Grammatically, the two options you mentioned would be possible. Even in English, the translation is; It is embarrassing, isn't it? So, simply by looking at the above sentence, people would not be able to understand what (or who) is embarrassing (embarrassed). However, in terms of the general sense, the first option would be most likely. She felt herself that she was embarrassed because you were there. ね sounds that she asked your agreement and this is quite casual. So, I personally feel that she did not take this seriously.