The bottom line for me is that while I think that the DM was punishing players for activities that they did as actual humans by enforcing the punishment on their characters, what is done is done. It's going to look foolish for the DM to go back and say they didn't sell the items after all and it ruins the story.
What needs to be done now:
-DM discusses with players that he is not going to tolerate people screwing around on their phones during D&D time (unless the phone is used for D&D purposes...my group uses smart phones all the time for actual D&D stuff, including character sheets for one player)
-Players know the value of the items they lost
-A sidequest of some sort is created to get the items back in a reasonable manner
-Time moves on, players and DM heal.
-DM has to be more specific and make sure the players are getting the full picture of things. What may seem as something obvious to the DM is not always obvious to the players. The DM already knows the value of the items, so a little description of them is more than enough to justify their significance to him. To the players, that same description may be nothing more than just weak story embellishment.
The DM in this case has to be care of these scenarios and how it affects his players longterm. From now on, he has already changed their play style. Every piece of loot they find, mundane or magical, is going to be closely inspected. Sessions that might have once been fluid now have the possibility of bogging down in the city as the players carefully inspect each item, one by one and having multiple confirmation, before they make any judgement as to its value. They are going to question every single NPC's motives to a degree that might slow the campaign down to a point where it is no longer about adventure and is instead just administrative.