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I have iPod Touch 4th generation with iOS 5.1.1. I am using the function that puts multiple icons together in a single folder/directory-like icon by moving an app icon on top of another. However, for the "Newsstand" icon, I cannot do it. Is there a restriction on the apps for this function to work?

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The Newstand app is built to be a more or less a folder of it's own. As you probably have noticed, you can't put folders inside other folders. Because this is a native app on iOS, we don't really know why they did this, but I'm confident it is indeed because of it's folder type style.

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