The Mac OS System Folder is where the core OS files and applications reside. The System Folder can usually be found on the top level of your startup volume.
The System Folder contains the System suitcase, the Finder, the Mac OS ROM, and System Resources, as well as all of your fonts, Control Panels, Extensions, preferences, Apple Menu Items, Startup Items, and Shutdown Items.
It is possible (but not advisable) to have more than one System Folder. This could be useful if you need to maintain multiple versions of an operating system on the same machine-- for testing purposes, for instance. The secret to doing this, without blowing everything up, is to "unbless" the System Folder that you're not using. Do this by moving the Finder out of the folder and to some other location. You'll notice that the System Folder icon changes from a folder with the Mac OS face to a plain old folder.
Do not unbless your only System Folder-- your machine will not start up.