A packet sniffer, sometimes referred to as a network monitor or network analyzer, can be used legitimately by a network or system administrator to monitor and troubleshoot network traffic. Using the information captured by the packet sniffer an administrator can identify erroneous packets and use the data to pinpoint bottlenecks and help maintain efficient network data transmission.
In its simple form a packet sniffer simply captures all of the packets of data that pass through a given network interface. Typically, the packet sniffer would only capture packets that were intended for the machine in question. However, if placed into promiscuous mode, the packet sniffer is also capable of capturing ALL packets traversing the network regardless of destination.
By placing a packet sniffer on a network in promiscuous mode, a malicious intruder can capture and analyze all of the network traffic. Within a given network, username and password information is generally transmitted in clear text which means that the information would be viewable by analyzing the packets being transmitted.
A packet sniffer can only capture packet information within a given subnet. So, its not possible for a malicious attacker to place a packet sniffer on their home ISP network and capture network traffic from inside your corporate network (although there are ways that exist to more or less "hijack" services running on your internal network to effectively perform packet sniffing from a remote location). In order to do so, the packet sniffer needs to be running on a computer that is inside the corporate network as well. However, if one machine on the internal network becomes compromised through a Trojan or other security breach, the intruder could run a packet sniffer from that machine and use the captured username and password information to compromise other machines on the network.
Detecting rogue packet sniffers on your network is not an easy task. By its very nature the packet sniffer is passive. It simply captures the packets that are traveling to the network interface it is monitoring. That means there is generally no signature or erroneous traffic to look for that would identify a machine running a packet sniffer. There are ways to identify network interfaces on your network that are running in promiscuous mode though and this might be used as a means for locating rogue packet sniffers.
If you are one of the good guys and you need to maintain and monitor a network, I recommend you become familiar with network monitors or packet sniffers such as Ethereal. Learn what types of information can be discerned from the captured data and how you can put it to use to keep your network running smoothly. But, also be aware that users on your network may be running rogue packet sniffers, either experimenting out of curiosity or with malicious intent, and that you should do what you can to make sure this does not happen.