Do you have any citations for the claim that "Mr. Smith," would be wrong in dialogue,
Many grammar rules are hard and fast, many others aren't so hard and fast. Some are different for newspapers as well. While some vary from country to country, and I go with what i was taught way back when. Another part of the problem we have with grammar discussion here is the majority of materials available for guidance today are aimed at writing academic or media documents, not fictional stories.
I had previously found a lot of reference links, but, sadly, they're in the system still held by the Gestapo. However, it really comes down to a few major aspects:
1. Dialogue is the written words of what is spoken.
2. Clarity of what you're conveying.
3. Uniformity of how you present things in your work.
What you write as dialogue should make complete sense to the reader with the words just as they are. Thus, Marcus Welby MD is read as MD not as Medical Doctor which it's short for. Agent Smith of the FBI is read as FBI and not as Federal Bureau of Investigation which it's short for. The same applies to all other titles and ranks.
Take Capt. If a character says, "Ask Capt. Benelli." Is he instructing the person to speak with Captain Benelli, or Capitaine Benelli because the same abbreviation is used for both, one is the rank in English and the other is Italian, but they can be two different people.
On the same front a person can ask, "Did you see Mr Renior?" and mean either the US man Mister Renoir or the Frenchman Monsiuer Renior from which the word Mister is derived and both use the same abbreviation.
Is Dr. short for doctor or drive? Do you use the same short versions for the non-English equivalents so Mr. Smith talks to S. Lopez?
I read a story here at SoL where I couldn't work out why a character's name kept jumping from John to the initials LT. I wrote to the author to be told it's the abbreviation for Lieutenant. Yet I've never seen or heard of that version before, I've always seen it as Lieut. Smith for the rank as an abbreviation.
For me the litmus test for dialogue is how a text to speech renders the work. You get some real weird things if you aren't careful In a recent story I mentioned a shotgun as .410 and then said it was a four-ten shotgun in the dialogue. The text to speech software says four-ten well, but renders the .410 as 'dot four one zero' and an other piece of software says 'decimal four hundred and ten.' - which do you use in real life?
In the end it all comes down to an author writing how he, or she or it, wants to write, but don't get mad at readers if they don't like a work due to it not be clear or uniform in how the you treat things in the story.