The middle animation of the picture above dosent use multiple bone per vertex, I should have made it clearer.

Well it sounds like your animations are going to be very expressive in range of motion, so the only thing I could say is that the actual time of the stretching should be made minimal. Since its a fighting game, the moves shouldn't take inordinate amounts of time on screen. If a character is to bend his torso 180 degrees backward, then this should be a quick animation, not long enough to expose the limitation of MED at the moment. I assume the character's standing animations dont call for extreme rotation, as in my opinion that would be out of place even in your type of fighting game.

If your going to use bones, stretching will be inescapable even with careful modelling of the trouble areas. However, you can combine animations, rotate heads and eyeballs toward the enemies, attach armor and weapons with minimal effort compared to a workaround with vertex animation and scale limbs realtime. Bone animation should be chosen if youd like to do these things.

Vertex animation however lets you hand animate any and all problem areas, and generally vertex animation looks better if the animator animates in layers of detail (like any professional hand animator). You can make muscles buldge, skin wrinkle and stretch with vertex animation. If you wanted to do that with bones, you would have to attach bones to every desired vertex. If a torso rotation looks too wooden, the animator can stretch and pull edges to curve out rotations.

Personally I wouldnt choose vertex animation because its impossible (or not worth the effort) to rotate limbs toward targets (head rotation independent of torso). You can't combine two animations (torso is punching, legs are running) and change these in real time. If you wanted the head to rotate with vertex animation, you would have to make the head a totally seperate model and attach it to the body (vec_set, vec_for_vertex), and this would show some obvious lighting inconsistancies with the head and body.

Degradation or unadaptability, take your pick.