J.L.
Amy,
You have every right to be concerned but dont panic yet.
There could be many reasons why your niece said what she said. She could have learned the info from TV, computer, from another child, or she could have seen something home related, etc.
Either way your daughter presented you with important information that does need to be addressed.
Since your niece is with you often and around your family you need to find out where and how she got the info from.
All you need to do is ask the child.
Be careful to not coach your niece meaning do not put words in her mouth. In my opinion your questions should be direct and simple.
You need to weed out the real issues that are at play.
Know that you are obligated to protect your daughter and your niece so you have every right to question what is happening in your home, with your child and with the children that are under your care.
Your next step would be addressing this matter with your sister for she is the mother.
FYI: Your sister may be willing to work with you on this or she may be on the defensive. Regardless of her reaction your goal is the safety and well-being of your child, niece/nephew and getting answers and solutions that you feel comfortable with.
If you learn that your niece has behavioral issue and that her issues are not from a more serious matter. You need to take control of the situation by either limiting the private time the kids spend with your child, and or by placing firm rules down for them and how they are to act and behave in your home and around your child.
I'm going to throw this out to you....
If you feel your niece has experienced the worse case scenario like some type of personal violation. That in itself is a whole different matter and needs to be addressed with great care.
Remember kids are resilient especially if that type of serious matter is looked into and addressed with care and concern for all parties involved.
Good Luck