I believe it is a varitone switch. It adds caps to the circuit for a thinner sound. The same as ones used on ES 355's. If I am not mistaken this guitar also features a dummy coil that makes the P90's operate in humbucking mode.
I think you're right on both counts, Jim. Another classic example of a neat idea from Gibson spoiled by things like the proprietary bridge, and in the case of the original Nighthawks, weird pickup configurations that could never be upgraded. Nice guitar otherwise - really versatile, playable, and much more comfortable than the lumpen Les Paul. I fell for one back in the late '80s, but the CFO prevailed.
Last time I saw one of these in action was in the hands of the appropriately named Carolyn Wonderland on Austin City Limits a year or two ago.