In the budding yeast Saccharomyces cerevisiae, the multifunctional protein Net1 is implicated in regulating the cell cycle function of the Cdc14 protein phosphatase. Genetic and cell biological data suggest that during interphase and early mitosis Net1 holds Cdc14 within the nucleolus where its activity is suppressed. Upon its transient release from Net1 at late anaphase, active Cdc14 promotes exit from mitosis by dephosphorylating targets in the nucleus and cytoplasm. In this paper we present evidence supporting the proposed role of Net1 in regulating Cdc14 and exit from mitosis. We show that the NH(2)-terminal fragment Net1(1-600) directly binds Cdc14 in vitro and is a highly specific competitive inhibitor of its activity (K(i) = 3 nm) with five different substrates including the physiologic targets Swi5 and Sic1. An analysis of truncation mutants indicates that the Cdc14 binding site is located within a segment of Net1 containing residues 1-341. We propose that Net1 inhibits by occluding the active site of Cdc14 because it acts as a competitive inhibitor, binds to a site located within the catalytic domain (residues 1-374), binds with reduced affinity to a Cdc14 C283S mutant in which an active site Cys is replaced, and is displaced by tungstate, a transition state analog known to bind in the catalytic site of protein-tyrosine phosphatases.