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OBJECTIVE: Neuropsychological studies have demonstrated verbal episodic memory deficits in schizophrenia during word encoding and retrieval. This study examined neural substrates of memory in an analysis that controlled for successful retrieval. METHOD: Event-related blood-oxygen-level-dependent (BOLD) functional magnetic resonance imaging (fMRI) was used to measure brain activation during word encoding and recognition in 14 patients with schizophrenia and 15 healthy comparison subjects. An unbiased multiple linear regression procedure was used to model the BOLD response, and task effects were detected by contrasting the signal before and after stimulus onset. RESULTS: Patients attended during encoding and had unimpaired reaction times and normal response biases during recognition, but they had lower recognition discriminability scores, compared with the healthy subjects. Analysis of contrasts was restricted to correct items. Previous findings of a deficit in bilateral prefrontal cortex activation during encoding in patients were reproduced, but patients showed greater parahippocampal activation rather than deficits in temporal lobe activation. During recognition, left dorsolateral prefrontal cortex activation was lower in the patients and right anterior prefrontal cortex activation was preserved, as in the authors’ previous study using positron emission tomography. Successful retrieval was associated with greater right dorsolateral prefrontal cortex activation in the comparison subjects, whereas orbitofrontal, superior frontal, mesial temporal, middle temporal, and inferior parietal regions were more active in the patients during successful retrieval. CONCLUSIONS: The pattern of prefrontal cortex underactivation and parahippocampal overactivation in the patients suggests that functional connectivity of dorsolateral prefrontal and temporal-limbic structures is disrupted by schizophrenia. This disruption may be reflected in the memory strategies of patients with schizophrenia, which include reliance on rote rehearsal rather than associative semantic processing.