ssfiiincsrdec08.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM N-CSR

CERTIFIED SHAREHOLDER REPORT OF REGISTERED

MANAGEMENT INVESTMENT COMPANIES

Investment Company Act file number		811-08110

SPECIAL SITUATIONS FUND III, L.P.
(Exact name of registrant as specified in charter)

527 MADISON AVENUE, SUITE 2600, NEW YORK, NEW YORK				10022
(Address of principal executive offices)				(Zip code)

Allen B. Levithan, Esq. c/o Lowenstein Sandler PC 65 Livingston Avenue Roseland, New Jersey 07068
(Name and address of agent for service)

Registrant’s telephone number, including area code			(212) 319-6670

Date of fiscal year end:	DECEMBER 31, 2008

Date of reporting period:	DECEMBER 31, 2008

Form N-CSR is to be used by management investment companies to file reports with the Commission not later than 10 days after the transmission to stockholders of any report that is required to be transmitted to stockholders under Rule 30e-1 under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may use the information provided on Form N-CSR in its regulatory, disclosure review, inspection, and policymaking roles.

A registrant is required to disclose the information specified by Form N-CSR, and the Commission will make this information public. A registrant is not required to respond to the collection of information contained in Form N-CSR unless the Form displays a currently valid Office of Management and Budget ("OMB") control number. Please direct comments concerning the accuracy of the information collection burden estimate and any suggestions for reducing the burden to Secretary, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. The OMB has reviewed this collection of information under the clearance requirements of 44 U.S.C. § 3507.

Item 1. Reports to Stockholders.

December 31, 2008
Special Situations Fund III, L.P.	Annual Report - Liquidation Basis

SPECIAL SITUATIONS FUND III, L.P.

(A Limited Partnership)

INDEX TO THE ANNUAL REPORT – LIQUIDATION BASIS

DECEMBER 31, 2008

_________________________________________________________________________________

PAGE

Report of Independent Registered Public Accounting Firm 1

Statement of Financial Condition – Liquidation Basis 2

Portfolio of Investments – Liquidation Basis 3

Statement of Operations – Liquidation Basis 10

Statements of Changes in Partners’ Capital – Liquidation Basis 11

Notes to the Financial Statements – Liquidation Basis 12

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Partners of

Special Situations Fund III, L.P.

We have audited the accompanying statement of financial condition – liquidation basis of Special Situations Fund III, L.P. (the “Fund”), including the portfolio of investments – liquidation basis, as of December 31, 2008, and the related statement of operations – liquidation basis for the year then ended and changes in partners' capital – liquidation basis for the years ended December 31, 2008 and 2007, and the financial highlights (Note 10) for the years ended December 31, 2008, 2007, 2006 and 2005. These financial statements and financial highlights are the responsibility of the Fund’s management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. The financial highlights (Note 10) for 2004 for Special Situations Fund III, L.P. were audited by other auditors whose report dated February 1, 2005, expressed an unqualified opinion on the financial highlights for 2004.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our procedures included confirmation of securities owned at December 31, 2008, by correspondence with the custodian and brokers. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

As described in Note 1 to the financial statements, the partners of the Fund voted in favor of liquidation on June 10, 2008 and the Fund commenced liquidation shortly thereafter. As a result, the Fund has changed its basis of accounting from the going-concern basis to a liquidation basis.

In our opinion, the financial statements and financial highlights (Note 10) referred to above, present fairly, in all material respects, the financial position of Special Situations Fund III, L.P. as of December 31, 2008, and the results of its operations for the year then ended, and the changes in its partners' capital for the years ended December 31, 2008 and 2007, and the financial highlights for the years ended December 31, 2008, 2007, 2006 and 2005, in conformity with accounting principles generally accepted in the United States of America applied on the bases described in the preceding paragraph.

Weiser LLP

New York, N. Y.

February 25, 2009

SPECIAL SITUATIONS FUND III, L.P.
(A Limited Partnership)

STATEMENT OF FINANCIAL CONDITION - LIQUIDATION BASIS

DECEMBER 31, 2008



ASSETS

Investments, at fair value (cost $6,592,849)		$	2,964,872
Cash and cash equivalents			1,208,566
Other assets			5,366

Total Assets		$	4,178,804

LIABILITIES AND PARTNERS' CAPITAL

Liabilities

Accrued Independent General Partners' fees		$	80,000
Accrued professional fees			64,138
Administrator's fee payable			37,696
Accrued expenses			32,570

Total Liabilities			214,404

Partners' Capital

Limited Partners			3,380,254
Corporate General Partner			536,673
Individual General Partners			47,473

Total Partners' Capital			3,964,400

Total Liabilities and Partners' Capital		$	4,178,804












See the accompanying Notes to the Financial Statements.

	2

SPECIAL SITUATIONS FUND III, L.P.
(A Limited Partnership)

PORTFOLIO OF INVESTMENTS - LIQUIDATION BASIS

DECEMBER 31, 2008

		Fair
Shares	Common Stocks	Value

NOTE 1 - GENERAL:

Organization:

Special Situations Fund III, L.P. (the “Fund”) was organized under the Delaware Revised Uniform Limited Partnership Act on October 18, 1993, and commenced investment operations on January 1, 1994. The Fund is a closed-end interval fund registered under the Investment Company Act of 1940 (the “1940 Act”). The Fund shall have perpetual existence unless sooner dissolved as provided for in the Agreement of Limited Partnership (the “Agreement”). See Liquidation and Dissolution section below.

The Agreement provides for not less than three “Individual General Partners” and a “Corporate General Partner.” The General Partners, as a group, must own not less than one percent (1%) of the Fund’s outstanding Units. The Fund has five Individual General Partners of which four are independent, as defined in the 1940 Act.

The Corporate General Partner and Investment Adviser is MGP Advisers Limited Partnership (“MGP”), of which the General Partner is AWM Investment Company, Inc. (“AWM”). MGP has appointed AWM as agent and nominee, with the rights, power and authority to act on behalf of MGP with respect to the execution of trades and related matters concerning the Fund. Austin W. Marxe, an Individual General Partner of the Fund and a limited partner of MGP owns directly and indirectly a controlling interest in MGP and AWM. Mr. Marxe is primarily responsible for managing the Fund’s investments and performing certain administrative services on its behalf.

The Fund sought long-term capital appreciation by investing primarily in equity securities and securities with equity features of publicly traded companies which possess a technological, market or product niche, which may be, for various reasons, undervalued, or with prospects of going private or being acquired.

Liquidation and Dissolution:

On March 10, 2008, the Independent General Partners approved the submission to a vote of the partners of a proposal to liquidate and dissolve the Fund (the “Liquidation Proposal”) in order to provide the Limited Partners with the opportunity to determine whether the liquidation of the Fund is a preferable alternative to its continued operation. The reduced liquidity of the Fund operating under the Safe Harbor Amendments which limited semi-annual repurchase offers to a maximum of 5% of Units outstanding per semi-annual period (or 10% per year) and increased the repurchase request deadline from 14 days to 60 days prior to the repurchase pricing date as well as the increased expense ratio as a result of various costs not decreasing in proportion to the Fund’s size, were an impetus for the Liquidation Proposal.

SPECIAL SITUATIONS FUND III, L.P.

(A Limited Partnership)

NOTES TO THE FINANCIAL STATEMENTS – LIQUIDATION BASIS

NOTE 1 - GENERAL (CONTINUED):

Liquidation and Dissolution (Continued):

Other considerations included the possibility that sales of the Fund’s securities as part of the liquidation may not result in the Fund receiving the maximum return on these securities due to market conditions at the time of the sales or the constraints imposed by the liquidation. In order to properly consider all relevant factors in determining whether to vote “For” or “Against” the Liquidation Proposal, MGP and the Individual General Partners resolved to withhold their vote until the Special Meeting of Partners.

On June 10, 2008 a Special Meeting of Partners was held whereby the requisite vote was cast in favor of the Liquidation Proposal. Matters discussed included those indicated above as well as the economic and market conditions at the time of the meeting. The current management will continue to operate the Fund during the liquidation process. MGP will continue to serve as the Fund’s Investment Adviser, but will not make new investments unless considered necessary to preserve the value of existing investments as well as invest in short-term liquid securities for cash management purposes. On December 2, 2008 the Independent General Partners approved the initial liquidating distribution of $24 million, representing in excess of 85% of the Fund’s net assets at the time, which was paid on December 8, 2008.

NOTE 2 - ACCOUNTING POLICIES:

The Fund measures its assets and liabilities at the amounts of fair value or cash, as appropriate, expected in liquidation and reports changes in estimates when they are known. The operating results as reflected on the statement of operations consist of those results from January 1, 2008 to June 10, 2008 (date resolved to liquidate) and the results of operations from that point to the end of the fiscal period.

Securities traded on a securities exchange or on the NASDAQ System are valued at the last reported sales price on the last business day of the reporting period. Securities for which no sale occurred on such day are valued at the average of the highest bid and lowest asked prices on the last trading day. Securities for which market quotations are not available are recorded at fair value as determined in good faith by the Individual General Partners. Warrant valuations determined in good faith by the General Partner utilize the Black Scholes model and take into account other factors deemed relevant. Securities transactions are recorded on trade date. Realized gains and losses on sales of securities are determined using the specific identification cost method. Dividend income is recorded on the ex-dividend date and interest income is recorded on the accrual basis.

SPECIAL SITUATIONS FUND III, L.P.

(A Limited Partnership)

NOTES TO THE FINANCIAL STATEMENTS – LIQUIDATION BASIS

NOTE 2 - ACCOUNTING POLICIES (CONTINUED):

Cash and cash equivalents consist principally of cash balances held in a brokerage account. The Fund considers all money market accounts and all highly liquid debt instruments purchased with original maturities of three months or less to be cash equivalents.

The Fund entered into agreements to lend portfolio securities to qualified borrowers in order to earn additional income. The terms of each lending agreement require that loans are secured by cash or securities with an aggregate market value at least equal to a percentage of the market value of the loaned securities agreed upon by the borrower and the Fund (which shall be not less than 100% of the market value of the loaned securities), computed on a daily basis. If the borrower defaults on its obligation to return the securities loaned because of insolvency or other reasons, the Fund could experience delays and costs in recovering the securities loaned or in gaining access to collateral. Gain or loss in the fair value of portfolio securities loaned that may occur during the term of the loan will be attributed to the Fund. At December 31, 2008, there were no securities loaned.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes – an Interpretation of FASB 109, Accounting for Income Taxes”. This Interpretation, which applies to all entities, including pass through entities such as the Fund, provides guidance for how uncertain tax positions should be recognized, measured, presented and disclosed in the financial statements. It is effective for all fiscal years beginning after December 15, 2006, and is to be applied to all open tax years as of the date of effectiveness. Management has concluded that there is no impact on the Fund’s financial statements as a result of implementing FIN 48.

NOTE 3 - ALLOCATION OF ACCOUNTING INCOME AND LOSSES:

The Agreement provides for allocations of profits and losses at the close of each fiscal period (see Note 4).

Net income is allocated: first, to MGP to the extent of any previous net losses allocated to MGP in excess of the other partners’ capital balances; next, to the partners in proportion to the number of Units held by each to the extent of net losses previously allocated to them; and, thereafter, 80% to the partners in proportion to the number of Units held by each and 20% performance allocation to MGP. If there is a loss for a fiscal period, the performance allocation to MGP will not apply to future periods until the loss has been recovered. The amount of loss carryover at December 31, 2008 was $12,296,858.

SPECIAL SITUATIONS FUND III, L.P.

(A Limited Partnership)

NOTES TO THE FINANCIAL STATEMENTS – LIQUIDATION BASIS

NOTE 3 - ALLOCATION OF ACCOUNTING INCOME AND LOSSES (CONTINUED):

Net losses are allocated to the partners in proportion to the number of Units held by each, provided, however, that losses in excess of an Individual General Partner’s or a Limited Partner’s capital balance will be allocated to MGP.

NOTE 4 - PARTNER CAPITAL ACCOUNT TRANSACTIONS:

All net income allocated to partners will be reinvested. In order to maintain a $25,000 price per Unit, the number of Units held by each partner at the close of each fiscal period (generally June 30 and December 31, commencing December 31, 1994), is adjusted to equal the partner’s capital account divided by $25,000.

As of the close of each fiscal period, the Fund will generally offer to repurchase 5% of the outstanding Units. The repurchase request deadline had generally been June 16 and December 17, of each year, but is subject to change based on the Securities and Exchange Commission’s approval of the exemptive request. In light of the liquidation discussed in Note 1, the Fund’s final offer to repurchase Units was for the period ended June 30, 2008. Future liquidating distributions will be determined by management based on relative cash balances.

The Fund has the right to sell additional Units at the beginning of each fiscal period, but will no longer be doing so as it is in the process of liquidating.

Changes in Units outstanding are as follows:

				Corporate			Individual
	Limited			General			General
	Partners			Partner			Partners			Total

Balance, December 31, 2006		1,561.3407			186.5161			18.3861			1,766.2429
Additional Units sold		3.2800			-			-			3.2800
Transfers		0.0275			(0.0275	)		-			-
Semi-annual adjustments of Units		(56.9511	)		12.7165			(0.7646	)		( 44.9992	)
Repurchases		(175.5373	)		-			-			(175.5373	)
Balance, December 31, 2007		1,332.1598			199.2051			17.6215			1,548.9864
Semi-annual adjustment of Units		(187.1672	)		(27.9882	)		(2.4758	)		(217.6312	)
Repurchases		(66.5677	)		-			-			(66.5677	)
Balance, June 30, 2008		1,078.4249			171.2169			15.1457			1,264.7875
Semi-annual adjustment of Units		(124.6677	)		(19.7930	)		(1.7509	)		(146.2116	)
Liquidating distribution		(818.5469	)		(129.9572	)		(11.4959	)		(960.0000	)
Balance, December 31, 2008		135.2103			21.4667			1.8989			158.5759

SPECIAL SITUATIONS FUND III, L.P.

(A Limited Partnership)

NOTES TO THE FINANCIAL STATEMENTS – LIQUIDATION BASIS

NOTE 5 - PURCHASES AND SALES OF SECURITIES:

Purchases and sales of securities for the year ended December 31, 2008 aggregated $7,106,749 and $30,486,379, respectively.

NOTE 6 - INCOME TAXES:

No provision for income taxes has been made in the accompanying financial statements as each partner is individually responsible for reporting income or loss based upon the partner’s respective share of the Fund’s income and expenses reported for income tax purposes.

NOTE 7 - RELATED PARTY TRANSACTIONS:

AWM is the administrator of the Fund. The administrator’s fee is computed monthly at an annual rate of 0.75% of the average net assets.

For 2008, the Fund paid each Independent General Partner an annual fee of $20,000. Effective January 1, 2009 the annual fee was reduced to $5,000 for each Independent General Partner.

NOTE 8 - OTHER AGREEMENTS:

The Fund entered into a consulting agreement whereby the consultant will provide management and financial advisory services to companies in which the Fund invests (“covered investments”). As compensation, the consultant earns ten percent of the appreciation on each covered investment for the agreed upon period. Of this amount, one half is currently payable and the remainder is deferred until a final payment date, as further defined in the consulting agreement.

NOTE 9 - FAIR VALUE MEASUREMENTS:

The Fund adopted Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS No. 157”) as of January 1, 2008 which expands disclosures about investments that are measured and reported at fair value. SFAS No. 157 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels explained below:

Level 1

Quoted prices are available in active markets for identical investments as of the reporting date. Investments included in this category include listed equities and listed derivatives. As required by SFAS No. 157, the Fund does not adjust the quoted price for these investments, even in situations where the Fund holds a large position and the sale could reasonably impact the quoted price.

SPECIAL SITUATIONS FUND III, L.P.

(A Limited Partnership)

NOTES TO THE FINANCIAL STATEMENTS – LIQUIDATION BASIS

NOTE 9 - FAIR VALUE MEASUREMENTS (CONTINUED):

Level 2

Pricing inputs are other than quoted market prices in active markets, which are either directly or indirectly observable as of the reporting date, and fair value can be determined through the use of models or other valuation methodologies. Investments which are generally included in this category include corporate debt, less liquid and restricted equity securities.

Level 3

Pricing inputs are unobservable for the investment and include situations where there is little, if any, market activity for the investment. The inputs into the determination of fair value required significant management judgment or estimation. Investments that are included in this category generally include interests in corporate private equity and warrants.

The following table summarizes the valuation of the Fund’s investments by SFAS No. 157 fair value hierarchy as described above as of December 31, 2008.

Description	Total		Level 1		Level 2		Level 3
Common Stocks	$	1,241,564	$	978,402	$	262,846	$	316
Preferred Stocks		1,065,894		-		451,259		614,635
Corporate Debt		290,852		-		-		290,852
Warrants		366,562		-		1,000		365,562
Total	$	2,964,872	$	978,402	$	715,105	$	1,271,365

The inputs or methodology used for valuing securities are not necessarily an indication of the risk associated with investing in those securities.

The following table discloses a reconciliation of investments at measured fair value on a recurring basis using significant unobservable inputs (Level 3) during the year ended December 31, 2008.

	Total			Common Stocks		Preferred Stocks			Corporate Debt			Warrants
Beginning Balance, January 1, 2008	$	1,756,078		$	-	$	614,635		$	210,755		$	930,688
Total gains or losses		(631,145	)		-		-			(66,019	)		(565,126	)
Purchases		22,291			-		22,291			-			-
Transfers in / out of Level 3		124,141			316		(22,291	)		146,116			-
Ending Balance, December 31, 2008	$	1,271,365		$	316	$	614,635		$	290,852		$	365,562

SPECIAL SITUATIONS FUND III, L.P.

(A Limited Partnership)

NOTES TO THE FINANCIAL STATEMENTS – LIQUIDATION BASIS

NOTE 9 - FAIR VALUE MEASUREMENTS (CONTINUED):

		Total				Common Stocks				Preferred Stocks				Corporate Debt				Warrants
The amount of gains (losses) included in income attributable to the change in unrealized gains (losses) relating to assets still held at December 31, 2008		$	(630,276	)		$	-			$	-			$	(65,150	)		$	(565,126	)

Gains and losses (realized and unrealized), if any, would be included in the net realized loss on investments and net change in unrealized depreciation in the Statement of Operations – Liquidation Basis.

The adoption of SFAS No. 157 did not have an impact on the Fund’s financial position or results of operations.

NOTE 10 - FINANCIAL HIGHLIGHTS:

	Year Ended December 31,
	2008			2007			2006			2005			2004
Ratio of investment expenses to average net assets1		0.00	%		0.00	%		0.00	%		0.00	%		0.00	%

Ratio of operating expenses to average net assets		1.73	%		1.33	%		1.65	%		0.86	%		0.84	%

Ratio of total expenses to average net assets		1.73	%		1.33	%		1.65	%		0.86	%		0.84	%

Ratio of net income (loss) to average net assets		(29.37	%)		(2.52	%)		15.21	%		2.53	%		23.09	%

Portfolio turnover rate		35.22	%		43.06	%		81.20	%		55.90	%		63.46	%
1The investment expenses reflected in the above ratio include, but are not limited to, consulting fees having a direct correlation to the performance of “covered investments,” as further defined in Note 8 herein.

SPECIAL SITUATIONS FUND III, L.P.

(A Limited Partnership)

NOTES TO THE FINANCIAL STATEMENTS – LIQUIDATION BASIS

NOTE 11 - RETURN ON PARTNER INVESTMENT:

At December 31, 2008, the value of a $25,000 investment made at each respective subscription date is as follows:

Subscription Date	Value		Subscription Date	Value
January 1, 1994	$	179,890	January 1, 2002	$	38,161
January 1, 1995		164,457	July 1, 2002		43,535
July 1, 1995		145,620	January 1, 2003		47,116
January 1, 1996		121,439	July 1, 2003		36,055
July 1, 1996		91,674	January 1, 2004		25,261
January 1, 1997		86,763	July 1, 2004		23,483
July 1, 1997		82,184	January 1, 2005		21,040
January 1, 1998		72,912	July 1, 2005		22,816
July 1, 1998		74,641	January 1, 2006		20,609
January 1, 1999		82,879	July 1, 2006		19,420
July 1, 1999		76,474	January 1, 2007		18,213
January 1, 2000		49,845	July 1, 2007		17,332
July 1, 2000		42,696	January 1, 2008		19,004
January 1, 2001		43,665	July 1, 2008		22,110
July 1, 2001		38,172

SPECIAL SITUATIONS FUND III, L.P.

(A Limited Partnership)

NOTES TO THE FINANCIAL STATEMENTS – LIQUIDATION BASIS

NOTE 12 - INVESTMENTS IN RESTRICTED AND ILLIQUID SECURITIES:

The Fund has made investments in securities that are not freely tradable due to Securities and Exchange Commission’s regulations. These restricted securities may not be sold except in exempt transactions or when they have become registered under the Securities Act of 1933. Investing in restricted securities generally poses a greater risk than investing in more widely held, publicly traded companies. Restrictions imposed on the sale of these securities and the lack of a secondary market may affect the timing and price obtained for such sales. The following is a list of restricted and illiquid securities valued by the Fund as of December 31, 2008:

Issuer	Type of Security	Acquisition Date	Acquisition Cost		Value		Value as a % of Partners’ Capital
Excapsa Software, Inc.	Common	2/7/06	$	282,219	$	40,609		1.02	%
E Ink Corporation, Series A	Preferred	11/7/05		241,773		241,773		6.10	%
E Ink Corporation, Series B	Preferred	7/17/07		33,242		33,242		0.84	%
E Ink Corporation, Series B	Preferred	9/12/07		84,952		84,952		2.14	%
Verdasys, Inc. Series B	Preferred	9/3/04		201,478		254,668		6.42	%
Vertical Communications	Preferred	4/16/08		22,597		13,200		0.33	%
Total restricted and illiquid securities			$	866,261	$	668,444		16.85	%

NOTE 13 - CREDIT RISK CONCENTRATION:

Cash and cash equivalents consist principally of a balances held in a brokerage account with Morgan Stanley & Co. Incorporated. The balances are secured by the Securities Investor Protection Corporation up to $500,000, including up to $100,000 for free cash balances. Cash balances and securities in excess of these limits are covered by additional insurance maintained by the broker. Amounts in excess of insurance coverage are secured by the good faith and credit of the broker.

SPECIAL SITUATIONS FUND III, L.P.

(A Limited Partnership)

NOTES TO THE FINANCIAL STATEMENTS – LIQUIDATION BASIS

NOTE 14 - APPROVAL OF ADVISORY CONTRACT (UNAUDITED):

At a special meeting of the Independent General Partners (“IGPs”) of the Fund held on December 2, 2008, the IGPs considered whether to approve the continuation of the existing Investment Advisory Agreement (the “Advisory Agreement”) between the Fund and MGP. In addition to the materials the IGPs had reviewed throughout the course of the year, the IGPs received materials relating to the advisory agreement before the meeting and had the opportunity to ask questions and request further information in connection with its consideration.

The approval of the Advisory Agreement and the continuation of MGP as the investment adviser of the Fund is based upon the following findings as well as the specific considerations discussed below: (1) that the Advisory Agreement with MGP is in the best interest of the Fund; (2) that the services to be performed by MGP pursuant to the Advisory Agreement are services required for the operation of the Fund; (3) that MGP can provide services the nature and quality of which are at least equal to those provided by others offering the same services; and (4) that the fees for such services are fair and reasonable in light of the usual and customary charges made by others for services of the same nature and quality.

In determining whether to approve the Advisory Agreement, the IGPs considered various relevant factors, including those discussed below.

Nature, Extent and Quality of Service

In considering the nature, extent and quality of service to the Fund, the IGPs reviewed the Fund’s investment objectives and strategy along with the advisory services provided to the Fund by MGP over both short- and long-term periods. The services provided include investment research, portfolio management and trading. The IGPs took into account the organizational depth and stability of the firm, noting that the Fund managers have considerable investment and trading experience and have managed the Fund since its inception. Furthermore, they do not use brokerage commissions to purchase third-party research.

Investment Performance

The IGPs considered the short- and long-term performance of the Fund, including both lesser and more profitable periods and noted favorable performance over the Fund’s history as compared with relevant market indices.

SPECIAL SITUATIONS FUND III, L.P.

(A Limited Partnership)

NOTES TO THE FINANCIAL STATEMENTS – LIQUIDATION BASIS

NOTE 14 - APPROVAL OF ADVISORY CONTRACT (UNAUDITED) (CONTINUED):

Costs of Services Provided

The IGPs considered the compensation arrangement with MGP, such that the performance allocation of 20% is customary for the Fund’s peer group. The IGPs also noted the use of a “highwater” mark in determining the profit threshold. The IGPs reviewed the expense ratio of the Fund and determined it to be fair and reasonable as compared to the Fund’s peer group. Although the administrative fee charged is below industry averages, the overall expense ratio has increased due to the reduction in the net assets of the Fund resulting from the exchange offer effective January 1, 2006.

Profits

The IGPs considered the level of MGP’s profits in managing the Fund and concluded that the profit was fair and customary based on the Fund’s peer group.

Economies of Scale

The IGPs, in considering economies of scale, reviewed whether there have been or if there is a potential for the realization of future economies of scale, and whether the Fund’s investors would benefit from such scale. The IGPs noted that the consideration of economies of scale is not a determining factor as it relates to the approval of the Advisory Agreement with MGP.

In considering whether to approve the continuation of the advisory agreement, the IGPs did not weigh any one factor more than another. They concluded that the approval of the agreement was in the best interest of the Fund. The advisory agreement will continue for one year and is renewable by the IGPs after that for successive one year periods.

NOTE 15 - PROXY VOTING (UNAUDITED):

A description of the policies and procedures that the Fund uses to determine how to vote proxies relating to its portfolio securities is available (1) without charge, upon request, by calling (212) 319-6670 or (2) on the Securities and Exchange Commission (“SEC”) website at www.sec.gov.

The Fund’s proxy voting record for the most recent 12-month period ended June 30 is available (1) without charge, upon request, by calling (212) 319-6670 or (2) on the SEC’s website at www.sec.gov. Information as of June 30 each year will generally be available by the following August 31.

SPECIAL SITUATIONS FUND III, L.P.

(A Limited Partnership)

NOTES TO THE FINANCIAL STATEMENTS – LIQUIDATION BASIS

NOTE 16 - FORM N-Q (UNAUDITED):

The Fund files a complete Portfolio of Investments for the first and third quarters of its fiscal year with the SEC on Form N-Q within 60 days of the end of such fiscal quarter. The Fund’s Form N-Q is available on the SEC’s website at www.sec.gov and may be reviewed and copied at the SEC’s Public Reference Room in Washington, DC. Information on the operation of the SEC’s Public Reference Room may be obtained by calling 1-800-SEC-0330.

Item 2. Code of Ethics.

The Registrant has adopted a Code of Ethics (the “Code of Ethics”) that applies to its principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, regardless of whether these individuals are employed by the Registrant or a third party. The Registrant undertakes to provide to any person without charge, upon request, a copy of the Code of Ethics. Such request can be made to Special Situations Fund III, L.P. at (212) 319-6670, 527 Madison Avenue, Suite 2600, New York, New York 10022, Attention: Rose M. Carling.

There have been no amendments to the Code of Ethics during the period covered by this report. In addition, during the period covered by this report, the Registrant has not granted any waivers, including an implicit waiver, from a provision of the Code of Ethics.

Item 3. Audit Committee Financial Expert.

The Registrant’s board of directors (or persons performing similar functions) has determined that Stanley S. Binder possesses the technical attributes identified in Instruction 2(b) of Item 3 to Form N-CSR to qualify as an “audit committee financial expert,” and has designated Stanley S. Binder as the audit committee financial expert. Stanley S. Binder is an “independent” director (or the functional equivalent thereof) pursuant to paragraph (a)(2) of Item 3 to Form N-CSR.

Item 4. Principal Accountant Fees and Services.

Audit Fees. The aggregate fees billed for each of the last two fiscal years for professional services rendered by the principal accountant for the audit of the Registrant’s annual financial statements or services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements for those fiscal years are $74,200 and $73,800 for 2008 and 2007, respectively.

Audit-Related Fees. There were no fees billed in each of the last two fiscal years for assurance and related services by the principal accountant that are reasonably related to the performance of the audit of the Registrant’s financial statements and are not reported under “Audit Fees” above.

Tax Fees. The aggregate fees billed in each of the last two fiscal years for professional services rendered by the principal accountant for tax compliance, tax advice, and tax planning are $18,100 and $22,800 for 2008 and 2007, respectively.

All Other Fees. There were no fees billed in each of the last two fiscal years for products and services provided by the principal accountant, other than the services reported above.

The audit committee of the Registrant was organized in 2003. All services to be performed for the Registrant by the Registrant’s accountant must be pre-approved by the audit committee. The above referenced fees for 2008 were pre-approved by the audit committee.

The aggregate fees paid by the Registrant for non-audit professional services rendered by the Registrant’s accountant to the Registrant’s investment advisor and any entity controlling, controlled by, or under common control with the Registrant’s investment adviser that provides ongoing services to the Registrant for 2008 and 2007 were $22,006 and $12,025, respectively.

Item 5. Audit Committee of Listed Registrants.

Not applicable.

Item 6. Schedule of Investments

The Audited Schedule of Investments is included in the report to shareholders filed under Item 1 of the Form.

Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End Management Investment Companies

The Registrant has adopted the following proxy voting policies and procedures of its investment adviser, MGP Advisers Limited Partnership:

PROXY VOTING POLICIES AND PROCEDURES

These policies and procedures apply to the voting of proxies by MGP Advisers Limited Partnership (the “Adviser”) for those client accounts over which the Adviser has proxy voting authority. Adviser is the investment adviser for Special Situations Fund III, L.P.

GENERAL

The Adviser’s proxy voting policies and procedures are designed to ensure that the Adviser complies with the requirements under Rule 206(4)-6 and Rule 204-2 promulgated under the Investment Advisers Act of 1940, as amended, and fulfills its obligations thereunder with respect to proxy voting, disclosure, and recordkeeping.

The Adviser’s objective is to ensure that its proxy voting activities on behalf of its clients are conducted in a manner consistent, under all circumstances, with the best interest of the clients. For most matters, however, the Adviser’s policy is not to vote where it believes the outcome is not in doubt in order to avoid the unnecessary expenditure of time and the cost to review the proxy materials in detail and carry out the vote. In such circumstances the Adviser believes that the client is best served by the Adviser’s devoting its time to investment activities on the client’s behalf.

PROXY VOTING POLICIES

The Adviser is committed to voting proxies in a manner consistent with the best interests of its clients. While the decision whether or not to vote a proxy must be made on a case-by-case basis, the Adviser generally does not vote a proxy if it believes the proposal is not adverse to the best interests of the client or if adverse, the outcome of the vote is not in doubt. In the situations where the Adviser does vote a proxy, the Adviser generally votes proxies in accordance with the following general guidelines:


Proxy Proposal Issue	Adviser’s Voting Policy

Routine Election of Directors	For
Issuance of Authorized Common Stock	For
Stock Repurchase Plans	For
Domestic Reincorporation	For
Director Indemnification	For
Require Shareholder Approval to Issue Preferred Stock	For
Require Shareholder Approval to Issue Golden Parachutes	For
Require Shareholder Approval of Poison Pill	For
Shareholders’ Right to Call Special Meetings	For
Shareholders’ Right to Act by Written Consent	For
Shareholder Ability to Remove Directors With or Without Cause	For
Shareholders Electing Directors to Fill Board Vacancies	For
Majority of Independent Directors	For
Board Committee Membership Exclusively of Independent Directors	For
401(k) Savings Plans for Employees	For
Anti-greenmail Charter or By-laws Amendments	For
Corporate Name Change	For
Ratification of Auditors	For
Supermajority Vote Requirement	Against
Blank Check Preferred	Against
Dual Classes of Stock	Against
Staggered or Classified Boards	Against
Fair Price Requirements	Against
Limited Terms for Directors	Against
Require Director Stock Ownership	Against

The following proxy proposal issues are so fact sensitive that no general voting policy with respect to such issues may be established by the Adviser:


Reprice Management Options	Fact Sensitive
Adopt/Amend Stock Option Plan	Fact Sensitive
Adopt/Amend Employee Stock Purchase Plan	Fact Sensitive
Approve Merger/Acquisition	Fact Sensitive
Spin-offs	Fact Sensitive
Corporate Restructurings	Fact Sensitive
Asset Sales	Fact Sensitive
Liquidations	Fact Sensitive
Adopt Poison Pill	Fact Sensitive
Golden Parachutes	Fact Sensitive
Executive/Director Compensation	Fact Sensitive
Social Issues	Fact Sensitive
Contested Election of Directors	Fact Sensitive
Stock Based Compensation for Directors	Fact Sensitive
Increase Authorized Shares	Fact Sensitive
Tender Offers	Fact Sensitive
Preemptive Rights	Fact Sensitive
Debt Restructuring	Fact Sensitive
Foreign Reincorporation	Fact Sensitive

PROXY VOTING PROCEDURES

The general partner (or other principals) of the Adviser will have the responsibility of voting proxies received by the Adviser on behalf of its clients. The Adviser will evaluate whether to vote the proxy proposals received by the Adviser. If the proxies are voted, the proxy proposals received by the Adviser and designated above in the proxy voting policies as “For” or “Against” will be voted by the Adviser in accordance with the proxy voting policies, and proxy proposals received by the Adviser and designated above in the proxy voting policies as “Fact Sensitive” (or not addressed in the proxy voting policies) will be reviewed by the Adviser on a case-by-case basis.

Notwithstanding the foregoing, the Adviser may vote a proxy contrary to the proxy voting guidelines if the Adviser determines that such action is in the best interest of the client. In the event that the Adviser votes contrary to the proxy voting guidelines, the Adviser will document the basis for the Adviser’s contrary voting decision.

In addition to not voting proxies where the Adviser deems the expenditure of time and cost of voting would exceed the anticipated benefit to the client, the Adviser may choose not to vote proxies in certain situations or for certain clients, such as (i) where a client has informed the Adviser that it wishes to retain the right to vote the proxy, (ii) where the proxy is received for a client account that has been terminated, or (iii) where a proxy is received by the Adviser for a security it no longer manages on behalf of a client.

MATERIAL CONFLICTS OF INTEREST

The Adviser may occasionally be subject to material conflicts of interest in the voting of proxies due to business or personal relationships it maintains with persons having an interest in the outcome of certain votes. The Adviser, its affiliates and/or its employees may also occasionally have business or personal relationships with the proponents of proxy proposals, participants in proxy contests, corporate directors and officers, or candidates for directorships.

If at anytime, the Adviser becomes aware of a material conflict of interest relating to a particular proxy proposal, the Adviser will handle the proposal as follows:

·	If the proposal is designated in proxy voting policies above as “For” or “Against,” the proposal will be voted by the Adviser in accordance with the proxy voting policies, provided little discretion on the part of the Adviser is involved; or

If the proposal is designated in the proxy voting policies above as “Fact Sensitive” (or not addressed in the proxy voting policies), the Adviser will either (i) disclose to the client such material conflict and vote the client’s shares in accordance with the client’s instructions or (ii) take such other action as is necessary to ensure that the Adviser’s vote (including the decision whether to vote) is based on the client’s best interest and not affected by the Adviser’s material conflict of interest.

PROXY VOTING RECORDS

In accordance with Rule 204-2, the Adviser will maintain the following records in connection with the Adviser’s proxy voting policies and procedures:

·	a copy of the proxy voting policies and procedures;

·	a copy of all proxy statements received regarding client’s securities;

·	a record of each vote the Adviser casts on behalf of a client;

written records of client requests for proxy voting information, including a copy of each written client request for information on how the Adviser voted proxies on behalf of the requesting client, and a copy of any written response by the Adviser to any (written or oral) client request for information on how the Adviser voted proxies on behalf of the requesting client; and

·	any documents prepared by the Adviser that were material to making a decision on how to vote, or that memorialized the basis for a voting decision.

Each of the foregoing records will be maintained and preserved by the Adviser for five years from the end of the last fiscal year in which an entry was made on such record, and for the first two years of such five-year period, shall be maintained at an appropriate office of the Adviser. Notwithstanding the foregoing, the Adviser may rely on proxy statements filed on the SEC’s EDGAR system instead of keeping its own copies. In addition, the Adviser may also rely upon a third party to maintain the foregoing records, provided such third party has provided to the Adviser an undertaking to provide a copy of such records promptly upon request.

DISCLOSURE TO CLIENTS

A copy of the Adviser’s written proxy voting policies and procedures will be provided to clients upon written request to the Adviser. In addition, information regarding how a client’s proxies were voted by the Adviser will be provided to a client upon written request to the Adviser.

Item 8.

Portfolio Managers of Closed-End Management Investment Companie.

As of the original filing of this report on March 4, 2009, Austin Marxe, President of AWM Investment Company, Inc, (“AWM”) since 1991 and David Greenhouse, Vice-President of AWM since 1992, are primarily responsible for the day-to-day management of the registrant’s portfolio. AWM serves as the general partner of MGP Advisers Limited Partnership (“MGP”), the registrant’s investment adviser. Pursuant to an agreement dated June 7, 2006 by and between the registrant, MGP and AWM, MGP appointed AWM as agent and nominee, with the rights, power and authority to execute trades and transact such other business as outlined in such agreement on behalf of the registrant. Mr. Marxe, Mr. Greenhouse and Adam Stettner are the limited partners of MGP. Mr. Marxe also serves as an Individual General Partner of the registrant.

Mr. Marxe, Mr. Greenhouse and Mr. Stettner also serve as members of the general partners to six other Special Situations funds (the “Affiliates”) that have performance based advisory fees, with combined total assets of $ 460,500,578 as of December 31, 2008.

On June 10, 2008 a Special Meeting of Partners was held whereby the requisite vote was cast in favor of a Liquidation Proposal. The current management will continue to operate the Fund during the liquidation process. MGP will continue to serve as the Fund’s Investment Adviser, but will not make new investments unless considered necessary to preserve the value of existing investments as well as invest in short-term liquid securities for cash management purposes.

MGP, the registrant’s investment advisor, receives a 20% performance allocation at six month periods ending June 30 and December 31. If there is a loss for an accounting period, the performance allocation to MGP will not apply to future periods until the loss has been recovered. All investment advisers of the Special Situations funds managed by Mr. Marxe, Mr. Greenhouse and Mr. Stettner receive similar 20% performance based advisory fees with loss recovery provisions.

As of December 31, 2008, Austin Marxe and David Greenhouse each own between $100,000 and $500,000 of equity securities in the registrant.

Item 9.

Purchases of Equity Securities by Closed-End Management Investment Company and Affiliated Purchasers.

Not applicable at this time.

Item 10.

Submission of Matters to a Vote of Security Holders.

Item 11.

Controls and Procedures.

(a) Based on an evaluation of the registrant's disclosure controls and procedures as of a date within 90 days of the filing date of this report, the registrant’s principal executive and principal financial officers, or persons performing similar functions, concluded that the disclosure controls and procedures are effective.

(b) There were no significant changes in the registrant's internal control over financial reporting that occurred during the registrant's last fiscal half-year that have materially affected, or are reasonably likely to materially affect, the registrant's internal control over financial reporting.

Item 12.

Exhibits.

(a)(1) NOT APPLICABLE.

(a)(2) CERTIFICATIONS REQUIRED BY ITEM 11(a)(2) OF FORM N-CSR ARE FILED HEREWITH AS EX-99.CERT.

(b) CERTIFICATIONS REQUIRED BY ITEM 11(b) OF FORM N-CSR ARE FILED HEREWITH AS EX-99.906CERT.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

SPECIAL SITUATIONS FUND III, L.P.

By: _/s/Austin Marxe__

Austin Marxe, Principal Executive Officer

Date: March 4, 2009

Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

By: _/s/Austin Marxe___

Austin Marxe, Principal Executive Officer

Date: March 4, 2009

By: _/s/ Peter E. Price_

Peter E. Price, Chief Operating Officer

Date: March 4, 2009

	Biotechnology 0.00%
43,151	Tapestry Pharmaceuticals, Inc.	$	73

	Business Services 0.00%
15,600	UTIX Group, Inc.		2

	Communication Equipment - Software 1.12%
1,424,157	ION Networks, Inc.		35,604
293,995	Vertical Communications, Inc.		8,820
			44,424

	Computer Services - Software 4.88%
87,715	3Dfx Interactive, Inc.		175
302,600	Excapsa Software, Inc. (Canada) (Illiquid)		40,609
430,000	Interplay Entertainment Corporation		34,400
36,698	LocatePlus Holdings Corporation		1,101
3,158	Primal Solutions, Inc.		316
42,456	Unify Corporation		116,753
			193,354

	Educational Products - Services 1.79%
59,176	China Education Alliance, Inc. (China)		71,011

	Electronic Components 0.92%
28,482	American Technology Corporation		24,210
73,125	Interlink Electronics, Inc.		12,066
			36,276

	Electronic - Display 0.00%
993,474	E Ink Corporation (Illiquid)		-

	Electronic Instruments 2.97%
18,500	Image Sensing Systems, Inc.		117,845

	Electronic Semiconductor 0.01%
77,750	PSi Technologies Holdings, Inc. (Philippines)		233

	Energy - Services 0.29%
34,489	Renegy Holdings, Inc.		11,381

	Environmental Services 2.94%
833,300	PDG Environmental, Inc.		116,662


See the accompanying Notes to the Financial Statements.

	3

	Financial Services - Miscellaneous 3.28%
26,330	Marlin Business Services Corp.	$	69,774
29,809	MicroFinancial Incorporated		60,214
			129,988

	Medical Devices & Equipment 0.02%
4,181	Precision Optics Corporation, Inc.		836

	Medical Instruments 0.06%
27,790	Caprius, Inc.		2,223

	Oil Equipment 0.00%
650	Beluga Composites Corporation		-

	Paper - Packaging 0.06%
44,211	Chase Packaging Corporation		2,211

	Retail 0.01%
33,737	Odimo Incorporated		506

	Security Equipment 2.55%
12,800	ICX Technologies, Inc.		101,248

	Semiconductor Equipment 2.35%
27,152	Integral Vision, Inc.		3,801
91,724	Nova Measuring Instruments, Ltd. (Israel)		50,448
35,299	Tegal Corporation		38,829
			93,078

	Services 2.64%
35,740	Collectors Universe, Inc.		104,718

	Technology - Miscellaneous 2.75%
13,270	Scopus Video Network, Ltd. (Israel)		69,004
66,610	Vuance, Ltd. (Israel)		39,966
			108,970

	Telecom Equipment 1.29%
17,000	Peco II, Inc.		51,000

	Telecom Services .93%
18,652	WPCS International Incorporated		36,744


See the accompanying Notes to the Financial Statements.

	4

	Telecommunications 0.47%
12,356	Emrise Corporation	$	18,781


	Total Common Stocks 31.32% (cost $5,367,243)		1,241,564


		Fair
Shares	Preferred Stocks	Value

	Communications Equipment - Software 0.48%
100	Vertical Communications, Inc. 10% convertible	$	5,660
22	Vertical Communications, Inc. convertible (Restricted)		13,200
			18,860

	Data Security 6.42%
100,739	Verdasys, Inc. Series B convertible (Illiquid)		254,668

	Electronic - Display 9.08%
549,484	E Ink Corporation Series A (Illiquid)		241,773
904,490	E Ink Corporation Series B (Illiquid)		118,194
			359,967

	Food 10.64%
35,163	Zhongpin, Inc. convertible (China)		421,956

	Medical Instruments 0.26%
1,612	Caprius, Inc. convertible		2,499
468	Caprius, Inc. convertible		7,944
			10,443

	Total Preferred Stocks 26.89% (cost $875,801)		1,065,894








See the accompanying Notes to the Financial Statements.

	5

	Computer Services - Software 2.51%
$ 9,167	Primal Solutions, Inc. 10% convertible, due 12/31/09	$	3,652
$ 41,716	Unify Corporation 5% convertible, due 10/31/10		41,716
$ 14,275	Unify Corporation 5% convertible, due 10/31/11		14,275
$ 40,000	Unify Corporation Revolving Credit, due 10/31/10		40,000
			99,643

	Consumer Products 2.44%
$ 120,886	Rockford Corporation 4.5% convertible, due 6/11/09		96,709

	Electronic Components 1.97%
$ 78,000	Interlink Electronics, Inc. 8% convertible, due 7/19/10		78,000

	Technology - Miscellaneous 0.41%
$ 33,000	Vuance, Ltd. 8% convertible, due 11/19/09 (Israel)		16,500

	Total Corporate Debt 7.33% (cost $337,043)		290,852


		Fair
Warrants	Warrants	Value

	Biotechnology 0.06%
96,038	La Jolla Pharmaceutical Company 12/14/10	$	893
3,847	Metabasis Therapeutics, Inc. 9/30/10		115
142,000	Opexa Therapeutics, Inc. 4/13/11		1,278
100,000	Tapestry Pharmaceuticals, Inc. 4/6/11		80
			2,366

	Building Materials 0.02%
200,000	American Mold Guard, Inc. Class A 4/26/11		400
200,000	American Mold Guard, Inc. Class B 4/26/11		600
			1,000

	Business Services 0.00%
1,500,000	UTIX Group, Inc. 1/13/11		-
1,731	UTIX Group, Inc. 11/9/11 (Restricted)		-
6,924	UTIX Group, Inc. 9/28/12 (Restricted)		-
6,924	UTIX Group, Inc. 11/15/12 (Restricted)		-
			-


See the accompanying Notes to the Financial Statements.

	6

	Communication Equipment - Software 0.39%
9,523	Vertical Communications, Inc. 9/28/15	$	285
94,340	Vertical Communications, Inc. 12/1/16		1,887
445,818	Vertical Communications, Inc. 6/27/18		13,375
			15,547

	Computer Services - Software 0.59%
805,910	LocatePlus Holding Corporation 7/8/10		242
55,000	Primal Solutions, Inc. 3/31/11		-
74,914	Unify Corporation 4/26/09		3,745
53,600	Unify Corporation 10/31/12		19,296
			23,283

	Consumer Products 0.00%
5,713	Rockford Corporation 6/11/09		-

	Electronic Components 0.22%
14,450	American Technology Corporation 7/18/09		289
32,422	American Technology Corporation 8/6/10		5,836
30,952	Interlink Electronics, Inc. 7/19/12		2,476
			8,601

	Electronic Equipment 0.09%
11,246	Iteris, Inc. B 9/28/11		3,599

	Energy - Technology 2.51%
175,438	Capstone Turbine Corporation 1/23/12		56,140
33,722	Quantum Fuel Systems Technologies Worldwide, Inc. 4/27/14		12,815
80,000	Quantum Fuel Systems Technologies Worldwide, Inc. 12/22/14		30,400
			99,355

	Food 4.94%
25,683	Zhongpin, Inc. 1/30/11		195,865

	Medical Instruments 0.09%
222,320	Caprius, Inc. 2/15/10		1,651
4,477	Caprius, Inc. 2/16/11		179
31,250	Caprius, Inc. 2/27/12		1,250
14,720	Caprius, Inc. 12/5/12		589
			3,669


See the accompanying Notes to the Financial Statements.

	7

		Semiconductor Equipment 0.08%
60,250		Tegal Corporation 7/14/10	$	482
270,793		Tegal Corporation 9/19/10		2,627
				3,109

		Technology - Miscellaneous 0.10%
90,990		Vuance, Ltd. 12/9/10 (Israel)		3,640
8,250		Vuance, Ltd. 11/19/11 (Israel)		412
				4,052

		Telecom Services 0.14%
705,171		WPCS International Incorporated 11/16/09		5,500

		Therapeutics 0.02%
12,868		Critical Therapeutics, Inc. 6/6/10		616
47,506		Memory Pharmaceuticals Corp. 9/22/10		-
				616

		Total Warrants 9.25% (cost $12,762)		366,562

		TOTAL INVESTMENTS 74.79% (cost $6,592,849)	$	2,964,872




	All percentages are relative to Partners' Capital.

	All securities are non-income producing except for Collectors Universe, Inc.,
	Interlink Electronics, Inc., MicroFinancial Incorporated, Primal Solutions, Inc.,
	Rockford Corporation, Unify Corporation, Vertical Communications, Inc., and
	Vuance, Ltd.












See the accompanying Notes to the Financial Statements.

		8

Biotechnology	$	2,439	0.06
Building Materials		1,000	0.03
Business Services		2	0.00
Communication Equipment - Software		78,831	1.99
Computer Services - Software		316,280	7.98
Consumer Products		96,709	2.44
Data Security		254,668	6.42
Educational Products - Services		71,011	1.79
Electronic Components		122,877	3.10
Electronic Equipment		3,599	0.09
Electronic - Display		359,967	9.08
Electronic Instruments		117,845	2.97
Electronic Semiconductor		233	0.01
Energy - Services		11,381	0.29
Energy - Technology		99,355	2.51
Environmental Services		116,662	2.94
Financial Services - Miscellaneous		129,988	3.28
Food		617,821	15.58
Medical Devices & Equipment		836	0.02
Medical Instruments		16,335	0.41
Oil Equipment		-	0.00
Paper - Packaging		2,211	0.06
Retail		506	0.01
Security Equipment		101,248	2.55
Semiconductor Equipment		96,187	2.43
Services		104,718	2.64
Technology - Miscellaneous		129,522	3.26
Telecom Equipment		51,000	1.29
Telecom Services		42,244	1.07
Telecommunications		18,781	0.47
Therapeutics		616	0.02

TOTAL PORTFOLIO	$	2,964,872	74.79	%






See the accompanying Notes to the Financial Statements.

		9

SPECIAL SITUATIONS FUND III, L.P.
(A Limited Partnership)

STATEMENT OF OPERATIONS - LIQUIDATION BASIS

FOR THE YEAR ENDED DECEMBER 31, 2008


REALIZED AND UNREALIZED LOSS ON INVESTMENTS
	Net realized loss on investments		$	(3,864,214)
	Net change in unrealized depreciation			(4,944,402)
		Net Realized and Unrealized Loss on Investments			$	(8,808,616)

INVESTMENT INCOME (LOSS)
	Investment Income
		Interest		179,040
		Dividends (net of withholding taxes of $979)		57,073
		Securities lending fees and other		11,777
		Total Investment Income		247,890

	Operating Expenses
		Administrator's fee		223,621
		Professional fees		174,680
		Independent General Partners' fees		80,000
		Custody fee and other		57,040
		Total Operating Expenses		535,341

		Net Investment Loss				(287,451)

NET LOSS					$	(9,096,067)











See the accompanying Notes to the Financial Statements.

		10



	Per Limited							Corporate			Individual
	Partners'				Limited			General			General
	Unit				Partners			Partner			Partners			Total

YEAR ENDED
DECEMBER 31, 2007:

BALANCE,
DECEMBER 31, 2006					$	39,033,516		$	4,662,904		$	459,652		$	44,156,072

Capital contributions						82,000			-			-			82,000

Capital transfers						689			(689	)		-			-

Allocation of net income (loss):

Corporate General

Partner - Performance						-			561,129			-			561,129

Partners						(1,423,779	)		(243,214	)		(19,115	)		(1,686,108	)

Repurchases						(4,388,432	)		-			-			(4,388,432	)

BALANCE,
DECEMBER 31, 2007		$	25,000			33,303,994			4,980,130			440,537			38,724,661

SIX MONTHS ENDED
JUNE 30, 2008:

Allocation of net loss		$	(3,512	)		(4,679,180	)		(699,704	)		(61,895	)		(5,440,779	)

Repurchases						(1,664,194	)		-			-			(1,664,194	)

BALANCE,
JUNE 30, 2008		$	25,000			26,960,620			4,280,426			378,642			31,619,688

SIX MONTHS ENDED
DECEMBER 31, 2008:

Allocation of net loss		$	(2,890	)		(3,116,692	)		(494,824	)		(43,772	)		(3,655,288	)

Liquidation distribution						(20,463,674	)		(3,248,929	)		(287,397	)		(24,000,000	)

BALANCE,
DECEMBER 31, 2008		$	25,000		$	3,380,254		$	536,673		$	47,473		$	3,964,400







See Note 4 for changes in Units outstanding.


See the accompanying Notes to the Financial Statements.

						11