According to an insider commenting to the New York Times, Papermaster's departure is as a result of "series of hardware problems, including some related to the iPod Touch." [The NYT is wrong here, it should be the iPad Nano, not Touch.]
Papermaster was hired by Apple in November of 2008, following a 25 year career at IBM. This resulted in a lawsuit where IBM sued Papermaster, claiming he agreed not to work for a competitor for a year. The case was settled after Papermaster testified in court that he had not revealed any trade secrets.
Apple's senior VP of Mac hardware engineering, Bob Mansfield, will take over Papermaster's roles. According to Apple PR, "Mr Mansfield already manages groups that create many of the key technologies for the iPhone and iPod touch, including the A4 chip, Retina display and touch screens."
If the insiders are to be believed, and Papermaster was pushed out of the door, that move calls into question Apple's continued insistence that there's nothing wrong with the iPhone 4's antenna and reception. However, given that Papermaster had only been working with Apple since April 2009, it's hard to see how much input he would have had into the design of the iPhone 4.