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I would definitely say this is a situation where an official is in a tough spot... one coach is doing something that is very unsportsmanlike, and the other coach has no power to do anything about it.
If, as officials, you believe your job is to uphold sportsmanship in the game, then, of course you have to do something. I'm guessing the rules don't exactly specify the procedure for this situation - and they probably don't because it can be dealt with in several ways. By rule, you can't really penalize the offending coach (well, you can forfeit the game), but it's something I think warrants a penalty. As some stated you could pull the coaches together and try to see what would happen - and after that, if I were an official, I would contact the league about it.
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