I recently installed XP on a friend's computer. He says (I can't verify this) that a bunch of files just vanished. I was looking and he intentionally place a folder called My Documents inside of his My Documents folder and all his files are in subfolders (subdirectories) under that. I think it's important to note that he was using Vista and something similar would happen where he'd end up with subdirectory after subdirectory named My Documents inside of his My Documents folder.

Is there any known issues with doing this in Windows? Does it affect all versions?

Interesting to know if new documents are defaulted to the 1st or 2nd folder, but it should be no issue. If the default is the 2nd subfolder then it sounds as if My Docs may have been redirected to My Docs, either manually or by policy. If it defualts to the original folder then all they did is dump everything under a subfolder and the name should have no bearing on operation. Just don't expect apps to find the My Music, My Pictures, etc that have been moved to a new location.