1. Yes, without a doubt the rotor needs to seat flush against the flange.
2. If the rotors are hub-centric (which would be ideal), then it doesn't matter how large the wheel stud holes are so long as they clear the wheel studs. If they're not hub-centric, I would buy or machine a hub-centric ring to make them hub-centric. Depending on how the rotors were converted to the 5x5.5" wheel pattern, the accuracy of the hole pattern should be taken into consideration since it sounds like that may be in doubt.
3. As stated by Donk, excessive runout of the rotor can cause piston knockback, which obviously negatively impacts caliper performance.
Since it sounds like you have a mag base and dial indicator, I would first enlarge the wheel stud holes in your rotors to 9/16 or 5/8, then make hub-centric if it isn't already, then install and measure runout. Index the rotor on the wheel stud pattern to see if it changes any...something you can get lucky and find a position where the runout of the axle flange and the runout of the rotor cancel one another out. For street applications, I generally like to see less than .004" total indicated runout (axial), however you can get away with more of off-road rigs with knobby tires, although I'd rather not. If there isn't any "happy place", then you can always remachine the axle face, the rotor, or both...or if you have access to an on-car brake lathe, you could do it in place.