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Description
Link to problem area:
https://spec.matrix.org/v1.5/client-server-api/#post_matrixclientv3user_directorysearch
Issue
the homeserver MUST at a minimum consider the users the requesting user shares a room with and those who reside in public rooms (known to the homeserver). The search MUST consider local users to the homeserver, and SHOULD query remote users as part of the search.
Assuming the intersection of these 2 sentences is the correct meaning, I get:

This appears to meet what the synapse docs say.
The alternative interpretation would be the conjunction of both sentences, i.e. must show all (local and remote) users in shared and public rooms AND all other local users and should further include remote users. This would appear to match enabling the synapse user_directory.search_all_users configuration option.
related
#1022