Why the hell would you be thinking about telling your parents?! Your poor sister - don't do that she'd be mortified! Does she know that everyone has seen it?
I don't think you should tell her off for what she did either or take the moral highground and get all self-righteous about it. She's paying the price now, don't make it worse. She's probably quite upset about this (if she knows that it's being circulated). This is your chance to be the cool older brother and be supportive, not act like a cock and make her feel worse.
It is child porn (technically). If I were you I'd let the guy know that every copy has to be deleted and nobody else will ever see it again - otherwise you're going to the police and getting him charge with distributing child pornography. There's no need to actually go to the police, but it might make it stop.