The cytoplasmic insulin receptor substrate-1 (IRS-1), which is multiply phosphorylated in vivo on tyrosine residues, is a known binding protein for the tandem src homology 2 (SH2) domain-containing protein tyrosine phosphatase, SH-PTP2. Eleven phosphotyrosyl (pY) peptides from IRS-1 were screened for allosteric activation of SH-PTP2 phosphatase activity toward phosphorylated, reduced, carboxyamidomethylated, and maleylated-lysozyme. Peptides IRS-1pY895, IRS-1pY1172, and IRS-1pY1222 showed up to 50-fold acceleration of dephosphorylation. Analyses of Arg to Lys mutants in either or both SH2 domains indicate that both the N-terminal (N-SH2) and C-terminal (C-SH2) domains function in allosteric activation. Direct determination by surface plasmon resonance of the dissociation constants between pY peptides and glutathione S-transferase fusions to N-SH2 and C-SH2 domains reveals a 240-fold preference of the N-SH2 domain (compared with the C-SH2 domain) for IRS-1pY1172. The N-SH2 domain prefers IRS-1pY1172 > IRS-1pY895 > IRS-1pY1222, whereas C-SH2 domain prefers IRS-1pY1222 > IRS-1pY895 > IRS-1pY1172. These data suggest that each SH2 domain can bind to a distinct pY sequence of multiply phosphorylated protein substrates such as IRS-1, while activating hydrolysis at a third pY sequence bound in the SH-PTP2 active site. In addition, proteolysis and truncation studies reveal an autoregulatory function for the C-terminal region of SH-PTP2. Limited tryptic cleavage within the C-terminus results in 27-fold activation of protein tyrosine phosphatase activity. The activated tryptic fragment cannot be further activated by pY peptide binding to the SH2 domains indicating that autoregulatory functions of the SH2 domains are dependent on the C-terminal region. These data suggest that multiple levels for control of SH-PTP2 enzymatic activity may exist in vitro and in vivo.