Yes. It has 3 settings - 0, 1, & 2. 0 is no soft focus and the lens functions normally (and is actually pretty sharp).
The switch is actually more like a lock, sliding it down allows you to rotate the front of the lens until it clicks into the detent for the two soft settings. It feels like you could use it between the settings (it just wouldn't snap into the detent), but I haven't tried that.
Someone else could explain the physics behind it a lot better than me, but basically it introduces spherical aberration to give the soft focus effect. It also affects the minimum focus distance slightly (it can focus closest on the soft 2 setting); not sure why that happens, but it doesn't really matter - more just an interesting side affect.
The main reason I got this lens is because Canon only makes two 135mm primes, and the 135 f/2L was outside of my price range (about $900). The 135 f/2.8 Soft Focus is about $300. I don't use the soft focus feature much, but it is fun to play around with.