It is early in Act 1, Scene 2 that Touchstone says the line, "The more pity, that fools may not speak wisely what wise men do foolishly" (86-87). What he is saying here is that it is a pity that a he as a court jester is not allowed to speak wisely about the things that allegedly wise men do foolishly. What's important to note is that, culturally, as part of their means of entertaining, court jesters were the only ones at court who were permitted to openly criticize their masters and other members of nobility. We frequently see Feste openly criticize both Lady Olivia and Duke Orsino in Twelfth Night. But what's interesting here is that, based on Celia's response, apparently Duke Frederick, who usurped Duke Senior, has forbidden the court jester from openly criticizing him, probably out of guilt and self-consciousness. We see Celia state that Touchstone has been silenced from making the comic, critical observations that would be typical of his role as a court jester in her lines:
By my troth, thou sayest true; for since the little wit that fools have was silenced, the little foolery that wise men have makes a great show. (88-91)
It's also important to note that when Touchstone made his ironic statement about being forbidden to comment on the foolish actions of those who are supposed to be thought of as wiser than fools, he, Celia, and Rosalind had been speaking of Duke Frederick. Touchstone had made a joke about one of Duke Frederick's knights, calling him dishonorable, especially because Duke Frederick loved him. Celia, who we know has no respect for her father, makes the ironic argument that her father's love is enough to prove that the knight is honorable. Celia's line is especially ironic because, in a conversation about honesty, she is speaking dishonestly about her own father. She knows full well that her father is a dishonorable man and that any one he loves will also be dishonorable, as evidenced by the fact that she does not hesitate to leave his court the moment he sentences Rosalind to join her own father in banishment; hence, she is only saying this reply to Touchstone to protect herself from any consequences that could ensue from slandering her father and warning Touchstone not to slander him as well.
All in all, Touchstone's line in question is a philosophical statement about foolish actions, especially Duke Frederick's foolish actions, and the entire conversation is about honesty and the dishonorableness of Duke Frederick's actions.