Receptor tyrosine kinases (RTKs) such as the fibroblast growth factor receptor (FGFR) and the epidermal growth factor receptor are overexpressed in a variety of cancers. In addition to overexpression, the FGFRs are found mutated in some cancers. The Src homology 2 domain-containing phosphotyrosine phosphatase (SHP2) is a critical mediator of RTK signaling, but its role in oncogenic RTK-induced cell transformation and cancer development is largely unknown. In the current report, we demonstrate that constitutively activated FGFR3 (K/E-FR3) transforms NIH-3T3 cells, and that SHP2 is a critical mediator of this transformation. Infection of K/E-FR3-transformed 3T3 cells with a retrovirus carrying a dominant-negative mutant of SHP2 (C/S-SHP2) retarded cell growth, reversed the transformation phenotype and inhibited focus-forming ability. Furthermore, treatment of K/E-FR3-transformed NIH-3T3 cells with PD98059 or LY294002, specific inhibitors of MEK and PI3K, respectively, inhibited focus formation. Biochemical analysis showed that K/E-FR3 activates the Ras-ERK and the PI3K signaling pathways, and that the C/S SHP2 mutant suppressed this effect via competitive displacement of interaction of the endogenous SHP2 with FRS2. However, the C/S SHP2 protein did not show any effect on receptor autophosphorylation, FRS2 tyrosine phosphorylation or interaction of Grb2 with K/E-FR3 or FRS2. Together, the results show that K/E-FR3 is transforming and that the Ras-ERK and the PI3K-Akt signaling pathways, which are positively regulated by SHP2, are important for K/E-FR3-induced transformation.