Player 2 did not declare defenders (he couldn't), so yes, one of player 2's heroes will take all the damage.
If player 1 already defended, I think that player 2 engaging the Nazgul would be a bad idea, but I would extrapolate that instead of being defended by player 1, it becomes undefended by player 2.
Once player 1's enemies finish attacking him, player 2's enemies will attack him, including the Nazgul (again) in this case. There aren't two combat phases in a row, the first Nazgul attack came during the part of the combat phase where enemies attack player 1. The rules state that you repeat the combat steps "for each enemy that [you are] engaged with." Thus, it doesn't matter that the Nazgul already attacked player 1. It is engaging player 2 during the time when enemies attack player 2, thus it attacks.
Finally, shadow cards attach to an enemy, so if the enemy moves after step 2, so does its shadow card, which will then be revealed in step 3.
Presumably, if you moved the Nazgul after step 1, the second player would then have the opportunity to declare one of HIS defenders, since it moved before the "Declare Defenders" step.
P.S. I'm using male pronouns because that's what the game does. I in no way want to disparage any female gamers. What I wouldn't give for English to have a non-awkward, gender-neutral, singular personal pronoun. Sigh...
