TRACON CTLR LOST LEGAL SEPARATION WITH TWO ACR ACFT WHEN THE XPONDER; MODE C; OF ONE ACFT JUMPED 1300 FT IN ALT CAUSING THE OTHER ACFT TCASII TO ISSUE AN RA TO DSND. BOTH ACFT MISSED EACH OTHER BY APPROX A HALF OF MI.

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ACR X WAS 5 MI SW OF ORD ON A 360 DEG HDG LEVEL AT 6000 FT. ACR Y; ON ORD DEP; WAS ON A SOUTHWESTERLY VECTOR CLBING OFF ORD TO 5000 FT (AS PER ORD 1 SID). MERGING TFC ADVISORIES WERE NOT ISSUED BECAUSE IT APPEARED THAT THE TARGETS WOULDN'T MERGE. ACR Y MODE C JUMPED TO INDICATE 6300 FT. ACR Y DID LEVEL AT 5000 FT; AS VERIFIED BY PLT RPT. ACR X'S TCASII ISSUED AN RA; BASED ON THE INACCURATE MODE C; AND THE PLTS DSNDED. THE PLTS OF ACR X THEN SAW ACR Y PASS BELOW THEM. THE AIRPLANES WERE SEPARATED UNTIL THE TCASII ISSUED THE RA BASED ON THE BAD MODE C INDICATION. THE PLTS OBEYED THE RA (AS REQUIRED) AND NOTIFIED ATC DURING THE DSCNT. AS A RESULT; THE AIRPLANES PASSED ABOUT 1/2 MI APART WITH 500-600 FT VERT SEPARATION. CONTRIBUTING FACTORS: ACR Y MODE C JUMPED FROM 2700 FT TO 6300 FT IN JUST A FEW RADAR UPDATES. THE CTLR WOULD HAVE TO BE WATCHING ACR Y AND NOTHING ELSE TO HAVE CAUGHT THE DISCREPANCY. POS RELIEF BRIEFINGS WERE BEING CONDUCTED AT BOTH SECTORS; S AND W DEP (CTLING ACR Y) AND N SATELLITE/N DEP (CTLING ACR X). BOTH TARGETS WERE VERY CLOSE TOGETHER; WITH POSSIBLE OVERLAP. THIS MADE IT DIFFICULT TO SEE THE DISCREPANCY.