No, it didn't. I assume you're not an attorney (and for that I commend you). "Hearsay" is a legal term that applies to evidence presented in court. Nothing said to Paterno was evidence presented in court.
Hearsay is a statement made out of court that is offered in court as evidence to prove the truth of the matter asserted. Because the information from McQueary was not being offered as evidence in court, it wasn't hearsay.
There are so many exceptions to the hearsay rule that your evidence professor will joke that excluding evidence as hearsay is an exception to the hearsay exceptions. In this case, what Paterno heard was not hearsay because it wasn't offered as evidence in court, consisting of a statement by McQueary made out of court as proof that what McQueary said was true. Even in court, it could be offered for other purposes (although a judge may find that what McQueary said was so highly prejudicial to Sandusky that he or she would exclude it on that basis).
Incidentally, Pennsylvania is one of only a handful of states in which Paterno, as a faculty member of a university, wasn't required by law to report a reasonable allegation of suspected child abuse. Pennsylvania's a little backwards in that respect. Apparently the Nittany Valley is even a little backwards for what Pennsylvanians who aren't fervent Penn State supporters think.
We've already been through this with Paterno apologists. If it was 'hearsay' when Paterno heard it, it was 'hearsay' when Curley and Schultz heard it. And 23 Pa. Cons. Stat. Section 2311 technically doesn't make Curley or Schultz responsible for reporting; the statute makes Spanier responsible. Curley and Schultz are only responsible because they didn't report up the ladder and failed to report it to the proper authorities.
Truth is if Paterno had not gone to University officials about what he had been told (not witnessed) he would still have his job...just like Boeheim does (and the folks at ESPN).
ESPN didn't do enough! In fact, they didn't do anything!
Just to add a bit, even if we assume that statements reported may have been hearsay if offered in court, a good police investigation tracks down the original witnesses to testify, so those statements are no longer hearsay at trial. And in this case, since we already know about McQeary, they simply could have gotten him to testify personally to what he witnessed, which isn't hearsay.
The fact that you hear an allegation second-hand isn't any excuse not to investigation.