It is possible for the clipboard to contain not just text (with newlines and tabs) but also control characters such as ESC which could have surprising effects if pasted into a terminal session, depending on what program is running on the server side. Copying text from a mischievous web page could put such characters onto the clipboard.
By default, PuTTY filters out the more unusual control characters, only letting through the more obvious text-formatting characters (newlines, tab, backspace, and DEL).
Setting this option stops this filtering; on paste, any character on the clipboard is sent to the session uncensored. This might be useful if you are deliberately using control character pasting as a simple form of scripting, for instance.