We have used the yellow gene of Drosophila melanogaster as a model system in which to study the molecular mechanisms by which the gypsy retrotransposon causes mutant phenotypes that can be reversed by nonallelic mutations at the suppressor of Hairy-wing locus. This gene encodes a 109,000 dalton protein that contains an acidic domain and 12 copies of the Zn finger motif, which are characteristic of some transcription factors and DNA binding proteins. The suppressible y2 allele is caused by the insertion of the gypsy element at -700 bp from the start of transcription of the yellow gene, resulting in a phenotype characterized by mouth parts and denticle belts in the larvae, and by bristles in the adults, that show wildtype coloration, but mutant wings and body cuticle in the adult flies. This phenotype is the result of the interaction of gypsy sequences homologous to mammalian enhancers with tissue-specific yellow transcriptional regulatory elements located upstream from the gypsy insertion site and responsible for the expression of the yellow gene in the mutated tissues. This interaction is dependent on the binding of the su(Hw) protein to the specific gypsy sequences involved in the induction of the mutant phenotype.