Steve.. With the sump drained out it will usually take a few moments for the "new oil" to work its way down, ready for the scavenge side to start to work. This is when the return "gulps" as the pump sucks air and the small amount of oil in the pick up pipe. The scavenge side should have no problem pumping oil through your temporary hose, way above the top of the tank. Once primed it should come out like a miniature fire hose. A good steady flow is what you would expect almost immediately from a bike in regular use, on start up. Are we actually getting a good return within seconds of starting up on a cleaned out sump? Not what should happen, there should be a delay.
If it only reached halfway up, was that the best it can do? Or did you shut it down in disgust? Just hope SRM haven't put another set of feed gears in the return side of the pump! No that's impossible isn't it?
We need to establish that feed and scavenge are balanced as designed, and that the oil level is maintained. If it is constantly falling that is the reason for the smoke. Too much going in, not enough coming out. If the level stays the same, the system is working fine, and the fault lies within the cylinder.
The overnight drip test would indicate the pump and crankcase ball valve are OK, but there still maybe a major leak on the pressure side, downstream of the valve. Rather unlikely, but possible.
The PRV is the next suspect. Dismantle and check carefully, making sure the ball seating area is undamaged.
Too thick a fibre washer between the inner and outer parts of the PRV will decrease the spring tension on the ball. You need a thin one, copper or aluminium. The sealing washer crankcase to PRV thickness is not critical.
I think you have an early engine, which has no oil feed to the cam trough. If the PRV is faulty, opening at low pressure, it will dump pressurised oil directly into the oil pump cavity, which will fill up and pass from there very quickly through the keyhole vent into the sump....a possible explanation for the rapid appearance of smoke.
Swarfy.