I tried yours with "#IMPLIED", it still gives me the error.
Yes, I'm using XML spy and I expected it to complain for the first example. It didn't and added tried the second example and it gave me some other error other than the one it should have as you menioned.
So I guess that the statement "Parameter entities may not be referenced within other declarations in the internal subset" is TRUE and XML spy is not satisfying this condition.
Thank you both for your response.