Well for a start phagocytosis is seen all the time, it is how amoebas ingest food. I assume your interlocutor means 'endosymbiosis' in which case he is still arguably wrong see
Yagita K, Matias RR, Yasuda T, Natividad FF, Enriquez GL, Endo T.
Acanthamoeba sp. from the Philippines: electron microscopy studies on naturally occurring bacterial symbionts.
Parasitol Res. 1995;81(2):98-102.
which clearly has a gram negative bacteria living in its cytoplasm and neither of which can be cultured successfully independently. If what he means is 'no one has observed an organism being phagocytosed and subsequently become an organelle' then he is probably right but that doesn't mean it hasn't ever happened, indeed there are numerous examples, such as this one in acanthamoeba, where it clearly has happened and the endosymbiont is still clearly distinguishable, in a way mitochondria arguably no longer are.
You should also ask him to start citing things properly 'a paper from MMBR in 1997' just doesn't cut it. I've tracked it down now it is
MICROBIOLOGY AND MOLECULAR BIOLOGY REVIEWS,
Dec. 1997, p. 456—502 Vol. 61, No. 4
Archaea and the Prokaryote-to-Eukaryote Transition
JAMES R. BROWN1 AND W. FORD DOOLITTLE
The sentence immediately preceding the one he quotes states that "bacteria living intracellularly
in a different bacterial species have been reported".
[This message has been edited by Wounded King, 08-22-2003]