http://unity3d.com/support/documentation/ScriptReference/Transform.LookAt.html

http://unity3d.com/support/documentation/ScriptReference/Quaternion.LookRotation.html

The two vectors you're cross-producting aren't necessarily at right angles, which will give you a skewed matrix. Try this:

• Cross the facing vector with the normal to get the right axis
• Cross the right axis with the facing vector to get a new "up" vector

This guarantees you an orthogonal matrix. But you'll get nasty snaps as you cross polygon boundaries (and the normal changes suddenly), so you may want to store this as a target matrix and seek the actual matrix towards it to smooth those transitions.

To elaborate on Jessy's fine reply, as you mentioned, you have to set forward and up simultaneously for it to work. Each transform.up= sets the entire rotation. So, it's like setting x=0.4; x=10; and hoping, since you didn't write 10.0 that it will give 10.4.

LookAt and LookRotation take a 2nd optional parm, as the up:

transform.LookAt(LookDirection, hit.normal);

Another cute trick is you can compute the smallest rotation between two vectors and apply that to your current rotation. "face this way" ignores your current rotation, but "tilt from where I am now to this new facing" respects your current orientation:

Quaternion RotTo = Quaternion.setFromToRotation(transform.forward, LookDir);
transform.rotation = transform.rotation * RotTo; // apply the spin
//   or  RotTo * transform.rotation;  (the order matters and I can never remember)

Have you tried using Quaternion.LookRotation? http://unity3d.com/support/documentation/ScriptReference/Quaternion.LookRotation.html

You pass that method a direction the object will face with it's z-axis and an up-vector which will determine the rotation of the object around that direction. This will give you a Quaternion you can assign to transform.rotation.

So in your case that would look like this:

transform.rotation = Quaternion.LookRotation(LookDirection, raycastHitInfo.WorldNormal);