Here's what happened:
John Doe has an account at X-Trade (any trading house)
John's networth is $50,000
John shorts 10,000 KBIO at $2 a few months ago because they said they have 1 week until liquidation
Shkreli announces plan to buy KBIO
KBIO gets squeezed up to $50 per share
John owes $500,000
John cannot pay
X-Trade must therefore eat it - houses, spouses accounts, etc. are NOT collateral for trading losses
X-Trade has authorities arrest Shkreli on shoddy charges, ie. he cheated a long time ago on some other stock
Shkreli cannot function while arrested
KBIO goes bankrupt
Well, almost everyone:
If John Doe somehow covered, his lenders are screwed. If he waited until now to cover, he wins, but I doubt it. I would imagine X-Trade somehow got paid.
Shkreli is virtually wiped out
So, X-Trade is made whole
Suppose E-Trade let a bunch of clients like John Doe short KBIO at $2.
KBIO goes to $50, and all the John Does cannot cover.
WHO is left holding the bag?
John Does' houses do not collateralize their accounts, even if the Does had houses. Most of them are worth maybe $25K. So WHO has to fork over the $500K loss?
Moreover, Shkreli was the one who lent out his shares, so he has a double win: His existing shares go up in value, and his short shares are called in, which drives the price further.
Heck, if Shrieky plays his cards right, he could bankrupt multiple trading houses.
But, oops! Someone in the financial mafia world lost big time by letting all the John Does short without sufficient capital. Therefore... arrested!
Then WHO is left holding the bag when John Doe cannot pay the margin. The guy had $30,000 in his entire account. He was short 10,000 shares that went to $150K, $300K, $500K.
Here's what happened:
KBIO was about to wind down operations.
Market Maker A: allowed John Doe to short 10,000 shares at $2
Some rich guy made a bid for some reason.
Market Maker B: squeezed KBIO up to $10, $20, $50
John Doe could not pay the margin. Erroneously, he thought his account, his wife's account, their house, etc. were going to have to be liquidated to pay the margin, which is false because ONLY John Doe's account is collateral.
However, someone still needs to make up the difference.
And that entity is Market Maker A and whomever John Doe used to trade.
So now, all of these market makers are brawling, some have lost big bucks allowing this months long shenanigans. And now they're screwed, too.
Do I feel bad for market makers?
Nope. Being a market maker is like having a license to steal. The biggest mafia in the world is the world of the invisible market maker.
Look what happened to BKCC on the 1,000 point drop a few months ago. Market Makers rammed it down to $1, then rebounded to $8, and so many of them got screwed, they had the SEC and NASDAQ undo all of those trades.