The COP9 signalosome is a multifunctional regulator essential for Drosophila development. A loss-of-function mutant in Drosophila COP9 signalosome subunit 5 (CSN5) develops melanotic bodies, a phenotype common to mutants in immune signaling. csn5(null) larvae accumulated high levels of Cactus that co-localizes with Dorsal to the nucleus. However, Dorsal-dependent transcriptional activity remained repressed in the absence of an inducing signal, despite its nuclear localization. Dorsal activity in mutant larvae and NFkappaB activity in CSN5 down-regulated mammalian cells can be induced following activation of the Toll/IL-1 pathway. csn5(null) larvae contained more hemocytes than wild-type (wt) larvae. A large portion of these cells have differentiated to lamellocytes (LM), a hemocyte cell type rarely seen in normal larvae. The results presented here indicate that CSN5 is a negative regulator of Dorsal subcellular localization, and of hemocyte proliferation and differentiation. These results further indicate that nuclear localization of Dorsal can be uncoupled from its activation. Surprisingly, CSN5 is not necessary for immune-induced degradation of Cactus.