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The loudness equalization does indeed affect how loud distant sounds are, which can cause confusion and disorientation. In my experience, however, I've gotten used to those settings over time. I can now tell more accurately where people are even though the sounds (almost) always sound very close by (such as in your example in your comment). It takes some practice, and I'm sure that it can also depend on the headphone setup each individual is using also.
At least now you have the benefit of knowing which setting you prefer!