Hi Tristan:
I am discussing this exact same issue on another forum, so it is timely.
I know that many TDs have seat 3 post small blind here (I would even guess more than half), but a few of us rule geeks agree that the rules don't actually support it.
First, while it is true that the rule says that an incoming player can get the big blind, small blind, or the button, it does also say that he has to fill in a seat and assume the rights and responsibilities of the position. This suggests that one must consider what the responsibilities of each seat are on the next hand -- seat 4, having posted big blind previously, is due for the small blind. Our view is that if the player did not draw seat 4, then that should be sufficient to not have them take on the responsibilities of a player who does draw seat 4. Seat 3 is therefore between the seat due to post the SB and the seat due for the button, and can sit out. It can make a difference to the game, particularly if the incoming player is short stacked.
Second, I don't think the same issue arises if a moving button rotation is used. In a moving button rotation, we move the button, and have subsequent players post blinds accordingly. In that case, certainly seat 3 should get the small blind. However, in tournaments, we are directed to use a dead button rotation, so I think we do need to worry about the placement of the big blind and the small blind first, and not last.
As I said, I think many people would just make seat 3 the small blind because it seems strange for a person to be sitting in between the Big blind and the button and not post, but I think you are effectively moving the responsibility for seat 4 to post SB one position backwards, which is at odds with the first sentence of the rule. I agree with those TDs who have pointed this out.
Re: seat 3 posting the small blind, if that should be standard, they should simply delete the words "to fill in seats assume the rights and responsibilities of the position. They" from the rule, and just say incoming players can get the big blind, the small blind and the button. But some might argue that if you are going to fiddle around with the responsibilities of each seat, consider whether seat 3 should simply post a single BB just to be consistent with the balancing rule, despite the shortcomings that you pointed out. I think the rule makes sense the way it is, it is just not applied consistently in this particular situation.