Commonwealth of the Northern Mariana Islands: Serious Economic,  
Fiscal, and Accountability Challenges (08-FEB-07, GAO-07-436T).  
                                                                 
The U.S. insular area of the Commonwealth of the Northern Mariana
Islands (CNMI) is a self-governing commonwealth of the United	 
States that comprises 14 islands in the North Pacific. In a	 
December 2006 report--U.S. Insular Areas: Economic, Fiscal, and  
Financial Accountability Challenges (GAO-07-119)--regarding four 
insular areas including CNMI, GAO identified and reported the	 
following: (1) economic challenges, including the effect of	 
changing tax and trade laws on their economies; (2) fiscal	 
condition; and (3) financial accountability, including compliance
with the Single Audit Act. The Chairman of the Senate Committee  
on Energy and Natural Resources, which requested the December	 
2006 report, asked GAO to present and discuss the results as they
pertain to CNMI. Our summary and conclusions are based on our	 
work performed for our December 2006 report on U.S. insular	 
areas. For this testimony we also had available CNMI's fiscal	 
year 2005 audited financial statements, which we have included in
our review, along with some recent developments in fiscal year	 
2006.								 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-07-436T					        
    ACCNO:   A65706						        
  TITLE:     Commonwealth of the Northern Mariana Islands: Serious    
Economic, Fiscal, and Accountability Challenges 		 
     DATE:   02/08/2007 
  SUBJECT:   Accountability					 
	     Auditing standards 				 
	     Economic analysis					 
	     Economic development				 
	     Federal funds					 
	     Financial analysis 				 
	     Financial management systems			 
	     Grant monitoring					 
	     Internal controls					 
	     Risk assessment					 
	     Schedule slippages 				 
	     Strategic planning 				 
	     Tax law						 
	     Trade agreements					 
	     Corrective action					 
	     Policies and procedures				 
	     Northern Mariana Islands				 

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GAO-07-436T

   

     * [1]Summary
     * [2]Narrow Economic Base and Intrinsic and External Factors Limi

          * [3]Decline in Garment Industry Tied to Trade Law Changes
          * [4]External Events Affect Tourism

     * [5]CNMI's Reported Fiscal Condition Continues to Weaken
     * [6]CNMI's Financial Accountability Remains Weak

          * [7]CNMI's Compliance with Single Audit Requirements
          * [8]CNMI Unable to Achieve "Clean" Audit Opinions Due to Persist
          * [9]Weaknesses over Financial Reporting and Compliance with Requ

     * [10]Efforts to Assist CNMI in Its Economic and Accountability Ch
     * [11]Conclusions
     * [12]GAO Contacts

          * [13]Order by Mail or Phone

Testimony
Before the Committee on Energy and Natural Resources, U.S. Senate

United States Government Accountability Office

GAO

For Release on Delivery Expected at 10:00 a.m. EST
Thursday, February 8, 2007

COMMONWEALTH OF THE NORTHERN MARIANA ISLANDS

Serious Economic, Fiscal, and Accountability Challenges

Statement of Jeanette Franzel, Director Financial Management and Assurance

GAO-07-436T

Mr. Chairman and Members of the Committee:

I am pleased to be here today to discuss the Commonwealth of the Northern
Mariana Islands' (CNMI) serious challenges in strengthening its economy,
fiscal condition, and financial accountability. CNMI is a self-governing
commonwealth of the United States that administers its own local
government functions under its own constitution. CNMI consists of 14
islands in the North Pacific with a total land area about 2.5 times the
size of Washington, D.C. In recent years, CNMI has experienced serious
economic and fiscal challenges, and several indicators point to a fiscal
crisis in fiscal year 2006.

Today, I will highlight our December 2006 report^1 on the recent economic
trends in the CNMI economy, its weakening fiscal condition, and its
financial accountability challenges, which we have updated to include
information for fiscal years 2005 and 2006.

Our summary and conclusions are based on our work performed for our
December 2006 report on U.S. insular areas, which included audited
financial statements through fiscal year 2004. For this testimony we also
had available CNMI's fiscal year 2005 audited financial statements, which
we have included in our review, along with some recent developments in
fiscal year 2006. We provided a draft of this statement to Department of
the Interior (DOI) officials who agreed with our conclusions and provided
technical comments, which we have incorporated throughout the statement as
appropriate. We conducted our work in accordance with generally accepted
government auditing standards.

Summary

The government of CNMI faces serious economic, fiscal, and financial
accountability challenges. The government's ability to strengthen CNMI's
economy has been constrained by CNMI's lack of diversification in
industries. CNMI's economy is highly dependent on two industries: garment
manufacturing and tourism. The garment manufacturing industry is facing
the challenges of remaining internationally competitive against low-wage
nations given recent changes in trade agreements. CNMI's tourism sector
experienced a sharp decline in the late 1990s, and a series of external
events, such as the economic trends of nearby countries and changes in
airline practices, have further hampered the sector. Both the garment and
tourism industries employ non-citizen workers who are paid wages lower
than the U.S. minimum wage.

^1GAO, U.S. Insular Areas: Economic, Fiscal, and Financial Accountability
Challenges, [14]GAO-07-119 (Washington, D.C.: Dec. 12, 2006). CNMI is one
of the subjects of this report.

The fiscal condition of CNMI's government has steadily weakened from
fiscal year 2001 through fiscal year 2005, the most recent year for which
audited financial statements for CNMI were available. CNMI's fund balance,
which generally reflects the amount of resources available for current
government operations, went into a deficit balance during fiscal year 2002
and continued to decline to a deficit balance of $84.1 million by the end
of fiscal year 2005. CNMI has also shown significant declines and negative
balances in its reported net assets, which is another measure of fiscal
health, and which represents the balance of total assets less liabilities.
In order to finance its government activities in an environment where
expenditures have exceeded revenues, CNMI has increased its debt, causing
its debt to asset ratio to increase significantly since fiscal year 2002.
In addition, several indicators point to a severe fiscal crisis during
fiscal year 2006. The CNMI government has implemented several drastic
cost-cutting and restructuring measures, including "austerity holidays"
consisting of biweekly furloughs, during which government workers are not
paid and many government operations are closed to reduce personnel and
operating costs during fiscal years 2006 and 2007. In addition, other
measures were passed, including restructuring of payments to the
retirement plan and reforming the rate of compensation for boards and
commissions.

The government of CNMI has long-standing financial accountability
problems, including the inability to achieve unqualified ("clean") audit
opinions on its financial statements, and numerous, long-standing material
weaknesses in internal control over financial reporting and compliance
with laws and regulations governing federal grant awards. CNMI received
$65.6 million in federal grants in fiscal year 2005, and its audited
financial statements are used by federal agencies for overseeing and
monitoring the use of federal grants. Progress has been made by CNMI
concerning the timely submission of its audit reports. Specifically, for
fiscal year 2004, CNMI's audited financial statements were 22 months late
compared with 1 month late for its fiscal year 2005 submission. However,
given CNMI's continued inability to achieve clean opinions on its
financial statements and the continuing material internal control
weaknesses over financial reporting, there is limited accountability over
federal grants to this insular area. Furthermore, the lack of timely and
reliable financial information hampers CNMI's ability to monitor programs
and the reliability of financial information, such as revenues and
expenditures, in order to make informed decisions.

The DOI's Office of Insular Affairs^2 (OIA) has ongoing efforts to support
economic development in CNMI and assist CNMI in addressing its
accountability issues. To help diversify and strengthen the insular area
economies (including CNMI), OIA has programs aimed at attracting American
businesses to the insular areas. However, the effectiveness of these
conferences and business opportunity missions is uncertain due to the lack
of formal evaluation of these efforts. In addition, DOI's OIA and
Inspector General (IG), along with other federal IGs, oversee CNMI's
efforts to improve its financial accountability. OIA monitors the progress
of completion and issuance of audit reports and provides general technical
assistance funds to train insular area employees and enhance financial
management systems and processes. Yet, progress has been slow and
inconsistent. A focused effort is called for where direct and targeted
attention is concentrated on the challenges facing CNMI to help CNMI
achieve economic and fiscal stability. OIA plays a key role in this effort
by helping CNMI and the other insular areas improve their business
climates, identify areas of potential for private sector investment, and
market insular areas to potential investors.

Strong leadership is needed to address CNMI's current challenges. During
2006, the CNMI government took dramatic steps to reverse prior patterns of
deficit spending. The CNMI government will need to continue to work toward
long-term sustainable solutions. In response to our recent report, OIA
expressed its commitments to continuing its comprehensive approach and to
implementing other innovative ideas to assist CNMI and the other insular
areas to continue to improve financial management and accountability and
to support economic development. We are encouraged by OIA's commitment to
taking a leadership position in assisting CNMI and monitoring CNMI's
progress in facing its current economic, fiscal, and accountability
challenges.

^2OIA's mission is to promote sound financial management processes, boost
economic development, and increase the federal government's responsiveness
to the unique needs of the insular areas.

Narrow Economic Base and Intrinsic and External Factors Limit Economic Progress
in CNMI

Several factors constrain CNMI's economic potential, including the lack of
diversification, scarce natural resources, small domestic markets, limited
infrastructure, and shortages of skilled labor. The United States
exercises sovereignty over CNMI, and, in general, federal laws apply to
CNMI.^3 However, federal minimum wage provisions and federal immigration
laws do not apply.^4 CNMI immigration policies and the demands for labor
by the garment manufacturing industry and tourism sector have resulted in
rapid population growth since 1980 such that the majority of the
population are non-U.S. citizens. (See fig. 1.) According to U.S. Census
Bureau data for 2000, the most recent census data available, about 56
percent of the CNMI population of 69,221 were not U.S. citizens.

Figure 1: Reported CNMI Population by Citizenship

^3CNMI is an unincorporated territory to which Congress has determined
that only selected parts of the U.S. Constitution apply. Residents born in
CNMI are U.S. citizens and although they have many of the rights of
citizens of the 50 states, CNMI residents cannot vote in national
elections and do not have voting representation in Congress.

^4The U.S. House of Representatives and the Senate recently passed H.R. 2,
"Fair Minimum Wage Act of 2007," which, if enacted, would make the federal
minimum wage provisions applicable to CNMI with a phased-in
implementation.

aU.S. citizenship was not conferred to residents of CNMI until 1986.
However, the CNMI Central Statistics Division has classified persons born
in CNMI together with persons born in the United States or other
territories as "U.S. citizens" for 1980.

bThe 2000 decennial population census is the most recent population census
information available.

According to U.S. Census Bureau data for 2000, the median household income
in CNMI was $22,898, a little more than half of the U.S. median household
income of almost $42,000 for 2000. The percentage of individuals in
poverty in 2000 was 46 percent, nearly four times the continental U.S.
rate of 12 percent in that same year.

CNMI's economy depends on two industries, garment manufacturing and
tourism, for its employment, production, and exports. These two industries
rely heavily on a noncitizen workforce. This workforce^5 represents more
than three quarters of the labor pool that are subject to the CNMI minimum
wage, which is lower than the U.S. minimum wage. The garment industry, for
example, uses textiles and labor imported mostly from China. A 1999 study
found that garment manufacturing and tourism accounted for about 85
percent of CNMI's total economic activity and 96 percent of its exports.^6
A 2005 estimate of CNMI's gross domestic product (GDP) suggest that, in
2002, the garment industry contributed to roughly 40 percent of CNMI's GDP
and 47 percent of payroll.^7 However, recent changes in trade laws have
increased foreign competition for CNMI's garment industry, while other
external events have negatively impacted its tourism sector.

Decline in Garment Industry Tied to Trade Law Changes

Recent developments in international trade laws have reduced CNMI's trade
advantages, and the garment industry has declined in recent years.
Historically, while garment exporters from other countries faced quotas
and duties in shipping to the U.S. market, CNMI's garment industry
benefited from quota-free and duty-free access to U.S. markets for
shipments of goods in which 50 percent of the value was added in CNMI.^8
In recent years, however, U.S. agreements with other textile-producing
countries have liberalized the textile and apparel trade. For example, in
January 2005, in accordance with one of the 1994 World Trade Organization
(WTO) Uruguay Round agreements, the United States eliminated quotas on
textile and apparel imports from other textile-producing countries,
leaving CNMI's apparel industry to operate under stiffer competition,
especially from low-wage countries such as China.^9 According to a DOI
official, more than 3,800 garment jobs were lost between April 2004 and
the end of July 2006, with 10 out of 27 garment factories closing.^10 U.S.
Department of Commerce data show that the value of CNMI shipments of
garments to the United States dropped by more than 16 percent between 2004
and 2005, from about $807 million to $677 million, and down from a peak of
$1 billion in 1998--2000. In 2006, reported garment exports to the United
States fell further, by an estimated 25 percent compared to 2005, with
exports declining to an estimated $497 million. The reported level of
shipments to the United States in 2006 was comparable to levels of sales
in 1995--1996, prior to the significant build-up of the industry. (See
fig. 2.) In December 2006, the largest and oldest garment factory closed.
Given that the garment industry is significant to CNMI's economy, these
developments will likely have a negative financial effect on government
revenue. For example, reported fees collected by the government on garment
exports fell 37 percent from $38.6 million in 2000 to $24.4 million in
2005.

^5The 2000 U.S. Census shows that noncitizens, predominantly Chinese and
Filipinos, make up over half of CNMI's population. Almost all of these
temporary foreign workers came to CNMI after 1990.

^6Business Development Center, Northern Marianas College, An Economic
Study for the Commonwealth of the Northern Mariana Islands, U.S.
Department of the Interior, October 1999.

^7See M. Rubin and S. Sawaya, Final Trip Report on Benchmark Estimates of
2002 Gross Domestic Product in the Commonwealth of the Northern Mariana
Islands (Washington, D.C.: U.S. Census Bureau, 2005). Many businesses,
including the garment factories, are owned and operated by foreigners.

^8According to the U.S. Harmonized Tariff Schedule, certain items of which
at least 50 percent of the value was added in a U.S. possession are
eligible for duty-free shipment to the United States.

^9GAO, U.S.-China Trade: Textile Safeguard Procedures Should Be Improved,
[15]GAO-05-296 (Washington, D.C.: Apr. 4, 2005.)

^10The burden of this job loss on the government may be mitigated to some
extent by the fact that garment industry workers are almost exclusively
foreigners on temporary guest visas. Also, data we obtained from the U.S.
Census Bureau indicate that foreign workers send much of their earnings
back to their countries of origin in the form of remittances; the
remainder, which is spent on local goods and services, is relatively
small, and as a result, has limited effect on local economic activity.
Remittances were estimated at about $80 million for 2002, roughly 10
percent of GDP, and at over $100 million in 2005.

Figure 2: Reported U.S. Apparel Imports from CNMI

aImport value for 2006 reflects 11 months of Commerce data and a GAO
estimate for December imports based on changes in monthly shipments in
2005.

External Events Affect Tourism

CNMI's tourism sector experienced a sharp decline in the late 1990s, and a
series of external events have further hampered the sector. Tourism became
a significant sector of economic activity in CNMI by the mid-1980s and
continued to grow into the 1990s. Due to its proximity to Asia, Asian
economic trends and other events have a direct effect on CNMI's economy.
For example, tourism in CNMI experienced a sharp decline in the late 1990s
with the Asian financial crisis and due to the cancellation of Korean Air
service to CNMI following an airplane crash on Guam in August 1997. (See
fig. 3.) Visitors from Korea, the second largest source of tourists,
decreased by 85 percent from 1996 to 1998. After a modest recovery in
2000, tourism faltered again with the September 11, 2001, terrorist
attacks on the United States. In 2003, according to CNMI officials,
tourism slowed--with a double-digit decline in arrivals for several
months--in reaction to the SARS epidemic and to the war in Iraq.

Tourism in CNMI is also subject to changes in airline practices. For
example, Japan Airlines (JAL) withdrew its direct flights between Tokyo
and Saipan in October 2005, raising concerns because roughly 30 percent of
all tourists and 40 percent of Japanese tourists arrive in CNMI on JAL
flights, according to CNMI and DOI officials. The Marianas Visitors
Authority's June 2006 data show that the downward trend in Japanese
arrivals is not being offset by the growth in arrivals from other markets
such as China and South Korea, with the total number of foreign visitors
dropping from 43,115 in June 2005 to 38,510 a year later.^11 At the same
time, CNMI has experienced increased Chinese tourists in recent years,
which offer the potential to reenergize the industry.

^11China Southern Airlines' August 2006 decision to suspend its flights
from Guangzhou City in China to Saipan in September because of low load
factor, high fuel costs, and low yield in fares is likely to slow the
growth of Chinese visitors and hinder CNMI's efforts to attract more
tourists from China.

Figure 3: Reported CNMI Visitor Arrivals by Nation

aUSA includes visitors from Guam.

bEffective October 2006, arrivals from Hong Kong are included with China.

CNMI's Reported Fiscal Condition Continues to Weaken

The fiscal condition of CNMI's government has steadily weakened from
fiscal year 2001 through fiscal year 2005, the most recent year for which
audited financial statements for CNMI were available. In addition, several
indicators point to a severe financial crisis in fiscal year 2006. As
shown in figure 4, CNMI's reported governmental fund balance declined from
a positive $3.5 million at the beginning of fiscal year 2001 to a deficit
of $84.1 million by the end of fiscal year 2005, as CNMI's expenditures
for its governmental activities consistently exceeded revenues in each
year since fiscal year 2002. Most of CNMI's governmental activities, which
include basic services such as public safety, health care, general
administration, streets and parks, and security and safety, are reported
in its governmental activities, or government funds. The fund balance (or
deficit) for these activities reflects the amount of funds available at
the end of the year for spending. A significant contributing factor to the
gap between expenditures and revenues is that actual expenditures have
exceeded budgeted expenditures each fiscal year during the period 2001
through 2005.^12

Figure 4: Reported Revenues, Expenditures, and Fund Balance for CNMI's
Government Activities

Another measure of fiscal health is the measure of net assets for
governmental activities, which represents total assets minus total
liabilities. As shown in table 1, CNMI has experienced a negative trend in
its balance of net assets for governmental activities, going from a
reported positive $40.6 million balance at the end of fiscal year 2001 to
a negative $38 million balance at the end of fiscal year 2005.^13 The
primary difference between the fund balance measure and net assets is that
the net assets include capital assets and long-term liabilities, whereas
the fund balance figure focuses on assets available for current period
expenditures and liabilities that are due and payable in the current
period.

^12 The over-expenditure of budget amounts has been recorded as a finding
in CNMI's single audits since fiscal year 2000.

Table 1: CNMI's Fiscal Condition

                                    Fiscal Years Ending September 30,
                            2001         2002         2003           2004         2005 
Data                                                                                   
Population                71,868       74,003       76,129         78,252       80,362 
Own source revenues  227,709,651  215,650,986  225,412,808    235,754,891  244,183,778 
Federal               49,348,134   71,964,627   57,560,034     63,006,595   64,346,950 
contributions                                                                          
Total Revenues      $277,057,785 $287,615,613 $282,972,842   $298,761,486  308,530,728 
Total Expenditures   258,177,431  314,985,333  303,986,379    352,488,419  343,370,293 
Revenues less         18,880,354 (27,369,720) (21,013,537)   (53,726,933) (34,839,565) 
Expenditures                                                                           
[Surplus/(Deficit)]                                                                    
Total net other        6,511,003    3,510,667            0     39,493,350        7,625 
financing^a                                                                            
Governmental funds     3,540,878   19,609,305  (4,249,748) (35,011,807)^b (49,245,390) 
beginning year                             ^b                                          
balance^c                                                                              
Governmental funds    17,219,852  (4,249,748) (25,263,285)   (49,245,390) (84,077,330) 
end of year balance                                                                    
Net Assets, end of    40,575,181 30,760,955^e   15,596,170   (18,656,437) (38,131,589) 
year^d                                                                                 
Change in net                 --  (9,814,226) (15,164,785)   (34,252,607) (19,475,152) 
assets                                                                                 
Calculations                                                                           
Federal                     17.8         25.0         20.3           21.1         20.9 
contributions as a                                                                     
percent of revenues                                                                    
Government revenue        $3,855       $3,887       $3,717         $3,818       $3,839 
per capita                                                                             
Government                 3,592        4,256        3,993          4,505        4,273 
expenditures per                                                                       
capita                                                                                 
Government revenue            --          .30           --             --           -- 
as percent of GDP^f                                                                    
Government                    --          .33           --             --           -- 
expenditures as                                                                        
percent of GDP^f                                                                       

Source: GAO analysis of single audit reports covering fiscal years 2001,
2002, 2003, 2004, and 2005. The estimate of GDP, in the amount of
$946,854,877, came from Final Trip Report on Benchmark Estimates of 2002
Gross Domestic Product in the Commonwealth of the Northern Mariana
Islands, U.S. Census Bureau, Feb. 11, 2005.

^13The net asset amount at September 30, 2005, when compared to the fund
balance amount as of the same date, includes an additional positive
balance of $46 million resulting from capital and deferred assets of
approximately $180.8 million less long-term liabilities of $134.8 million.

Notes: Financial data in table 1 reflects CNMI's financial statements for
its governmental activities, which include most of CNMI's basic services.
This financial data does not include CNMI's component units, which are
legally separate but related to CNMI. This financial data also does not
include CNMI's fiduciary funds, because those funds cannot be used to
finance CNMI operations.

CNMI's audited financial statements received qualified opinions from its
external auditors and therefore, these amounts are subject to the
limitations cited by the auditors in their opinions and to the material
internal control weaknesses identified.

aOther financing includes transfers in and out of other funds.

bThe end-of-year fund balance for the prior fiscal year may not agree with
the beginning of year fund balance for the succeeding fiscal year due to
amounts being restated in subsequent financial statements. We could not
readily identify explanations for these restatements because comparative
information was not always available or disclosures were not made in
subsequent financial statements.

cGovernmental funds finance most of the basic services provided by the
government.

dNet assets are capital assets and other assets, such as cash and
receivables, less liabilities.

eThe amount reported is the restated amount from the 2003 Single Audit
Report, corrected because of excluded and misstated amounts.

fGDP estimates are not available for 2001, 2003, 2004, and 2005.

In order to finance its government activities in an environment where
expenditures have exceeded revenues, CNMI has increased its debt and has
not made the required contributions to its retirement fund. CNMI's
reported balance of notes and bonds payable has increased from $83 million
in fiscal year 2002 to $113 million in fiscal year 2005, representing an
increase of 36 percent. CNMI's balance owed to its pension fund has
increased from $72 million in 2002 to $120 million in 2005, representing
an increase of 67 percent. CNMI has also been incurring penalties on the
unpaid liabilities to the pension fund. The total amount of assessed
penalties was $24 million as of September 30, 2005.

As shown in figure 5, CNMI's reported debt to assets ratio^14 has
increased significantly, from 89.8 percent in fiscal year 2002 to 113.5
percent in 2005. In other words, at the end of fiscal year 2005, CNMI owed
$1.14 for every $1.00 in assets that it held.

^14The debt to asset ratio measures the extent to which CNMI had funded
its assets with debt. The lower the debt percentage, the more equity CNMI
has in its assets.

Figure 5: CNMI Debt to Assets

Although CNMI's audited fiscal year 2006 financial statements are not yet
available, indicators point to a severe fiscal crisis during fiscal year
2006. In a May 5, 2006 letter to the CNMI Legislative leaders, Governor
Benigno R. Fitial stated that "the Commonwealth is facing an unsustainable
economic emergency. . . . I regret to say that the nature and extent of
these financial problems are such that there is no simple or painless
solution." CNMI has implemented several significant cost-cutting and
restructuring measures during fiscal year 2006. For instance, in August
2006, CNMI enacted its Public Law No. 15-24 to implement "austerity
holidays" consisting of bi-weekly furloughs, during which government
employees are not paid and many government operations are closed. This
measure was taken to help alleviate the financial crisis by saving
millions of dollars in both personnel and operational costs. The measure
declared unpaid holidays once per pay period for the remainder of fiscal
years 2006 and 2007, reducing the government's normal pay period to 72
hours every 2 weeks. In June of 2006, CNMI enacted Public Law No. 15-15 to
authorize the CNMI government to suspend the government's employer
contributions to the retirement fund for the remainder of fiscal years
2006 and 2007. In addition, CNMI has passed laws to restructure loans
among its component units, reform the rate of compensation for members of
boards and commissions, increase the governor's authority to reprogram
funds, extend the date for full funding of the retirement fund's defined
benefit plan,^15 and create a defined contribution retirement plan for
government employees hired on or after January 1, 2007. These measures are
immediate and dramatic, and are indicative of severe financial problems
that will likely call for long-term solutions.

CNMI's Financial Accountability Remains Weak

CNMI has had long-standing financial accountability problems, including
the late issuance of its single audit reports, the inability to achieve
unqualified ("clean") audit opinions on its financial statements, and
numerous material weaknesses in internal controls over financial
operations and compliance with laws and regulations governing federal
grant awards.

CNMI's Compliance with Single Audit Requirements

CNMI received a reported $65.6 million in federal grants in fiscal year
2005 from a number of federal agencies. The five largest federal grantors
in 2005 for CNMI included the Departments of Agriculture, Health and Human
Services, Interior, Homeland Security, and Labor. As a nonfederal entity
expending more than $500,000 a year in federal awards, CNMI is required to
submit a single audit report each year to comply with the Single Audit
Act, as amended.^16 Single audits are audits of the recipient
organization--the government in the case of CNMI--that focus on the
recipient's financial statements, internal controls,^17 and compliance
with laws and regulations governing federal grants.^18 One of the
objectives of the act is to promote sound financial management, including
effective internal controls, with respect to federal expenditures of the
recipient organization. Single audits also provide key information about
the federal grantee's financial management and reporting and are an
important control used by federal agencies for overseeing and monitoring
the use of federal grants.

^15Based on the actuarial report, dated October 1, 2004, the unfunded
pension liability was estimated at $552,042,142.

^1631 U.S.C. Chp. 75.

^17Internal control is an integral component of an organization's
management that provides reasonable assurance that the following
objectives are being achieved--effectiveness and efficiency of operations,
reliability of financial reporting, and compliance with applicable laws
and regulations. Internal control also serves as the first line of defense
in safeguarding assets and preventing and detecting errors and fraud.

^18Office of Management and Budget (OMB) Circular No. A-133, Audits of
States, Local Governments, and Non-Profit Organizations, establishes
policies for federal agencies to use in implementing the Single Audit Act
and provides an administrative foundation for consistent and uniform audit
requirements for nonfederal entities administering federal awards.

For fiscal years 1997 through 2005, CNMI did not submit its single audit
reports by the due date, which is generally no later than 9 months after
the fiscal year end.^19 CNMI's late submission of single audit reports
means that the federal agencies overseeing federal grants to CNMI did not
have current audited information about CNMI's use of federal grant funds.
As shown in table 2, CNMI's single audit submissions were significantly
late for fiscal years 1997 through 2004. However, CNMI has made
significant progress in 2005 by submitting its fiscal year 2005 single
audit report less than 1 month late.

Table 2: Reported Single Audit Act Report Submissions for Fiscal Years
1997 through 2005

                   Date single audit   Date single audit report     Number of 
Fiscal year end        report due                   received months late^a 
09/30/1997             10/31/1998                 12/28/1999            14 
09/30/1998             10/31/1999                 12/28/1999             2 
09/30/1999             06/30/2000                 10/19/2000             4 
09/30/2000             06/30/2001                 10/17/2002            16 
09/30/2001             06/30/2002                 06/06/2003            11 
09/30/2002             06/30/2003                 08/09/2004            13 
09/30/2003             06/30/2004                 07/06/2005            12 
09/30/2004           06/30/2005^b                 04/17/2006            22 
09/30/2005             06/30/2006                 07/19/2006             1 

Source: Auditors' reports, Federal Audit Clearinghouse, and GAO analysis.

aCalculated based on the submission form date without regard to extensions
granted to CNMI. The form date is the date the Federal Audit Clearinghouse
receives the required single audit form certifying that the audit has been
performed and summarizing its findings.

bCNMI received an extension until February 28, 2006 for submission of the
fiscal year 2004 single audit report.

^19Under the Single Audit Act, the single audit reporting package is
generally required to be submitted to the Federal Audit Clearinghouse
either 30 days after the receipt of the auditor's report or 9 months after
the end of the period under audit.

CNMI Unable to Achieve "Clean" Audit Opinions Due to Persistent, Significant
Weaknesses

Auditors are required by OMB Circular No. A-133 to provide opinions (or
disclaimers of opinion, as appropriate) as to whether the (1) financial
statements are presented fairly in all material respects in conformity
with generally accepted accounting principles (GAAP) and (2) auditee
complied with laws, regulations, and the provisions of contracts or grant
agreements that could have a direct and material effect on each major
federal program.

The CNMI government has been unable to achieve unqualified ("clean")^20
audit opinions on its financial statements, receiving qualified opinions
on the financial statements issued for fiscal years 1997 through 2005.
Auditors render a qualified opinion when they identify one or more
specific matters that affect the fair presentation of the financial
statements. The effect of the auditors' qualified opinion can be
significant enough to reduce the usefulness and reliability of CNMI's
financial statements.

CNMI has made some progress in addressing the matters that resulted in the
qualified opinions on its financial statements for fiscal years 2001
through 2003. However, some of the issues continued to exist in 2004 and
2005. The auditors identified the following issues in fiscal year 2005
that resulted in the most recent qualified audit opinion: (1) inadequacies
in the accounting records regarding taxes receivable, advances, accounts
payable, tax rebates payable, other liabilities and accruals, and the
reserve for continuing appropriations, (2) inadequacies in accounting
records and internal controls regarding the capital assets of the Northern
Marianas College, and (3) the lack of audited financial statements for the
Commonwealth Utilities Corporation, which represents a significant
component unit of CNMI.

Auditors for CNMI also rendered qualified opinions on CNMI's compliance
with the requirements for major federal award programs from 1997 through
2005. In fiscal year 2005, the auditors cited noncompliance in the areas
of allowable costs, cash management, eligibility, property management,
procurement, and other requirements.

^20Auditors express an unqualified ("clean") opinion on financial
statements when they have determined, based on sufficient review work,
that the financial statements are presented fairly in all material
respects, in accordance with generally accepted accounting principles.

Weaknesses over Financial Reporting and Compliance with Requirements for Major
Federal Programs

CNMI has long-standing and significant internal control weaknesses over
financial reporting and compliance with requirements for federal grants.
Table 3 shows the number of material weaknesses and reportable conditions
for CNMI for fiscal years 2001 through 2005. The large number and the
significance of reported internal control weaknesses raise serious
questions about the integrity and reliability of CNMI's financial
statements and its compliance with requirements of major federal programs.
Furthermore, the lack of reliable financial information hampers CNMI's
ability to monitor programs and financial information such as revenues and
expenses and to make timely, informed decisions.

Table 3: Reported Weaknesses Identified in the Auditors' Reports for
Fiscal Years 2001 through 2005

                                              Compliance with requirements
          Internal control over financial   applicable to each major program
            reporting in accordance with       and internal control over
           government auditing standards    compliance with OMB Circular No.
          (report on financial statements)  A-133 (report on federal awards)
Fiscal     Material   Reportable            Material     Reportable        
year     weaknesses   conditions  Total   weaknesses     conditions  Total 
2001             10            0     10            4             13     17 
2002              9            1     10            2             14     16 
2003             10            2     12            1             15     16 
2004              8            5     13            2             31     33 
2005              9            4     13            2             36     38 

Source: CNMI single audit reports for fiscal years 2001 through 2005.

CNMI's 13 internal control reportable conditions^21 for fiscal year 2005,
9 of which were material weaknesses,^22 indicate a lack of sound internal
control over financial reporting needed to provide adequate assurance that
transactions are properly recorded, assets are properly safeguarded, and
controls are adequate to prevent or detect fraud, waste, abuse, and
mismanagement. For example, one of the material internal control
weaknesses that the auditors reported for CNMI's government for fiscal
year 2005 was the lack of audited fiscal year 2005 financial statements of
the Commonwealth Utilities Corporation (Corporation), a significant
component unit of CNMI.^23 Because the Corporation's financial statements
were unaudited, the auditors could not determine the propriety of account
balances presented in the financial statements that would affect CNMI's
basic financial statements. CNMI's auditors also reported other
significant material internal control weaknesses that have continued from
previous years, such as improper tracking and lack of support for advances
to vendors, travel advances to employees, liabilities recorded in the
General Fund, and tax rebates payable. Due to the lack of detailed
subsidiary ledgers and other supporting evidence, the auditors could not
determine the propriety of these account balances. According to the
auditors, the effect of these weaknesses is a possible misstatement of
expenditures and related advances and liabilities, which also resulted in
a qualification of the opinion on the fiscal year 2005 CNMI financial
statements. Consequently, CNMI's financial statements may not be reliable.

^21Reportable conditions over financial reporting are matters that come to
an auditor's attention related to significant deficiencies in the design
or operation of internal controls that could adversely affect the entity's
ability to produce financial statements that fairly represent the entity's
financial condition.

^22Material weaknesses in financial reporting are reportable conditions in
which the design or operation of internal controls does not reduce to a
relatively low level the risk that misstatements caused by error or
fraud--material in relation to the financial statements being audited--may
occur and not be detected in a timely period by employees in the normal
course of performing their duties.

As shown in table 3, auditors also reported 38 reportable conditions^24 in
CNMI's compliance with requirements for major federal programs and the
internal controls intended to ensure compliance with these requirements.
Two of these reportable conditions were considered material weaknesses.^25

One of the two material internal control weaknesses affecting compliance
with federal programs reported for CNMI's government for fiscal year 2005
included the failure to record expenditures for the Medical Assistance
Program when they were incurred. Specifically, the auditors identified
expenditures in fiscal year 2005 for billings from service providers for
services rendered in previous years. The effect of this weakness is that
expenditures reported to the grantor agency, the U.S. Department of Health
and Human Services, are based on the paid date and not, as required, the
service date. In addition, actual expenditures incurred during the year
are not properly recorded and, therefore, current year expenditures and
unrecorded liabilities are understated. The other material weakness
affecting compliance related to the lack of adherence to established
policies and procedures for managing and tracking property and equipment
purchased with federal grant funds. As a result, CNMI's government was not
in compliance with federal property standards and its own property
management policies and procedures. The other 36 reportable conditions
concerned compliance with requirements regarding allowable costs; cash
management; eligibility; equipment and property management; matching,
level of effort, and earmarking; procurement and suspensions and
debarment; reporting; subrecipient monitoring; and special tests and
provisions that are applicable to CNMI's major federal programs.

^23A component unit is an organization that is not part of the primary
government activities but for which the nature and significance of their
relationship with a primary government are such that excluding the
organization would cause the reporting entity's statements to be
misleading or incomplete.

^24In the context of compliance, reportable conditions are matters that
come to an auditor's attention related to significant deficiencies in the
design or operation of internal controls over compliance that could
adversely affect the entity's ability to operate a major federal program
within the applicable requirements of laws, regulations, contracts, and
grants.

^25Material weaknesses in this context are reportable conditions in which
internal controls do not reduce to a relatively low level the risk of
noncompliance with applicable requirements of laws, regulations,
contracts, and grants that would be material to the major federal program
being audited and undetected in a timely way by employees in the normal
course of performing their duties.

In CNMI's corrective action plan for fiscal year 2005, CNMI officials
agreed with almost all of the auditors' findings. According to its fiscal
year 2005 corrective action plan, CNMI is working to get a current audit
of its component unit, the Commonwealth Utilities Corporation. Other
planned actions include properly reconciling advances to vendors;
reviewing travel advance balances and making adjustments as needed,
including making payroll deductions if expense vouchers are not filed
timely; implementing procurement receiving procedures for prepaid items;
making necessary corrections to its automated tax system to enable
auditors to better review tax returns; determining the correct balances
for construction projects; implementing controls over verifying
eligibility for Medicaid and restricting access to the related data; and
ensuring proper completion of inventories. The plan provides that most of
the findings will be addressed by the end of fiscal year 2007. It is
important to note however, that many of the auditors' findings,
particularly those categorized as material weaknesses, are longstanding
findings going back in some cases to 1987.

Efforts to Assist CNMI in Its Economic and Accountability Challenges

OIA has ongoing efforts to support economic development in CNMI and assist
CNMI in addressing its accountability issues. OIA has in the last 3 years
sponsored conferences in the United States and business-opportunity
missions in the insular areas to attract American businesses to the
insular areas. The main goal of these efforts is to facilitate interaction
and the exchange of information between U.S. firms and government and
business officials from the insular areas to spur new investment in a
variety of industries. Innovative projects such as setting up a production
and mass mailing facility in CNMI aimed at the Japanese market are
reported to be underway.

OIA's efforts in helping to create links between the business communities
in the United States and CNMI are key to helping meet some of the economic
challenges. In our recent report,^26 we concluded that the insular areas
would benefit from formal periodic OIA evaluation of its conferences and
business-opportunity missions, including assessments of the cost and
benefit of its activities and the extent to which these efforts are
creating partnerships with businesses in other nations. In our December
2006 report, we recommended that OIA conduct such formal periodic
evaluations to assess the effect of these activities on creating private
sector jobs and increasing insular area income. OIA agreed with our
recommendation.

DOI's OIA and IG, other federal inspectors general, and local auditing
authorities assist or oversee CNMI's efforts to improve its financial
accountability.^27 OIA monitors the progress of completion and issuance of
the single audit reports as well as providing general technical assistance
funds to provide training for insular area employees and funds to enhance
financial management systems and processes. DOI's IG has audit oversight
responsibilities for federal funds in the insular area.

To promote sound financial management processes in the insular area
government, OIA has increased its focus on bringing the CNMI government
into compliance with the Single Audit Act. For example, OIA created an
incentive for CNMI to comply with the act by stating that an insular area
cannot receive capital funding unless its government is in compliance with
the act or has presented a plan, approved by OIA, that is designed to
bring the government into compliance by a certain date. In addition, OIA
provides general technical assistance funds for training and other direct
assistance, such as grants, to help the insular area governments comply
with the act and to improve their financial management systems and
environments. The Graduate School of the U.S. Department of Agriculture
(USDA) has been working with OIA for over a decade through its Pacific
Islands and Virgin Islands Training Initiatives (PITI and VITI) to provide
training and technical assistance.

^26 [16]GAO-07-119 .

^27Although the insular areas receive grants from many federal agencies,
one of the grant-making agencies is designated as the cognizant agency for
purposes of the Single Audit Act. The cognizant agencies have specific
responsibilities under OMB Circular No. A-133. The cognizant agency is
usually the agency that provides the predominant amount of funding. The
cognizant agency for CNMI is DOI.

OIA staff members make site visits to CNMI as part of its oversight
activities. In our December 2006 report, we recommended that OIA develop a
standardized framework for its site visits to improve the effectiveness of
its monitoring. We also recommended that OIA develop and implement
procedures for formal evaluation of progress made by the insular areas to
resolve accountability findings and set a time frame for achieving clean
audit opinions. OIA agreed with our recommendations and noted that it had
already made some progress during fiscal year 2006. Establishing a routine
procedure of documenting the results of site visits in a standard
framework would help ensure that (1) all staff members making site visits
are consistent in their focus on overall accountability objectives and (2)
OIA staff has a mechanism for recording and following up on the unique
situations facing CNMI.

Conclusions

CNMI faces daunting economic, fiscal, and financial accountability
challenges. CNMI's economic and fiscal conditions are affected by its
economy's general dependence on two key industries. In addition, although
progress has been made in improving financial accountability, CNMI
continues to have serious internal control and accountability problems
that increase its risk of fraud, waste, abuse, and mismanagement.

Efforts to meet formidable fiscal challenges in CNMI are exacerbated by
delayed and incomplete financial reporting that does not provide officials
with the timely and complete information they need for effective decision
making. Timely and reliable financial information is especially important
as CNMI continues to take actions to deal with its fiscal crisis.

OIA has ongoing efforts to assist CNMI in addressing its accountability
issues and to support economic development in CNMI. OIA officials monitor
CNMI's progress in submitting single audit reports, and OIA provides
funding to improve financial management. Yet, progress has been slow and
inconsistent. The benefit to CNMI of past and current assistance is
unclear. Federal agencies and CNMI have sponsored and participated in
conferences, training sessions, and other programs to improve
accountability, but knowing what has and has not been effective and
drawing the right lessons from this experience is hampered by a lack of
formal evaluation and data collection.

Strong leadership is needed for CNMI to weather its current crisis and
establish a sustainable and prosperous path for the future. During 2006,
the CNMI government took dramatic steps to reverse prior patterns of
deficit spending. The CNMI government will need to continue to work toward
long-term sustainable solutions. A focused effort is called for in which
direct and targeted attention is concentrated on the challenges facing
CNMI, with feedback mechanisms for continuing improvement to help CNMI
achieve economic, fiscal, and financial stability. OIA plays a key role in
this effort. In its comments on our December 2006 report, OIA pointed out
that it provides "a crucial leadership role and can provide important
technical assistance" to help CNMI and the other insular areas improve
their business climates, identify areas of potential for private sector
investment, and market insular areas to potential investors. It also noted
that improving accountability for federal financial assistance for CNMI
and other insular areas is a major priority. OIA has stated its commitment
to continuing its comprehensive approach and to implementing other
innovative ideas to assist CNMI and the other insular areas in continuing
to improve financial management and accountability. Leadership on the part
of the CNMI government and OIA is critical to addressing the challenges
CNMI faces and to providing long-term stability and prosperity for this
insular area.

Mr. Chairman and Members of the Committee, this concludes my statement. I
would be pleased to answer any questions that you and other Members of the
Committee may have at this time.

GAO Contacts

For further information about this testimony, please contact Jeanette
Franzel, Director, Financial Management and Assurance at (202) 512-9471 or
[email protected] , or David Gootnick, Director, International Affairs
and Trade at (202) 512-4128 or [email protected] . Contact points for
our Offices of Congressional Relations and Public Affairs may be found on
the last page of this testimony. The following individuals made important
contributions to this report: Norma Samuel, Cheryl Clark, Anh Dang, Meg
Mills, Maxine Hattery, and Emil Friberg, Jr.

(194656)

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Highlights of [26]GAO-07-436T , a testimony to Committee on Energy and
Natural Resources, U.S. Senate

February 8, 2007

COMMONWEALTH OF THE NORTHERN MARIANA ISLANDS

Serious Economic, Fiscal, and Accountability Challenges

The U.S. insular area of the Commonwealth of the Northern Mariana Islands
(CNMI) is a self-governing commonwealth of the United States that
comprises 14 islands in the North Pacific.

In a December 2006 report--U.S. Insular Areas: Economic, Fiscal, and
Financial Accountability Challenges ( [27]GAO-07-119 )--regarding four
insular areas including CNMI, GAO identified and reported the following:
(1) economic challenges, including the effect of changing tax and trade
laws on their economies; (2) fiscal condition; and (3) financial
accountability, including compliance with the Single Audit Act.

The Chairman of the Senate Committee on Energy and Natural Resources,
which requested the December 2006 report, asked GAO to present and discuss
the results as they pertain to CNMI. Our summary and conclusions are based
on our work performed for our December 2006 report on U.S. insular areas.
For this testimony we also had available CNMI's fiscal year 2005 audited
financial statements, which we have included in our review, along with
some recent developments in fiscal year 2006.

The Commonwealth of the Northern Mariana Islands (CNMI) faces serious
economic, fiscal, and financial accountability challenges. CNMI's economy
depends heavily on two industries, garment manufacturing and tourism.
However, recent changes in U.S. trade law have increased foreign
competition for CNMI's garment industry, while other external events have
negatively affected its tourism sector.

CNMI's garment industry has declined in recent years with factory closings
and reduced production. The value of garment shipments to the United
States dropped by more than 16 percent between 2004 and 2005 and by an
estimated 25 percent in 2006.

Tourism in CNMI declined sharply in the late 1990s as a result of a series
of external events, including the Asian financial crisis; cancellation of
Korean Air service; and fears of international crises such as the SARS
epidemic, terrorism, and the Iraq war. In 2005, Japan Airlines withdrew
direct flights to the capital.

The fiscal condition of CNMI's government has steadily weakened from
fiscal year 2001 through fiscal year 2005, as government spending has
exceeded revenues each year since 2002. CNMI ended fiscal year 2005 with a
deficit of $84.1 million in its governmental fund balance. CNMI's
liabilities also exceed its assets for its primary government. Indicators
point to a severe financial crisis in fiscal year 2006. In response, the
CNMI government has implemented cost-cutting and restructuring measures,
including "austerity holidays," consisting of biweekly furloughs during
which government workers are not paid and many government operations are
closed to reduce personnel and operating costs.

CNMI's long-standing financial accountability problems include the late
submission of financial audit reports, inability to achieve "clean"
opinions in its financial statements by the independent financial
auditors, and reports showing serious internal control weaknesses over
financial reporting. Many of the auditors' findings are longstanding,
going back in some cases to 1987.

Federal agencies and CNMI have sponsored and participated in conferences,
training sessions, technical assistance, and other programs to improve
CNMI's economy, fiscal condition, and accountability. During 2006, the
CNMI government took steps to reverse its prior patterns of deficit
spending. It will need to continue to work toward long-term sustainable
solutions, with concentrated attention on the challenges facing the
islands and feedback mechanisms for continuing improvement. Leadership on
the part of the CNMI government and the Department of the Interior's
Office of Insular Affairs is critical to providing long-term stability and
prosperity for this U.S. insular area.

References

Visible links
  14. httpp://www.gao.gov/cgi-bin/getrpt?GAO-07-119
  15. httpp://www.gao.gov/cgi-bin/getrpt?GAO-05-296
  16. httpp://www.gao.gov/cgi-bin/getrpt?GAO-07-119 
  26. httpp://www.gao.gov/cgi-bin/getrpt?GAO-07-436t
  27. httpp://www.gao.gov/cgi-bin/getrpt?GAO-07-119
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