Infection of mice with Friend spleen focus-forming virus (SFFV) results in a multistage erythroleukemia. In the first stage, the SFFV envelope glycoprotein interacts with the erythropoietin receptor and a short form of the receptor tyrosine kinase sf-Stk, resulting in constitutive activation of signal transducing molecules and the development of erythropoietin (Epo)-independent erythroid hyperplasia and polycythemia. The second stage results from the outgrowth of a rare virus-infected erythroid cell that expresses nonphysiological levels of the myeloid transcription factor PU.1. These cells exhibit a differentiation block and can be grown as murine erythroleukemia (MEL) cell lines. In this study, we examined SFFV MEL cells to determine whether their transformed phenotype was associated with a block in the activation of any Epo signal-transducing molecules. Our studies indicate that Epo- or SFFV-induced activation of STAT1/3 DNA binding activity is blocked in SFFV MEL cells. The block is at the level of tyrosine phosphorylation of STAT1, although Jak2 phosphorylation is not blocked in these cells. In contrast to Epo, alpha interferon can induce STAT1 phosphorylation and DNA binding in SFFV MEL cells. The SFFV-transformed cells were shown to express elevated levels of the hematopoietic phosphatase SHP-1, and treatment of the cells with a phosphatase inhibitor restored STAT1 tyrosine phosphorylation. MEL cells derived from Friend murine leukemia virus (MuLV) or ME26 MuLV-infected mice, which do not express PU.1, express lower levels of SHP-1 and are not blocked in STAT1/3 DNA-binding activity. Our studies suggest that SFFV-infected erythroid cells become transformed when differentiation signals activated by STAT1/3 are blocked due to high SHP-1 levels induced by inappropriate expression of the PU.1 protein.