Nowadays, the use of SharePoint folders is considered to be evil for a variety of reasons. http://stovereffect.com/2010/07/12/metadata-versus-folders/ provides a nice discussion about the shortcomings of folders.   

End users are typically very comfortable with working with folder structures.

• Folders are great for finding info when you know your way around the folder structure.
• Folders improve the efficiency of data access because the creation of a folder leads to the creation of an internal index. See: http://sharepointdragons.com/2012/01/09/using-folders-or-not/
• Folders work great in scenarios where file shares are used. In a file share, the only way of classifying files is through filename and folder structure. In SharePoint we have a choice, and you could consider using both folders and metadata together.
• Folders are great for applying security settings, default ("location specific") metadata
• Folders work a lot better with Windows explorer views. In a flat structure you see everything and nothing in one view....
• Document sets inherit from the folder content type. So, even if you resent the idea of using folders, you're probably still a fan of using them without recognizing it (that is, unless you deny the usefulness of Document Sets).
• You can use folders while still removing them from view. If you don't want to use the folders all the time, create a view that does not display the folders. In 'Library settings' - 'Create View' - 'standard view' - under 'Folders' - you have a choice of 'show all items without folders'. This will turn your folder based structure into a flat library.
• You can set default metadata values for every folder. In 'Library settings', 'Column Default Value settings', you can set defaults on all of you subfolder starting from the root(inherits by default). Also check out the Location-Based Metadata defaults feature: http://msdn.microsoft.com/en-us/library/ee557925.aspx .
• Folders is a great way to introduce metadata to old school change-reluctant users, using default folder values will allow you to add metadata without the user noticing.
• Folders save you time in migrations if you can copy an existing fileshare folder structure.

They have disadvantages too:

• If you don't know the folder structure, finding info is easier using metadata based navigation.
• Folders increase URL length, which breaks when it pops above around 260 characters. See: http://www.loisandclark.eu/Pages/limitsurl.aspx
• Folders don't look great when you put a Library web part on a page (there's no navigation back up to the parent folder).
• Folders without metadata, can cause you to 'loose' documents.

Additional comments about Security...
You can have several document libraries in one site, that is also a way to separate security/permissions. There is a commercial third party tool available for SharePoint that allows you to set permissions by the use of metadata. So, if you're interested in that, you can investigate further.

Best Practices:
Try and keep the folder hierarchy as flat and minimal as you can, but don't limit yourself to metadata views exclusively. Mix the opportunities for the best results!  If you choose to depend on metadata only, you should separate sets of documents by putting them in its own websites and set the permissions on this level. If you need a more granular rights management, folders/libraries are the easier way to do it.

Inspired by forum discussion: http://social.technet.microsoft.com/Forums/en-US/sharepoint2010setup/thread/c34190e0-89a6-4953-9eae-2b4e32067d14

Also check out the overview of SharePoint 2010 Best Practices at: http://social.technet.microsoft.com/wiki/contents/articles/8666.sharepoint-2010-best-practices-en.aspx