At Melvin scale it most likely is illegal, if they didn’t have a reasonable chance at getting the shares they needed (which at ~140% of float, they don’t).
Person A has 100 shares. Melvin borrows 40 shares from A, and sells it to Person B.
Person A + Person B now have 140 shares combined (while Melvin has -40 shares). If PersonA + PersonB agree to loan shares to Melvin for another short sell, they've become able to drop to -140 shares, by borrowing 60 of Person A's remaining shares, and then 40 shares from B.
Nothing illegal here, as long as Person A and Person B agree to the terms.
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And again: Melvin seemed to hold puts, not shorts. So this entire point is moot anyway. Puts are a bear-bet, but they're kind of unrelated to short-selling.
Yeah. Misinformation.
#1. Melvin seems to have held a significant number of puts as far as I can tell.
#2. Even if they were stupid enough to short 150% of the available shares, I don't believe there's anything illegal about that.