The only thing that fixed this was Proxy 2.0 SP1. I tried all the articles. I am assuming that the "w3proxy.dll" was corrupted or in conflict with other dlls.
As per Microsoft: "This behavior can occur because when you upgrade your computer from IIS 3.0 to IIS 4.0 and Proxy Server 2.0 is installed, you need to reinstall the W3proxy.dll file". See ME209397
to fix this problem.
As per Microsoft: "Several different configuration issues can cause this event to be logged. If the Data box contains "0x0000003b" as described in the "Symptoms" section, one known cause is that a service that is listening on port 1080 is running. Because a service is already bound to port 1080, the Socks Proxy service that listens on port 1080 by default does not bind to the socket. The result is that the Web Proxy also does not initialize, causing event ID 127 to be logged. ". See the links below for resolution.