Down-regulation (degradation) of cell surface proteins within the lysosomal lumen depends on the function of the multivesicular body (MVB) sorting pathway. The function of this pathway requires the class E vacuolar protein sorting (Vps) proteins. Of the class E Vps proteins, both the ESCRT-I complex (composed of the class E proteins Vps23, 28, and 37) and Vps27 (mammalian hepatocyte receptor tyrosine kinase substrate, Hrs) have been shown to interact with ubiquitin, a signal for entry into the MVB pathway. We demonstrate that activation of the MVB sorting reaction is dictated largely through interactions between Vps27 and the endosomally enriched lipid species phosphatidylinositol 3-phosphate via the FYVE domain (Fab1, YGL023, Vps27, and EEA1) of Vps27. ESCRT-I then physically binds to Vps27 on endosomal membranes via a domain within the COOH terminus of Vps27. A peptide sequence in this domain, PTVP, is involved in the function of Vps27 in the MVB pathway, the efficient endosomal recruitment of ESCRT-I, and is related to a motif in HIV-1 Gag protein that is capable of interacting with Tsg101, the mammalian homologue of Vps23. We propose that compartmental specificity for the MVB sorting reaction is the result of interactions of Vps27 with phosphatidylinositol 3-phosphate and ubiquitin. Vps27 subsequently recruits/activates ESCRT-I on endosomes, thereby facilitating sorting of ubiquitinated MVB cargoes.