That's a bass roll-off switch. In position I, it gives you the normal frequency range of the ME-80 mic head you're using. In positions II and III, it filters out the lower frequencies to reduce wind noise, handling noise or other low frequency sound. I never really found it to work that well.
By the way, that switch is actually on the K3 power supply. The ME-80 mic head is the other part that screws onto the power supply. People usually refer to the whole thing screwed together as an "ME-80," but you can actually get other mic heads (ME-40, ME-60, etc.) for that power supply that give you different pickup patterns (making the mic more or less directional, depending on the mic head). There's even a lavalier that can be powered from it. It's useful to know that the Sennheiser considers the power supply to be a separate part, especially when someone tries to sell you an "ME-80" on eBay that actually doesn't have the power supply with it.
My K3 is modified so that that switch doesn't roll off bass, but sets the mic as follows:
I -- microphone
II -- stun
III -- kill
I once left it on stun and knocked out the mayor. We packed up and sneaked out while he was still unconcious, and he never figured out what happened.