Under normal conditions, brain apolipoprotein E (apoE) is secreted and lipidated by astrocytes, then taken up by neurons via receptor mediated endocytosis. Free apoE is either degraded in intraneuronal lysosomal compartments or released. Here we identified a novel way by which apoE undergoes proteolysis in the extracellular space via a secreted neuronal protease. We show that apoE is cleaved in neuronal conditioned media by a secreted serine protease. This apoE cleavage was inhibited by PMSF and α1-antichymotrypsin, but not neuroserpin-1 or inhibitors of thrombin and cathepsin G, supporting its identity as a chymotrypsin like protease. In addition, apoE incubation with purified chymotrypsin produced a similar pattern of apoE fragments. Analysis of apoE fragments by mass spectrometry showed cleavages occurring at the C-terminal side of apoE tryptophan residues, further supporting our identification of cleavage by chymotrypsin like protease. Hippocampal neurons were more efficient in mediating this apoE cleavage than cortical neurons. Proteolysis of apoE4 generated higher levels of low molecular weight fragments compared to apoE3. Primary glial cultures released an inhibitor of this proteolytic activity. Together, these studies reveal novel mechanism by which apoE can be regulated and therefore could be useful in designing apoE directed AD therapeutic approaches.