The cytoplasmic protein tyrosine phosphatase, PTP-PEST, associates with the focal adhesion proteins p130cas and paxillin and has recently been implicated in cell migration. In this study, we investigated the mechanism by which PTP-PEST regulates this phenomenon. We find that PTP-PEST is activated in an adhesion-dependent manner and localizes to the tips of membrane protrusions in spreading fibroblasts. We show that the catalytic activity of PTP-PEST is a key determinant for its effects on motility. Overexpression of PTP-PEST, but not a catalytically inactive form, impairs haptotaxis, cell spreading and formation of membrane protrusions in CHOK1 cells. In addition, overexpression of PTP-PEST in Rat1 fibroblasts perturbs membrane ruffling and motility in response to PDGF stimulation. The expression level of PTP-PEST modulates the activity of the small GTPase, Rac1. PTP-PEST overexpression suppresses activation of Rac1 in response to both integrin-mediated adhesion or growth factor stimulation. In contrast, fibroblasts that lack PTP-PEST expression show enhanced Rac1 activity. Co-expression of constitutively active Rac1 with PTP-PEST overcomes the inhibition of cell spreading and migration indicating that PTP-PEST acts by antagonizing Rac1 activation. Our data suggest a model in which PTP-PEST is activated by integrins and localized to regions where it can control motile events at the leading edge through inhibition of the small GTPase Rac1.