Heat exchanger filling up reservoir tank

[llewis01]

A few years ago I install new manifolds that would allow me to totally cool engine and manifolds to cut down on rusting out. The boat is a 1994 Albemarle 265 with a 454. Since Albemarle does cool the manifolds I went a heat exchanger for a Merc. As in the pic you can see how I did it. My problem is the reservoir stays over full all the time If I empty it, It will fill backup. My engine temp stays between 168-170. So I have a couple questions.
1. Should the reservoir tank be above or below the heat exchanger ?
2. Should the thermostat be install in the heat exchanger or in the engine block?

Thanks