Previously, we demonstrated that the Src tyrosine kinase interacts with the Shp-2 tyrosine phosphatase. To determine whether Shp-2 regulates Src kinase activity, we measured Src activity in cells overexpressing wild-type or catalytically-inactive C463S Shp-2. We observed a 2–3-fold increase in the specific activity of Src in both cell types and the increase did not appear to be due to dephosphorylation of Tyr 527 or phosphorylation of Tyr 416 on Src. Conversely, we observed a 2–3-fold decrease in the specific activity of Src when Shp-2 expression was inhibited. Using glutathione S-transferase-fusion proteins, we demonstrated that Shp-2 binds to the SH3 domain of Src. Our findings reveal that the Shp-2 tyrosine phosphatase can regulate the Src tyrosine kinase by a non-enzymatic mechanism. We also found that the phosphatase activity of Shp-2 immunoprecipitates is downregulated in cells transformed by Src or other proteins, and that Shp-2 preferentially associates with the membrane fraction of transformed cells. We suggest that membrane-association of Shp-2 is important for regulating Shp-2 activity.