If difficult child 3 said that, my response would be to take him aside and make it clear that such talk is not acceptable in any way. I would also discuss with him where he first heard that sort of talk. if he said, "Nowhere," I would then say, "There is a reason you don't hear other kids saying that. It is because it is inappropriate, you might hear a toddler saying silly things like that but it is not clever, it is not funny and it can make some people angry with you."
If he says, "So-and-so says it," then you need to deal with that differently, but still say, "So-and-so is not clever to say that. Anyone saying things like tat can seem to other people to be very rude, silly and not very clever."
The next line you deal with - "Why is smelling your penis something anyone would want to do? Does it smell of anything pretty, like lemons or strawberries? Or does it smell particularly bad? Either would be wrong and a bit weird. Your penis is private, it is yours and is not something to be talked about like that. Do I ask you to smell my private parts? I think you would be horrified if I suggested it. Do I walk up to the shopkeeper and say, "Smell my armpit!" It would be a bit silly, wouldn't it? And it wouldn't help me buy the groceries."
You then deal with, "What were you trying to do when you said that? Did you want to play with her but didn't know how to start playing? Maybe we need to find a better way, and practice it. If she's someone you don't want to play with, then you say to her, "Please leave me alone," or you stay away from her. But if you want to play with her, then the best thing you can do is to go up to her and say, 'Hello, my name is Wee. Would you like to play?' If you just walk up and get in her face with something too intimate and gross, she is possibly going to be too scared or too disgusted to want to play with you, and that would be sad."
Find him some simple, easy games he likes that he could use as an ice-breaker. Then next time this happens, break in and say to Wee, "That was not appropriate. Now let's do it right. What do you think X would like to play? Now, remember what we practised. Go introduce yourself and ask her nicely if she would like to play."
It's quite likely that at some stage, some of Wee's "friends" have used smelling intimate body areas as a means of entertainment. Wee needs to know this was inappropriate and was just plain wrong. He also needs to know that, unfair though it is, "normal" kids might play this way, but difficult children cannot, because people will always assume that the difficult child who plays this way is mentally ill, a danger Occupational Therapist (OT) others and they then are scared of the difficult child. Our kids have to be seen to be 'cleaner' and more in control, than other kids. Not fair, but a fact of life.
I explained it to difficult child 3 this way - although other boys in his grade would push and shove one another in play, if difficult child 3 did it, he would be punished for fighting or bullying. But he was only doing to other kids, what they did to him. It wasn't fair. So I made it clear to difficult child 3 - other kids can do it and not get into trouble. But the difficult child is always watched for the slightest indication of putting a foot wrong. So while other kids might hit difficult child 3(and this was also unacceptable) difficult child 3 was not permitted (by me) to hit back, because he would then be blamed as the aggressor and the one who stated it. So he had to be held to a higher standard of behaviour, purely because he was a difficult child and people would be too quick to blame the weird kid.
So if some other kid is thinking it's witty and clever to say, "Smell my penis," Wee has to keep getting told, "That boy might be able to say it and not bethought horrible or weird (although personally, I don't want to meet that boy, he doesn't sound very nice if he says things like that and thinks they are funny). But you - I'm sorry, it's not fair, but you have to have higher standards."
Too often people try to "make allowances" for the difficult child, when they need tight direction even more, because too often it's other kids who have led them stray or taught them bad habits. But even if it's something he thought up for himself - he needs to not only know it's wrong, but he needs to rehearse a more appropriate way to interact.
Reacting with shock, disgust or horror is bad. reacting with condescension is much better, but matter-of-fact boredom and firm "we don't talk like that," is best of all.
With a difficult child, you should never ignore it, because other people who don't understand will misconstrue it and put a really sick interpretation on it.
Marg