Activin has numerous biological activities including regulation of follicular development, spermatogenesis, and steroidogenesis within the gonads. Activities of activin are regulated by follistatin (FST), an activin binding protein, and perhaps follistatin-like 3 (FSTL3; also known as FLRG and FSRP). FSTL3 is a recently described member of the FST family having an overall structure and activity profile similar to that of FST, including binding and neutralization of activin. FSTL3 is most highly expressed in the placenta and testis, whereas FST is highest in the ovary and kidney, suggesting that FSTL3 has biological actions that do not entirely overlap those of FST. To investigate the role of local FSTL3 as a potential regulator of activin action in gonad development and function, we examined FSTL3 expression in the mouse testis. FSTL3 protein was localized to Leydig cells, spermatagonia, and mature spermatids in normal male mice. We then created transgenic mice using a human FSTL3 cDNA driven by the mouse alpha-inhibin promoter. Three of five transgenic founders were fertile and were bred to establish lines. In the highest expressing line 3, transgene expression was largely restricted to gonads, with pituitary, adrenal, brain, and uterine expression being substantially lower. Gonad weights, sperm counts, and fertility were significantly reduced in transgenic males, and reduced litter size was evident in line 3 females. Within the testis, highest transgene expression was observed in Sertoli cells, and although most tubules showed evidence of normal spermatogenic development, degenerating tubules devoid of germ cells and Leydig cell hyperplasia were also evident in every line 3 animal examined. Ovaries from line 3 females contained fewer antral follicles and more apparent follicular atresia. Although circulating human FSTL3 levels were undetectable, FSH and LH levels in adult transgenic mice were not significantly different from wild-type animals. However, testosterone levels were significantly increased at d 21 and significantly reduced at d 60 compared with wild-type males. These results suggest that FSTL3 is likely to be a local regulator of activin action in gonadal development and gametogenesis and, further, that activin appears to have important actions in gonadal development and function that are critical for normal reproduction.