SMA ACFT TRANSITING CLASS B AIRSPACE UNDER POSITIVE ATC CTL. RPTR PLT WAS INSTRUCTED TO MAINTAIN 3500 FT; APCH CTLR REMINDED PLT TO MAINTAIN 3500 FT WHEN THE CTLR WAS SHOWING 4000 FT ON HIS ALT READOUT. RPTR CONFIRMED CURRENT ALTIMETER AND STILL SHOWED ALT OF 3500 FT. EVENTUALLY CTLR HAD RPTR TURN OFF HIS ERRONEOUS XPONDER DUE TO ALT RPTING ERROR OF 500 FT.

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CLRED TO ENTER MSP CLASS B AIRSPACE AND TOLD TO CLB TO 3500 FT MSL. UPON LEVELOFF; MSP APCH ADVISED ME THAT I WAS CLRED TO 3500 FT; NOT 4000 FT WHICH IS WHAT THEY WERE SHOWING ME AT ON RADAR. I CONFIRMED THE CURRENT ALTIMETER SETTING AND VERIFIED THAT I WAS LEVEL AT 3500 FT MSL INDICATED. SUSPECTING XPONDER ENCODING ERROR; I ASKED IF THEY WOULD LIKE ME TO EXIT THE CLASS B OR CONTINUE AS ORIGINALLY REQUESTED. APCH CLRED ME TO CONTINUE THROUGH THE CLASS B AT 3500 FT MSL INDICATED. I AM SUBMITTING THIS RPT DUE TO THE LOCATION (OVER MSP ARPT) AND ANY TCASII ADVISORIES IT MAY HAVE CAUSED. I WAS NOT TOLD TO STOP ALT SQUAWK UNTIL DIRECTLY OVER THE MSP ARPT. DUE TO THE APPARENT XPONDER ENCODING ERROR ON THE ACFT I WAS FLYING; I DON'T THINK I COULD HAVE DONE ANYTHING DIFFERENT. HOWEVER; SINCE THE CTLR CLRED ME TO CONTINUE ON COURSE AT 3500 FT MSL INDICATED; I WAS SURPRISED THAT I WAS NOT TOLD TO STOP ALT SQUAWK IMMEDIATELY AND CONTINUE VFR RPTING. THE XPONDER ENCODING ERROR WAS LARGE (BTWN 400-500 FT).