is now working on establishing the subrecipient agreement framework and the associated policies and procedures to align with DOI's requirements, taking into account the Uniform Guidance provisions on pass-through entity requirements referred to in the recommendation. Management also disagrees with condition 2. The Compact sector grants concerned are paid on an advance basis: under Article IV, Section 5(b)(i) of the FPA, periodic payments for operational grants are made as soon as practicable after the first business day of each fiscal quarter to fund the financial requirements of that quarter. The time-elapsing provision relied upon in the criteria — Article IV, Section 5(b)(ii) — applies only to sector grants for infrastructure projects, which are paid on the basis of accrued expenditures. The requirement to minimize the time elapsing therefore does not apply to these disbursements to the states, unless they relate to infrastructure. In any event, as demonstrated by the samples tested, funds are disbursed to the states within the month of receipt, through the FSM National Government's required wire-out approval process as described in the response to Finding 2024-010. With respect to the questioned costs of $94,422,154 — the total of subrecipient disbursements made during the year — management's position is that the matters identified constitute, at most, internal control deficiencies relating to the formal documentation of subrecipient monitoring policies and procedures. That framework is now being established, and in accordance with the agreement with DOI, it is to be implemented by 1 October 2026. The conditions do not warrant questioned costs. All samples requested were provided to the auditors, vouched, and cleared, meaning the underlying disbursements are fully supported by adequate documentation. The costs did not result from a violation of the terms and conditions of the Federal award, given that the FPA prescribes no subrecipient monitoring procedures and the pass-through classification is a newly proposed treatment still being settled with DOI; and the costs are not unreasonable, representing the allocation of Compact sector grant funds to the FSM State Governments as approved through JEMCO. Under the definition of questioned costs in 2 CFR 200.1, including paragraph (3)(i), questioning the entire population of subrecipient disbursements on account of an internal control deficiency is not warranted. Management accordingly requests that the finding be reported as an internal control deficiency with questioned costs of $0. Summary Schedule — Remarks (2024-013): Repeat 2023-009. Condition 1 disagreed — a subrecipient agreement exists, signed annually by the President and Governors as allottees, facilitated by the Office of Compact Management, covering conditions 1(a)–(d), with allocations approved through JEMCO; the FPA prescribes no subrecipient monitoring procedures, and the pass-through classification for National is a new treatment per DOI discussions. Condition 2 disagreed — Compact sector grants are paid on an advance basis under FPA Article IV, Section 5(b)(i); the time-elapsing proviso in Section 5(b)(ii) applies only to infrastructure, and in any event disbursements to states are made within the month of receipt. At most internal control deficiencies — the monitoring framework is being established and, per the DOI agreement, is to be implemented by 1 October 2026. Questioned costs contested — all samples provided, vouched, and cleared; per 2 CFR 200.1, including paragraph (3)(i), questioned costs of $0 are warranted. Auditor Response: Condition 1 – Based on February 11, 2026 communication provided by the Department of Interior, the interpretation that the FPA aligns with the provisions of 2 CFR 200.332 is correct and consistent with expectation that FSMNG should conduct subrecipient monitoring procedures over funds passed down to the different FSM states. Condition 2 – The amount of questioned cost identified pertains to fund 19 infrastructure projects passed-through to each state, therefore subject to be monitored for timeliness of disbursement as required by the FPA.