Here we identify the humpty dumpty (humdy) mouse mutant with failure to close the neural tube and optic fissure, causing exencephaly and retinal coloboma, common birth defects. The humdy mutation disrupts Phactr4, an uncharacterized protein phosphatase 1 (PP1) and actin regulator family member, and the missense mutation specifically disrupts binding to PP1. Phactr4 is initially expressed in the ventral cranial neural tube, a region of regulated proliferation, and after neural closure throughout the dorsoventral axis. humdy embryos display elevated proliferation and abnormally phosphorylated, inactive PP1, resulting in Rb hyperphosphorylation, derepression of E2F targets, and abnormal cell-cycle progression. Exencephaly, coloboma, and abnormal proliferation in humdy embryos are rescued by loss of E2f1, demonstrating the cell cycle is the key target controlled by Phactr4. Thus, Phactr4 is critical for the spatially and temporally regulated transition in proliferation through differential regulation of PP1 and the cell cycle during neurulation and eye development.