The decapentaplegic (dpp) gene directs numerous developmental events in Drosophila melanogaster. dpp encodes a member of the Transforming Growth Factor-beta family of secreted signaling molecules. At this time, mechanisms of dpp signaling have not yet been fully described. Therefore we conducted a genetic screen for new dpp signaling pathway components. The screen exploited a transvection-dependent dpp phenotype: heldout wings. The screen generated 30 mutations that appear to disrupt transvection at dpp. One of the mutations is a translocation with a recessive lethal breakpoint in cytological region 23C1-2. Genetic analyses identified a number of mutations allelic to this breakpoint. The 23C1-2 complementation group includes several mutations in the newly discovered gene lilliputian (lilli). lilli mutations that disrupt the transvection-dependent dpp phenotype are also dominant maternal enhancers of recessive embryonic lethal alleles of dpp and screw. lilli zygotic mutant embryos exhibit a partially ventralized phenotype similar to dpp embryonic lethal mutations. Phylogenetic analyses revealed that lilli encodes the only Drosophila member of a family of transcription factors that includes the human genes causing Fragile-X mental retardation (FMR2) and Burkitt's Lymphoma (LAF4). Taken together, the genetic and phylogenetic data suggest that lilli may be an activator of dpp expression in embryonic dorsal-ventral patterning and wing development.