When gossip or a story is being passed around, being told to one person, who retells it to another, and with each re-telling the story is changed slightly, until by the last re-telling it has changed almost beyond recognition of the original story.
Guy 1: Dude, John just told me about that girl and the guy from down the hall having sex in the closet!
Guy 2: No dude that never happened! He just grabbed her boob accidentally outside of the closet. That's a serious chinese whisper effect!