The Gli3 zinc finger transcription factor is expressed in developing forebrain, with the highest levels of expression in dorsal telencephalon. In Gli3'/' embryos the dorsal telencephalon is abnormally small and fails to develop dorsomedial telencephalic structures, including hippocampus and cortical hem, while the ventral telencephalon appears to expand. A hurdle to understanding the underlying mechanisms is that abnormalities of developing Gli3'/' telencephalic cells in Gli3'/' mutants result from a combination of their own cell autonomous defects and defects in the Gli3'/' cells that surround them. Here we used chimeras to identify some of the defects of Gli3'/' telencephalic cells that are likely to be autonomous by studying how Gli3'/' cells develop when surrounded by a majority of wild-type cells. We found that Gli3'/' cells are present in all components of the Gli3'/''Gli3+/+ chimeric forebrain, including dorsomedial structures, in proportions that either equal or exceed proportions found elsewhere in the embryo. Gli3'/' cells segregate from Gli3+/+ cells to form many abnormal structures particularly in dorsal telencephalon. Gli3'/' cells in some locations are misspecified: in those parts of the dorsal telencephalon near to its boundaries with the diencephalon and the ventral telencephalon, mutant cells express sets of transcription factors expressed by wild-type cells on the other side of the boundary. Elsewhere in the dorsal telencephalon, in the diencephalon and in the ventral telencephalon, mutant cells express sets of transcription factors similar to those expressed by their immediately surrounding wild-type cells. We propose that an important cell autonomous action of Gli3 is to regulate the competence of dorsal telencephalic cells, preventing cells near to its boundaries expressing regulatory factors normally restricted to adjacent tissues.