We have investigated the role of the bone morphogenetic protein (BMP) pathway during neural tissue formation in the ascidian embryo. The orthologue of the BMP antagonist, chordin, was isolated from the ascidian Halocynthia roretzi. While both the expression pattern and the phenotype observed by overexpressing chordin or BMPb (the dpp-subclass BMP) do not suggest a role for these factors in neural induction, BMP/CHORDIN antagonism was found to affect neural patterning. Overexpression of BMPb induced ectopic sensory pigment cells in the brain lineages that do not normally form pigment cells and suppressed pressure organ formation within the brain. Reciprocally, overexpressing chordin suppressed pigment cell formation and induced ectopic pressure organ. We show that pigment cell formation occurs in three steps. (1) During cleavage stages ectodermal cells are neuralized by a vegetal signal that can be substituted by bFGF. (2) At the early gastrula stage, BMPb secreted from the lateral nerve cord blastomeres induces those neuralized blastomeres in close proximity to adopt a pigment cell fate. (3) At the tailbud stage, among these pigment cell precursors, BMPb induces the differentiation of specifically the anterior type of pigment cell, the otolith; while posteriorly, CHORDIN suppresses BMP activity and allows ocellus differentiation.