MD80 AND B727 HAD LESS THAN LEGAL SEPARATION WHEN THE MD80 DSNDED BELOW HIS CLRED ALT.

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ON DEC/WED/98; ACR FLT ABC BLOCKED OUT OF MIAMI AT XA20 LCL TIME FOR A 2 HR 29 MIN FLT TO NEW YORK'S JFK ARPT. FLT ABC WAS AIRBORNE AT XA42 LCL TIME. AT THE TIME OF THE RPTED INCIDENT; FLT ABC WAS CRUISING AT FL330 WITH A SPD OF MACH .750. ACFT WAS ON A HDG OF 045 DEGS AS ASSIGNED BY ATC FOR A HEADING TO GO DIRECT TO SWL (SNOW HILL) VOR WHEN ABLE. THE FLT WAS AIRBORNE APPROX 1 HR 40 MINS AND WAS IN THE NORFOLK; VA; AREA. INFLT WX CONDITIONS WERE IMC WITH CONTINUOUS LIGHT TO OCCASIONAL MODERATE TURB. THE ENG ANTI-ICE WAS ON WITH THE CABIN SEAT BELT SIGN TURNED ON. MY FO REQUESTED TO USE THE LAVATORY. REQUEST WAS GRANTED AND HE LEFT THE FLT DECK. ATC ASKED WHAT OUR SPD WAS AND COULD WE INCREASE OUR SPD FOR TFC. MY RESPONSE WAS THAT WE WERE EXPERIENCING TURB AND WOULD PREFER TO MAINTAIN THE PRESENT SPD OR DSND TO A SMOOTHER ALT. ATC THEN DIRECTED US TO TURN R TO A 100 DEG HDG AND DSND AND MAINTAIN FL310. I READ BACK THE CLRNC AS GIVEN. I REACHED OVER ON THE FGP (FLT GUIDANCE CTL PANEL) AND SELECTED THE ALT SET KNOB TO FL310. I THEN PULLED THE KNOB TO ARM THE ALT CAPTURE FUNCTION. I LOOKED AT THE FMA (FLT MODE ANNUNCIATOR) TO CONFIRM THAT THE ALT CAPTURE LIGHT WAS ILLUMINATED. I THEN TURNED THE FGP (FLT GUIDANCE CTL PANEL) PITCH CTL KNOB TO DSND THE ACFT AT 1000 FPM. I THEN SET THE HEADING SELECT KNOB INADVERTENTLY TO 010 DEGS. I LOOKED AT MY FLT INSTS TO SEE THAT THE ACFT WAS RESPONDING TO THE AUTOFLT INPUTS. AT ABOUT 10 DEGS IN THE TURN TO THE L; ATC RESPONDED WITH ACR THAT WAS A R TURN TO A 100 DEG HDG. I ANSWERED WITH 'ROGER R TURN TO 100 DEGS FOR ACR FLT ABC.' I RESELECTED 100 DEGS ON THE HEADING SELECT KNOB AND PULLED IT OUT TO ENGAGE THE HEADING SELECT MODE. I RESELECTED THE BANK ANGLE KNOB FROM 10 DEGS TO 15 DEGS TO MORE QUICKLY COMPLY WITH ATC'S REQUEST FOR A R TURN. I THEN RETURNED MY ATTN TO THE FLT INSTS TO SEE THAT THE ACFT WAS RESPONDING APPROPRIATELY. AT THIS TIME MY FO RETURNED TO THE FLT DECK. I WAS TEMPORARILY DISTRACTED WHILE I STOWED MY OXYGEN MASK; DONNED MY HEADSET/BOOM MIKE AND EXPLAINED TO MY FO THE HEADING/ALT CHANGE. THE NEXT THING I HEARD WAS ATC ASKING US WHAT ALT WE WERE AT. I LOOKED AT THE FLT INSTS AND STATED THAT WE WERE OUT OF FL310 FOR FL300 AS WAS SHOWN IN THE FGP (FLT GUIDANCE CTL PANEL) ALT PRESELECT READOUT WINDOW. ATC STATED THAT WE HAD ONLY BEEN CLRED TO FL310 AND THAT WAS WHAT WE HAD READ BACK TO THEM. I IMMEDIATELY TURNED OFF THE AUTOPLT AND RETURNED THE ACFT TO FL310. THE LOWEST LEVEL THAT THE ACFT DSNDED TO BEFORE IT WAS RETURNED TO FL310; WAS 30600 FT. WE DID NOT RECEIVE A TCASII WARNING OR ALERT. MY FO SAID THAT HE OBSERVED A TCASII TARGET AT OUR 6 O'CLOCK POS; 1600 FT BELOW US GOING FROM R TO L. BEFORE LEAVING THE SECTOR FREQ I ASKED THE CTLR IF THERE HAD BEEN A TFC CONFLICT. HE STATED THAT HE DID NOT KNOW BUT THAT IT WAS BEING LOOKED INTO. THE FLT CONTINUED ON TO JFK WITHOUT FURTHER INCIDENT. IN RETROSPECT THE ONLY EXPLANATION I HAVE FOR FL300 BEING IN THE ALT PRESELECT READOUT WINDOW MIGHT BE THAT WHEN I PULLED THE ALT SELECT KNOB TO ARM THE AUTO CAPTURE FUNCTION IT CHANGED 1000 FT. THE KNOB IS DESIGNED TO CHANGE IN 1000 FT INCREMENTS FOR EACH DETENT WHEN TURNED. WHY THE ERROR WAS NOT FOUND ON XCHK I DO NOT KNOW.