A common pathogenic event that occurs in all forms of Alzheimer's disease is the progressive accumulation of amyloid beta-peptide (Abeta) in brain regions responsible for higher cognitive functions. Inhibition of acyl-coenzyme A: cholesterol acyltransferase (ACAT), which generates intracellular cholesteryl esters from free cholesterol and fatty acids, reduces the biogenesis of the Abeta from the amyloid precursor protein (APP). Here we have used AC29 cells, defective in ACAT activity, to show that ACAT activity steers APP either toward or away from a novel proteolytic pathway that replaces both alpha and the amyloidogenic beta cleavages of APP. This alternative pathway involves a novel cleavage of APP holoprotein at Glu281, which correlates with reduced ACAT activity and Abeta generation in AC29 cells. This sterol-dependent cleavage of APP occurs in the endosomal compartment after internalization of cell surface APP. The resulting novel C-terminal fragment APP-C470 is destined to proteasomal degradation limiting the availability of APP for the Abeta generating system. The proportion of APP molecules that are directed to the novel cleavage pathway is regulated by the ratio of free cholesterol and cholesteryl esters in cells. These results suggest that subcellular cholesterol distribution may be an important regulator of the cellular fate of APP holoprotein and that there may exist several competing proteolytic systems responsible for APP processing within the endosomal compartment.