Cartilage tumors, accounting for 22% of skeletal system tumors, are characterized by the formation of exostoses, enchondroma(s) or both, and cause significant morbidity and mortality. Both benign and malignant cartilaginous tumors can develop at various ages, and can show autosomal dominant inheritance or occur sporadically. The molecular mechanism underlying the development and progression of these cartilaginous lesions remains incompletely understood. Shp2, encoded by the Ptpn11 gene, is one of two Src homology 2 domain-containing protein-tyrosine phosphatases, and is required for most, if not all, receptor tyrosine kinase (RTK), cytokine, and integrin signaling pathways. Global deletion of Shp2 in mice results in early embryonic lethality, whereas postnatal Shp2 deficiency in various tissues/cells has diverse effects on their development and function. Several human malignancies, most notably childhood myeloproliferative disorders, are associated with Ptpn11 gain-of-function (GOF) mutations. Several lines of evidence indicate that Shp2 plays an important role in skeletal development and homoeostasis; however, little is known about its role in vivo. Recently Ptpn11 truncated mutations (presumably protein null) are reported to cause human metachondromatosis, a benign cartilage tumor syndrome with malignant potentials. By taking a tissue-specific gene knockout approach, we report here that Shp2 loss-of-function mutation, in contrast to its GOF mutants in other tissues/cells, causes widespread and severe cartilaginous tumors, strongly suggesting that Shp2 has a tissue specific-tumor suppressor function. These studies also identify the target of cartilage malignancies caused by Shp2 deficiency as a novel cell population with stem/progenitor properties located within the groove of Ranvier. Materials and Methods: Mice carrying Ptpn11 floxed (fl) or cathepsin K-Cre (Ctsk-Cre) were described previously. To generate Ctsk-expressing cell specific Shp2 deficient mice and study the role of Shp2 in these cells to regulate skeletal development and homeostasis, Ptpn11 floxed mice were bred to Ctsk-Cre mice to generate Ptpn11fl/fl;Ctsk-Cre (KO) and Ptpn11fl/+;Ctsk-Cre (Control) animals. To track the fate of Ctsk + cartilaginous cells in vivo in the presence or absence of Shp2, Roza26lacZ (R26lacZ) and Roza26EYFP (R26YFP) reporter alleles were bred to Control and KO mice to generate Control/R26YFP, KO/R26YFP, Control/R26lacZ and KO/R26lacZ compound mice, respectively. YFP-positive cartilaginous cells were isolated by serial enzymatic digestions of epiphyseal cartilage with hyaluronidase/Trypsin/ collagenase D and FACS sorting. Cell surface marker expression was determined by FACS analysis after staining with fluorescence-labeled antibodies. For histological analysis, skeletal tissues were removed from mice after euthanasia and fixed in 4% paraformaldehyde; after decalcification, embedding, and sectioning, they were stained with HELysMCre mcie, revealed that the cartilage phenotype in KO mice was not osteoclast-autonomous. Therefore to identify the cellular origin of the cartilage lesions in KO mice, we conducted a reporter study by using Ctsk-Cre mediated R26lacZ or YFP expression. Surprisingly, we found that the Ctsk promoter is active not only in mature osteoclasts, but also in a subset of cells that live in perichondrial groove of Ranvier. Deficiency of Shp2 in these cells causes unrestrained proliferation, chondrogenic differentiation, and exostoses/enchondroma(s) formation. These cells were found to share several mesenchymal/chondroprogenitor markers, such as CD44, CD90, Stro1 and jagged1. Biochemical analysis shows that Shp2 deficiency impaired Erk activation and caused elevated expression of Indian hedgehog (Ihh) and PTHrP in cartilage lesions. In summary, we specifically ablated Shp2 in Ctsk-expressing cells (primarily in mature osteoclasts and subsets of cartilaginous cells) in mice and found that Shp2, in addition to having a role in osteoclastogenesis in vitro and in vivo, negatively regulates the proliferation and chondrogenic differentiation of a unique population of ctsk+ perichondrial cartilaginous cells. Loss of Shp2 in these cells causes cell proliferation, chondrogenic differentiation, and cartilage tumorigenesis at the metaphyses of tubular bones. This phenotype is strikingly similar to the human disease metachondromatosis. Mechanistically, we believe that this pathogenic process is triggered by ectopic and/or elevated Ihh expression due to impaired Erk activation in Shp2- deficient perichondrial cells. If confirmed, these data identify hedgehog pathway inhibitors as potential therapeutic agents in metachromatosis patients. Our results, in concert with previous studies, show that, depending on the cellular context, Shp2 can act as an oncogene or a tumor suppressor gene. Citation Format: {Authors}. {Abstract title} [abstract]. In: Proceedings of the 103rd Annual Meeting of the American Association for Cancer Research; 2012 Mar 31-Apr 4; Chicago, IL. Philadelphia (PA): AACR; Cancer Res 2012;72(8 Suppl):Abstract nr SY15-01. doi:1538-7445.AM2012-SY15-01