The dispute came after a complaint was made by Andy Ellam, managing director of web design firm 2-Minute-Website.com, on behalf its clients.
According to Ellam, Wanadoo's search results did not make it clear that they were, in fact, sponsored links and that they were ranked according to the amount of money sponsors paid, not according to their relevance.
Ellam said that he had made the complaint on behalf of small clients, who could not afford to spend hundreds of pounds on marketing.
"Consumers are likely to be fooled into thinking these ads are unbiased search results, and small businesses who should appear in the listings are suffering," he said.
In responding to the complaint, the ISP, which was rebranded by French parent Wanadoo in April, said that all the sponsored links were clearly identified as being delivered by Overture, which provides online advertising services, by a hyperlink at the foot of each sponsored search result.
It went on to explain that clicking on the hyperlink opened a pop-up box explaining that Overture ranked the search results by the amount each advertiser bid for inclusion in the search, with the highest bidder appearing at the top of the search results.
Wanadoo argued against the charge that its advertising was misleading by saying that sponsored results were all checked manually for relevance to the search criteria and the most relevant result always appeared first. It claimed that because advertisers had to pay each time a consumer clicked on their search entry, it was in their interests to appear only in relevant search results.
The Advertising Standards Authority, which regulates all non-broadcasting advertising in the UK, rejected Wanadoo's arguments.
It said that because sponsored links were not clearly identified by a headline or title, and the search page did not contain an explanation of the purpose of the hyperlink, consumers were unlikely to realise that the Overture hyperlink indicated that results were sponsored and therefore could be misled.
It has asked the company to ensure that sponsored links are clearly identified in future.
A spokesperson for Wanadoo said: "We are looking at the ASA report with interest, but we have no further comment at this time."
The site's search page has not yet been redesigned to highlight a separate section for paid-for searches.
2-minute-Website is a design company where anyone can get their own website for less than £100.
"We've contacted the ASA about a number of other UK search engines," Ellam said, "and we've asked it to issue UK guidelines to correspond with those in the US, where the Federal Trade Commission ensures search sites make 'clear and conspicuous disclosure' when advertisers have paid to appear in their results."
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