Absolutely, they over-reacted. Teacher was probably so upset about someone actually stealing the phone off the table that he's got his better judgement completely clouded. There is no doubt in my mind, he is going to be fired.
He didn't handle it well from the very beginning though. Why did he confiscate the phones in the first place? Just tell students to turn their phones off and put them in their backpacks. "If I see your cell phone during a test, you're out" – would be a simple enough preventive measure. Once he had confiscated the phones, he was responsible for them.
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