In UGameInstance::StartPlayInEditorGameInstance, the server instance will go through the normal process of creating the URL using BuildPlayWorldURL, which checks the FGameInstancePIEParameters' bStartInSpectatorMode flag and adds the "SpectatorOnly=1" option to the URL if it is true.
However, when starting a PIE client instance, a basic "127.0.0.1:17777" URL will be created without checking bStartInSpectatorMode. The client instance will call Browse with this URL to connect to the server instance, so the client will start with the default game pawn rather than as a spectator.
Using multiplayer PIE options (e.g. Number of Players > 1 and Net Mode set to "Play As Client"), hold the Control key while pressing the play button to start the instances in spectator mode.
Expected: the clients would be using the default spectator pawns
Actual: the clients will be using the game's default pawns
There's no existing public thread on this issue, so head over to Questions & Answers just mention UE-170221 in the post.