Hmm. Just tried this on my iPhone 3G out of curiosity. And the image rotated 180 degrees during playback, whether or not the controls were displayed.
Here's what I observed. When the phone is rotated (physically) while the controls are displayed, they automatically disappear until image rotation is complete and then pop back up on their own. I have no idea why I'm seeing different behaviour. Tried it on a few clips just to see if I might experience a difference with other content. But none so far. Odd.