A partial C-terminal cDNA sequence of a novel Drosophila mitogen-activated protein kinase phosphatase (MKP), designated DMKP-3, was identified from an epitope expressed sequence tag database, and the missing N-terminal cDNA fragment was cloned from a Drosophila cDNA library. DMKP-3 is a protein of 411 amino acids, with a calculated molecular mass of 45.8 kDa; the deduced amino acid sequence is most similar to that of mammalian MKP-3. Recombinant DMKP-3 produced in Escherichia coli retained intrinsic tyrosine phosphatase activity. In addition, DMKP-3 specifically inhibited extracellular-signal-regulated kinase (ERK) activity, but was without a significant affect on c-Jun N-terminal kinase (JNK) and p38 activities, when it was overexpressed in Schneider cells. DMKP-3 interacted specifically with Drosophila ERK (DERK) via its N-terminal domain. In addition, DMKP-3 specifically inhibited Elk-1-dependent trans-reporter gene expression in mammalian CV1 cells, and dephosphorylated activated mammalian ERK in vitro. DMKP-3 is uniquely localized in the cytoplasm within Schneider cells, and gene expression is tightly regulated during development. Thus DMKP-3 is a Drosophila homologue of mammalian MKP-3, and may play important roles in the regulation of various developmental processes.