The fused gene encodes a serine-threonine kinase that functions as a positive regulator of Hedgehog signal transduction in Drosophila embryogenesis, wing morphogenesis, and somatic cell development during oogenesis. Here, we have characterized the germline ovarian tumors present in adult ovaries of fused mutant females, a phenotype not observed upon deregulation of any other component of Hedgehog signaling. In the strongest fused mutant contexts, we found that tumorous ovarian follicles accumulate early spectrosome-containing germ cells corresponding to germline stem cells and/or early cystoblasts as evidenced by activated Dpp signal transduction and transcriptional repression of bag-of-marbles, encoding the cystoblast determination factor. These early germ cells are maintained far from their usual position in a specialized niche of somatic cells in the apical part of the germarium, which appears normal in size in fused mutant ovarioles. Therefore, these results indicate a novel function for fused in downregulation of Dpp signaling which is necessary for de-repression of bag-of-marbles and consequent cystoblast determination. The abnormal accumulation of these early germ cells seems to be due primarily to defects in differentiation since we show that germline stem cell proliferation in the germarium is not affected. A later block in germline development, at the 16-cell cyst stage before significant nurse cell and oocyte differentiation, was also observed in tumorous follicles when fused function was only partially lowered. Finally, fused mutant ovaries exhibit some germline cysts having undergone a supernumerary fifth mitotic division. Through clonal analysis, we provide evidence that fused regulates these cystocyte divisions cell autonomously, while the tumorous phenotype probably reflects both a somatic and germline requirement for fused for cyst and follicle development.