The tumour suppressor protein merlin (encoded by the neurofibromatosis type 2 gene NF2) is an important regulator of proliferation in many cell and tissue types. Merlin is activated by dephosphorylation at serine 518 (S518), which occurs on serum withdrawal or on cell-cell or cell-matrix contact. However, the relevant phosphatase that activates merlin's tumour suppressor function is unknown. Here we identify this enzyme as the myosin phosphatase (MYPT-1-PP1delta). The cellular MYPT-1-PP1delta-specific inhibitor CPI-17 causes a loss of merlin function characterized by merlin phosphorylation, Ras activation and transformation. Constitutively active merlin (S518A) reverses CPI-17-induced transformation, showing that merlin is the decisive substrate of MYPT-1-PP1delta in tumour suppression. In addition we show that CPI-17 levels are raised in several human tumour cell lines and that the downregulation of CPI-17 induces merlin dephosphorylation, inhibits Ras activation and abolishes the transformed phenotype. MYPT-1-PP1delta and its substrate merlin are part of a previously undescribed tumour suppressor cascade that can be hindered in two ways, by mutation of the NF2 gene and by upregulation of the oncoprotein CPI-17.