The way they are surrounding him is probaby a taught technique. I could see the point in completely restraining him and the dog before the dog was outed so that he wouldn't fire back up and get bit again, possibly somewhere much more dangerous like the face or neck.
Video is extremely deceptive in what it shows. What looks clear cut often isn't and a different angle can show a radically different event.
Was the dog biting his clothes or are they trained to actually grab flesh?
Flesh. Clothes can be quickly shed allowing the bad guy to get away. That's a very good argument for teaching a deep, full bite, so that the dog actually grabs part of the suspect and not his winter jacket.
Do police dogs obey the command "release"? Did the trainer not say it or not want the dog to release?
It depends on the agency whether or not the out command is used on the street and how it is done. Some departments have stopped using it altogether due to liability. If the officer is telling the dog to out and the dog doesn't, the dog is disobeying and any injury sustained from that point on could potentially be be used against them. Instead many agencies simply lift the dog off the bite.
Watch the video again. In the beginning, the suspect is holding some kind of yellow cloth (maybe a raincoat?) in a manner consistent with someone hiding a hand-held weapon. The streets appear to be blocked off by police cars and tape (though that might just be construction). It looks to me like a standoff with a potentially armed suspect who is hiding his "weapon" under that raincoat. After the cloth is blown out of his hands (my guess is with a bean bag round) there is clearly something in his right hand. He then throws the object at the police and when they see his hands are now empty they move in for an arrest. Pay attention to how the officers approach the suspect. The cautiously "step and drag" (a kind of fighting stance) towards him and use riot shields to approach his feet and torso. This guy has definitely gotten the agencies attention with whatever he did. At the end of the video the handler either outs the dog verbally or physically, but not until he is completely surrounded by officers who are immobilizing him onto the ground with a riot shield.
"My first priority will be to reinstate the assault weapons ban PERMANENTLY as soon as I take office...I intend to work with Congress on a national no carry law, 1 gun a month purchase limits, and bans on all semi-automatic guns."-Barack Obama
"When in doubt, whip it out."-Nuge