Protein-tyrosine phosphatase 1B (PTP1B) has been implicated as an important regulator in several signaling pathways including those initiated by insulin and leptin. Potent and specific PTP1B inhibitors could serve as useful tools in elucidating the physiological functions of PTP1B and may constitute valuable therapeutics in the treatment of several human diseases. We have determined the crystal structure of PTP1B in complex with compound 2, the most potent and selective PTP1B inhibitor reported to date. The structure at 2.15-A resolution reveals that compound 2 simultaneously binds to the active site and a unique proximal noncatalytic site formed by Lys-41, Arg-47, and Asp-48. The structural data are further corroborated by results from kinetic analyses of the interactions of PTP1B and its site-directed mutants with compound 2 and several of its variants. Although many of the residues important for interactions between PTP1B and compound 2 are not unique to PTP1B, the combinations of all contact residues differ between PTP isozymes, which provide a structural basis for potent and selective PTP1B inhibition. Our data further suggest that potent, yet highly selective, PTP1B inhibitory agents can be acquired by targeting the area defined by residues Lys-41, Arg-47, and Asp-48, in addition to the previously identified second aryl phosphate-binding pocket.