UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK A.J. and LISA ZUCARELLI, on Behalf of Civil Action No. ________________ Themselves and all others similarly situated, Plaintiffs, CLASS ACTION COMPLAINT v. FOR THE VIOLATION OF THE FEDERAL SECURITIES LAWS MERRILL LYNCH & CO., INC., and HENRY BLODGET, Defendants. JURY TRIAL DEMANDED Plaintiffs A.J. and Lisa Zucarelli (“ Plaintiffs”) alleges the following based upon the investigation of counsel, which included a review of United States Securities and Exchange Commission (“SEC”) filings by LookSmart, Ltd. (“LookSmart” or the “Company”), as well as regulatory filings and reports, securities analysts’ reports and advisories about LookSmart issued by Merrill Lynch & Co. (“Merrill Lynch”), press releases and other public statements issued by Merrill Lynch, and media reports about LookSmart. Plaintiffs believe that substantial additional evidentiary support will exist for the allegations set forth herein after a reasonable opportunity for discovery. NATURE OF THE CLAIM 1. This is a federal securities class action brought by Plaintiffs against Defendants Merrill Lynch and Henry Blodget (“Blodget”) on behalf of a class (the “Class”) consisting of all persons or entities who purchased LookSmart securities from May 25, 2000 through April 27, 2001, inclusive (the “Class Period”). Plaintiffs seek to recover damages caused to the Class by Defendants’ violations of Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”), Rule 10b-5 promulgated thereunder, and Section 20(a) of the Exchange Act. 2. This action arises as a result of the manipulation by means of deceptive and manipulative acts, practices, devices and contrivances, of the market prices of LookSmart securities with the intent, purpose and effect of creating and maintaining artificially high market prices. Defendants accomplished the manipulation by issuing Merrill Lynch analyst reports regarding LookSmart that recommended the purchase of LookSmart common stock, and set price targets for LookSmart common stock, which were materially false and misleading, lacked any reasonable factual basis, and were contrary to the actual beliefs held by the analysts. When issuing their LookSmart analyst reports, Defendants failed to disclose significant, material conflicts of interest which resulted from their use of Blodget’s reputation and his ability to influence the actions of buyers and sellers of Internet securities by issuing favorable analyst reports, in order to curry favor with internet companies and thereby to obtain the their investment banking business for Merrill Lynch. Furthermore, in issuing their LookSmart analyst reports, in which they recommended the purchase of LookSmart stock, Defendants failed to disclose material, non-public, adverse information which they possessed about LookSmart. Defendants fraudulently recommended, in their LookSmart reports, the purchase of LookSmart common stock while at the time of the recommendations circulated contemporaneous internal e-mails stating they “should aggressively link coverage with banking” - a clear conflict of interest, and an indication that the recommendations issued lacked any reasonable factual basis. Throughout the Class Period, Defendants maintained at least a “NEUTRAL/BUY” recommendation on LookSmart in order to obtain and support lucrative financial deals for Merrill Lynch, while circulating contemporaneous internal e-mails in conflict with published information. 3. The Class Period runs from May 25, 2000 to April 27, 2001, inclusive. 4. As demonstrated herein, Blodget’s highly-publicized reputation as an analyst of Internet companies, coupled with Defendants’ positive reports and “ACCUMULATE/BUY” and “NEUTRAL/BUY” recommendations on LookSmart, significantly and artificially inflated the price of LookSmart securities throughout the Class Period. Defendants’ recommendations of 2 LookSmart and the price targets which they set for LookSmart common stock lacked a reasonable basis in fact, failed to state the true beliefs of the analysts, and were dominated and influenced by Defendants’ undisclosed material conflict of interest arising out of Merrill Lynch’s desire to act as a financial advisor to LookSmart. 5. On April 8, 2002, the Office of the Attorney General of the State of New York (the “Attorney General”) filed in the Supreme Court of the State of New York, County of New York an Application for an Order Pursuant to [New York] General Business Law Sec. 354 (the “Application”), which Application named Merrill Lynch, Blodget and other past or present officers or employees of Merrill Lynch as Respondents. In support of the Application, the Attorney General filed an Affidavit in Support of Application for an Order Pursuant to General Business Law Sec. 354. The Affidavit was sworn to by Eric Dinallo, Chief of the Investment Protection Bureau of the New York State Department of Law (the “Dinallo Affidavit” or “Dinallo Aff.”). A copy of the Dinallo Affidavit is attached hereto as Exhibit A, and it is incorporated herein, in full by reference. JURISDICTION AND VENUE 6. This Court has jurisdiction over the subject matter of this action pursuant to Section 27 of the Securities Exchange Act of 1934 (the “Exchange Act”), 15 U.S.C. §78aa, and 28 U.S.C. §1331. This action arises under Sections 10(b) and 20(a) of the Exchange Act, 15 U.S.C. §78j(b) and §78t(a), and the rules and regulations promulgated thereunder, including SEC Rule 10b-5, 17 C.F.R. 240.10b-5. 7. Venue is proper in this District pursuant to Section 27 of the Exchange Act (15 U.S.C. §78aa) and 28 U.S.C. §1391(b) and (c). Substantial acts in furtherance of the alleged fraud and/or its effects have occurred within this District and Merrill Lynch maintains multiple offices in this District. 8. In connection with the facts and omissions alleged in this Complaint, Defendants, directly or indirectly, used the means and instrumentalities of interstate commerce, including, but 3 not limited to, the mails, interstate telephone communications, and the facilities of the national securities markets. PARTIES 9. Plaintiffs A.J. and Lisa Zucarelli purchased LookSmart securities, as set forth in the attached certification, and was damaged thereby. 10. Defendant Merrill Lynch has its headquarters located at 4 World Financial Center, 250 Vesey Street New York, New York. Defendant Merrill Lynch is the largest securities broker in the United States and maintains multiple offices in this District. Merrill Lynch claims to be one of the world’s leading financial management and advisory companies with offices in 44 countries and total client assets of about $1.6 trillion. As an investment bank, Merrill Lynch claims to be the top global underwriter and market maker of debt and equity securities and a leading strategic advisor to corporations, institutions, and individuals worldwide. 11. Defendant Blodget was at all relevant times an Internet stock analyst and First Vice President of Merrill Lynch. In the Fall of 2001, Merrill Lynch asked Blodget to resign by offering him a buy-out offer which would pay Blodget approximately $2 million. On November 14, 2001, it was announced that Blodget was resigning as an Internet analyst at Merrill Lynch. SUBSTANTIVE ALLEGATIONS Background 12. Since 1999, the internet research analysts (the “internet group”) at Merrill Lynch have published on a regular basis ratings for internet stocks, including LookSmart, that were materially false and misleading because: (1) the ratings in many cases did not reflect the analysts’ true opinions of the companies; (2) no “reduce” or “sell” recommendations were issued as a matter of undisclosed, internal policy, thereby converting a published five-point rating scale into a de facto three-point system; and (3) Merrill Lynch failed to disclose to the public that Merrill Lynch’s ratings were tarnished by an undisclosed material conflict of interest: the research analysts were acting as quasi-investment bankers for the companies at issue, often initiating, 4 continuing, and/or manipulating research coverage for the purpose of attracting and keeping investment banking clients, thereby producing misleading ratings that were neither objective nor independent, contrary to Merrill Lynch’s representations to the public. 13. There was a serious breakdown of the separation between the Merrill Lynch banking and research departments, a separation that was critical to the integrity of the recommendations issued to the public by Merrill Lynch. Merrill Lynch’s stated policies reflect an understanding that this separation is crucial. In describing such separation breakdowns during a Congressional hearing on July 31, 2001, Chairman Richard H. Baker of the Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, commented: Maybe there hasn’t been a complete erosion in the Chinese walls that traditionally shield analysts from investment banking interests. But I have to say that I believe there are some folks out there manufacturing a lot of Chinese ladders for people to climb back and forth over those walls as they deem appropriate. Analyzing the Analysts: Hearings Before the Subcomm. on Capital Markets, Insurance, and Government Sponsored Enterprises of the House Comm. on Financial Services, 107th Cong. 117 (2001) (statement of Chairman Richard H. Baker). 14. The pressure put on the Merrill Lynch internet group to appease both investment bankers and potential investment banking clients led the group to ignore the bottom two categories of the