It doesn't matter if the dealer is Class 3, or what the upper might or might not be made into. Someone brought him a rifle that had a short barrel, and that is not registered as an SBR under the NFA. He cannot legally accept it, or possess it, or modify it. He cannot put on an extension. Even as a Class 3 dealer, he can deal only in NFA firearms that are properly registered and transferred to him on the proper forms, not illegal guns that come through the door. In fact, most Class 3 dealers would call BATFE immediately and, if possible, detain the seller. The fact that the dealer did not do so indicates that he is running a shady operation, willing to take a chance for a profit.
I repeat, the owner also could not legally modify the rifle or sell it; the felony has already been committed by illegal possession. The only thing the owner could have done legally was to surrender the rifle and take his lumps for the money. I will also repeat that an unregistered SBR is contraband, just like a counterfeit bill or illegal drugs. If some innocent person accidentally finds himself in possession of a stash of fake $100 bills, he can't legally pass them off on someone else, and no "money dealer" (bank) will just "take it off his hands".
Jim