The Bankruptcy Blind Spot: How Fraud Thrives When Investors Stand Still

On January 29, 2026, federal prosecutors in the Southern District of New York unsealed a nine-count indictment against Patrick James, founder and former CEO of First Brands Group, and his brother Edward James, a former senior executive at the company.^[¹] The allegations are staggering in both scale and audacity: an eight-year scheme involving fabricated invoices, double- and triple-pledged collateral, falsified financial statements, and hundreds of millions of dollars funneled into personal accounts—all while First Brands appeared, on paper, to be a thriving global automotive parts supplier. When the company filed for Chapter 11 on September 28, 2025, it declared $12 million in cash against more than $9 billion in liabilities. Its lenders now face billions in losses.^[²]

The indictment describes the operation in unvarnished terms: prosecutors allege that First Brands was run, in effect, as a Ponzi scheme, with new loan proceeds used to repay old lenders and to finance the personal lifestyle of its founder.^[³] An executive has already pleaded guilty and is cooperating with the government.^[⁴]

The natural reaction is shock. But a more instructive reaction—especially for institutional investors and creditors—is to ask the harder question: how did it go on for eight years?

The Mechanics of Concealment

The First Brands case is not an anomaly of scale. It is an anomaly of duration. And duration, in the context of corporate fraud, is the product of two forces: sophisticated concealment by insiders and insufficient scrutiny by those with the most to lose.

The indictment describes a layered architecture of deception. At the foundation, First Brands employees—at the direction of Patrick and Edward James—submitted fabricated invoices to the company’s factoring partners: financing counterparties that purchased the company’s accounts receivable in exchange for upfront cash advances. Some invoices were for transactions that never occurred. Others were inflated to make them appear more valuable. Through these schemes, First Brands sold its factoring partners billions of dollars of receivables that did not exist.^[⁵]

Above this layer sat a parallel scheme involving what were internally referred to as “round trips” or, euphemistically, “corporate initiatives.” Under this arrangement, First Brands submitted false invoice information to financing partners who believed their funds were paying the company’s suppliers. In reality, the money was diverted back to First Brands itself to cover operating shortfalls—interest payments, rent, lease obligations—and, ultimately, to fund transfers to Patrick James personally.^[⁶]

The most structurally sophisticated layer involved off-balance-sheet entities. Patrick James allegedly established entities with no independent business operations—the indictment refers to them as the “James Entities”—to incur massive debt that was concealed from First Brands’ senior lenders. The James Entities obtained inventory financing by pledging collateral that was, in fact, already encumbered by the senior lenders’ existing liens. To further obscure the source of funds, loan proceeds were routed through a customer collections entity maintained outside the First Brands corporate structure, then disbursed to subsidiaries before being swept into the company’s operating account—designed so that the cash appeared to be ordinary customer receipts rather than what it actually was: the proceeds of fraudulently obtained loans.^[⁷]

The layering is what matters for institutional investors. Each stratum of deception was specifically engineered to survive a different type of due diligence. Factoring partners who verified invoices were shown fabricated documentation. Senior lenders who reviewed financial statements received manipulated versions—the indictment describes internal “bridge files” that juxtaposed accurate financials with the falsified versions distributed to creditors.^[⁸] Off-balance-sheet lenders who required unencumbered collateral were pledged assets that had already been pledged elsewhere.

This was not a simple fraud. It was a full-spectrum counterintelligence operation directed at the company’s own capital providers. And it worked for nearly a decade.

A Systemic Pattern, Not an Isolated Case

First Brands is the latest and most dramatic example, but the underlying pattern—fraud preceding or precipitating a corporate bankruptcy, with creditors bearing the catastrophic losses—has become alarmingly familiar.

In December 2025, just weeks before the First Brands indictment, federal prosecutors in the same jurisdiction unveiled criminal fraud charges against top executives of Tricolor, a subprime auto lender that filed to liquidate in bankruptcy just eighteen days before First Brands itself sought Chapter 11 protection.^[⁹] The proximity of these two cases, both out of the Southern District of New York, underscores a broader trend.

The data tells a consistent story. According to Cornerstone Research, large corporate bankruptcy filings—involving companies with assets exceeding $100 million—reached 117 in the twelve-month period ending June 30, 2025, representing a 44% increase over the historical annual average of 81 filings between 2005 and 2024. Mega-bankruptcies, involving companies with over $1 billion in assets, rose to 32, up from 24 in the preceding twelve-month period.^[¹⁰] The American Bankruptcy Institute reported that total bankruptcy filings across all chapters reached 565,759 in calendar year 2025, an 11% increase over 2024.^[¹¹]

Not all of these filings involve fraud. But the FBI has estimated that approximately 10% of bankruptcy filings involve some form of fraudulent activity.^[¹²] At scale, that figure implies tens of thousands of potentially fraudulent cases annually—and in the corporate context, the dollar amounts per case are substantial.

The deeper question is one of structural incentive. Under Chapter 11, the debtor typically remains “in possession”—meaning the same management team that may have presided over (or perpetrated) the fraud continues to operate the business under court supervision.^[¹³] While the Bankruptcy Code provides for the appointment of a case trustee “for cause, including fraud, dishonesty, incompetence, or gross mismanagement,” such appointments remain the exception rather than the rule.^[¹⁴] The result is a procedural environment in which the burden of detection falls disproportionately on creditors—the very parties who are already at an informational disadvantage.

The Creditor Passivity Problem

The First Brands indictment reveals something more uncomfortable than mere fraud. It reveals the failure of creditor oversight.

Consider the timeline. The indictment alleges that the schemes operated from “at least in or about 2018 through in or about 2025″—spanning eight calendar years.^[¹⁵] During this period, First Brands was not a private, closely held company operating in the shadows. It was a multinational enterprise with approximately $5 billion in annual net sales, employing 17,000 people in North America, financing relationships with multiple banks and direct lenders, and growing rapidly through debt-financed acquisitions.^[¹⁶] The company was, by any measure, a significant counterparty to sophisticated institutional capital providers.

And yet, the fraud persisted. This demands an honest assessment of creditor behavior—not to assign blame, but to identify where the system failed and how it can be improved.

The most obvious failure is reliance on borrower-prepared financial information without independent verification. The indictment describes “bridge files” maintained internally at First Brands that contained both accurate and manipulated financials.^[¹⁷] This means the true financial position of the company existed in documentary form—it was simply not shared with the people who were owed billions of dollars. The discrepancy between the real financials and the falsified versions distributed to lenders should, in theory, have been detectable through independent forensic review of the company’s general ledger, accounts receivable aging, and collateral documentation.

The second failure is the absence of coordinated creditor action. First Brands had multiple categories of financing partners—factors, senior lenders, off-balance-sheet lenders—each operating in informational silos. Patrick James allegedly exploited this fragmentation by pledging the same collateral to multiple parties, confident that no single creditor had visibility into the company’s full liability structure.^[¹⁸] Coordinated scrutiny across creditor classes would have surfaced the double- and triple-pledged collateral far sooner.

The third, and perhaps most consequential, failure is a cultural one. Institutional creditors, particularly in leveraged lending and asset-based finance, often operate on the assumption that sophisticated borrowers are acting in good faith. Verification protocols exist, but they are frequently backward-looking and formulaic—quarterly covenant compliance packages, borrowing base certificates, annual audited financials. These mechanisms are designed to detect deterioration in credit quality, not to uncover deliberate, systematic deception. They are, in other words, calibrated for the wrong threat.

The Inadequacy of Post-Hoc Remediation

When fraud of this nature finally surfaces, the remediation apparatus swings into action. Forensic advisors are hired. Adversary proceedings are filed. Rule 2004 examinations are initiated. Independent examiners are appointed. The legal and advisory fees are enormous—and they are paid out of the bankruptcy estate, further reducing recoveries for the very creditors who were defrauded.

In the First Brands case, restructuring advisors now running the company told the Houston bankruptcy court in late January 2026 that the fraud was “more pervasive and damaging than they initially realized.”^[¹⁹] At least 4,000 employees in North America had already lost their jobs as the company began winding down major business lines—Brake Parts, Cardone aftermarket parts, Autolite spark plugs—because it could not sustain operations across all divisions.^[²⁰] The economic carnage extends well beyond the balance sheet.

The post-hoc legal proceedings will be lengthy, expensive, and only partially effective. Patrick James posted a $50 million bond, secured in part by a Hamptons residence.^[²¹] Even if criminal convictions are obtained, the recovery of diverted assets is a multiyear endeavor that rarely results in full restitution. Creditors in cases of this magnitude historically recover a fraction of their claims—often significantly less than fifty cents on the dollar for general unsecured creditors.^[²²]

This is the fundamental problem. Post-hoc remediation is not capital protection. It is loss mitigation. The distinction matters enormously to institutional investors for whom capital preservation is not merely a strategy but a fiduciary obligation.

A Different Model of Engagement

The pattern across First Brands, Tricolor, and any number of historical precedents is consistent: the earlier that anomalies are identified, the more value is preserved. The later that fraud is surfaced, the more catastrophic the losses.

This observation has implications for how institutional investors—whether creditors, equity holders, or both—approach their capital allocations. Passive reliance on standard diligence protocols, audited financial statements, and borrowing base certificates is insufficient when the counterparty is actively working to defeat those exact mechanisms. The challenge is not one of information availability; it is one of information verification, independently conducted, with the specific mandate of identifying discrepancies that borrower-prepared documentation is designed to conceal.

The forensic accounting tools to identify the warning signs at First Brands existed well before the bankruptcy filing. The discrepancy between reported financial position and actual cash flows. The pattern of rapid, debt-financed acquisitions without proportionate free cash flow generation. The structural opacity of off-balance-sheet arrangements involving related-party entities. The mismatch between reported collateral values and the consideration implied by actual financing terms. These are identifiable patterns—provided someone is looking for them.

The creditors’ committee system under the Bankruptcy Code provides one mechanism for coordinated oversight, but it is activated only after a filing has occurred—by which point, in a fraud case, enormous value has already been destroyed.^[²³] The Bankruptcy Code also contemplates the SEC’s right to appear and be heard in Chapter 11 proceedings, but the Commission’s recent enforcement posture has not prioritized bankruptcy-adjacent fraud with the urgency the moment demands.^[²⁴]

What remains is the role of private market participants themselves. The most effective capital preservation occurs when investors treat verification as an ongoing discipline—not a pre-closing checklist that is filed away once the ink dries. In a market environment where large corporate bankruptcies are running 44% above historical averages and fraud continues to operate behind layers of structural complexity, the cost of passivity is measured not in basis points but in total loss of principal.^[²⁵]

Conclusion

The First Brands case will be studied for years. Its mechanics are instructive. Its scale is extraordinary. But its most important lesson is the simplest one: sophisticated fraud does not succeed merely because it is clever. It succeeds because the people with the most to lose are not asking the right questions, at the right depth, with sufficient independence.

The creditors who will ultimately bear billions in losses from First Brands were not unsophisticated. They were major banks and direct lenders with large compliance teams and experienced credit officers. What they lacked was not capability but orientation. They were monitoring for credit deterioration when they should have been testing for veracity.

In an environment of rising bankruptcy filings, elevated leverage across the corporate landscape, and a regulatory apparatus that is stretched thin, the burden of financial integrity falls increasingly on investors and creditors themselves. Those who engage actively—who verify independently, who challenge borrower-prepared narratives, who look for what management does not want them to see—are not merely better positioned. They are the only ones positioned to avoid being the last to know that the numbers were never real.

The views expressed herein are those of Buxton Helmsley, Inc. and are provided for informational purposes only. This article does not constitute investment advice or a recommendation to buy or sell any security. References to specific companies or cases are for illustrative purposes only and do not constitute an endorsement or solicitation of any kind.

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Referenced Sources:

^[¹] U.S. Department of Justice, U.S. Attorney’s Office, Southern District of New York, “First Brands Executives Charged With Multibillion-Dollar Fraud,” Press Release, January 29, 2026.

^[²] Id.

^[³] Statement of Executive Special Agent in Charge Kareem Carter, IRS Criminal Investigation, Washington, D.C. Field Office, as quoted in U.S. Department of Justice Press Release, January 29, 2026 (describing the defendants’ operation of First Brands as a “‘Ponzi’ scheme in which new loan proceeds were used to pay back old lenders and to fund their extravagant lifestyle”).

^[⁴] U.S. Department of Justice, S.D.N.Y., United States v. Peter Andrew Brumbergs, 26 Cr. 25 (AT), guilty plea entered January 26, 2026.

^[⁵] U.S. Department of Justice, S.D.N.Y., United States v. Patrick James and Edward James, 26 Cr. 29 (AT), Indictment (unsealed January 29, 2026).

^[⁶] Id.

^[⁷] Id.

^[⁸] Id.

^[⁹] Jonathan Stempel, “First Brands founder Patrick James pleads not guilty to fraud,” Reuters, February 4, 2026.

^[¹⁰] Cornerstone Research, “Trends in Large Corporate Bankruptcy and Financial Distress: Midyear 2025 Update,” September 24, 2025.

^[¹¹] American Bankruptcy Institute, Bankruptcy Statistics, Calendar Year 2025 (reporting total filings of 565,759, an 11% increase over 2024).

^[¹²] Federal Bureau of Investigation, Bankruptcy Fraud estimates, as cited in Debt.org, “Bankruptcy Fraud—What Is It?” (estimating that approximately 10% of bankruptcy filings involve fraudulent activity).

^[¹³] 11 U.S.C. § 1107 (conferring the rights, powers, and duties of a trustee upon the debtor in possession); 11 U.S.C. § 1108 (authorizing the trustee to operate the debtor’s business).

^[¹⁴] 11 U.S.C. § 1104(a)(1) (providing for appointment of a trustee “for cause, including fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor by current management”).

^[¹⁵] United States v. Patrick James and Edward James, 26 Cr. 29 (AT), Indictment.

^[¹⁶] U.S. Department of Justice Press Release, January 29, 2026 (reporting approximately $5 billion in net annual sales); CNBC, “First Brands founder Patrick James and his brother indicted for fraud,” January 29, 2026 (reporting 17,000 employees in North America).

^[¹⁷] United States v. Patrick James and Edward James, 26 Cr. 29 (AT), Indictment.

^[¹⁸] Id.

^[¹⁹] Claims Journal, “Founder of Auto Parts Maker Charged With Fraud That Wiped Out Billions,” January 30, 2026 (quoting bankruptcy lawyer Sunny Singh at a January 29, 2026, hearing before the Houston bankruptcy court).

^[²⁰] Id.

^[²¹] Transport Topics, “First Brands Founder Uses Hamptons Home for $50 Million Bond,” February 2026.

^[²²] Standard & Poor’s LossStats Database, as cited in CRG Financial (reporting average recovery rates of 72% for bank debt and 29% for senior unsecured bonds during the 2002–2003 downturn; general unsecured creditor recovery rates have historically been materially lower).

^[²³] 11 U.S.C. § 1102 (providing for the appointment of a committee of unsecured creditors “as soon as practicable after the order for relief under chapter 11”).

^[²⁴] See 11 U.S.C. § 1109(a) (granting the SEC the right to “raise, and may appear and be heard on, any issue in a case under this chapter”); see also Buxton Helmsley, Inc., “Four: The Number That Should Keep Every Investor Up at Night,” Insights, February 2026.

^[²⁵] Cornerstone Research, supra note 10.